Case Study #2.

Let’s take a look at how the SBRA works in a situation of a hypothetical California restaurant owner with the following financial circumstances.  In this blog, we do cover a lot of financial data quickly.  Don’t worry about taking notes, the full text of this presentation can also be reviewed in the written blog section of the website.

  1. Owner owns a home. There are two mortgages against it. First mortgage of $300,000. A second mortgage of $200,000. 15 year loan. The home is worth $400,000. The entire $200,000 loan was put into the business.
  2. The restaurant has a contract to purchase equipment.  Original contract: $150,000, 84 months at 12%. $105,848 owed with 57 months left on the contract.  Equipment only worth $20,000. 
  3. Five years ago, owner entered into a 10 year lease at two dollars per square foot. The space is currently renting for four dollars per square foot. Because of Covid shut down orders, owner is six months behind on his $5000 a month rent.
  4. Restaurant leases furniture.
  5. Owner received an emergency SBA loan of $150,000 six months ago. 45 days ago, owner paid Discover credit card $75,000 on a pre-existing credit card debt. 100 days ago, owner repaid his brother $50,000 but then borrowed from brother again $40,000.
  6. Owner has $100,000 in other credit card debt.

Owner’s monthly payments:

  1. Monthly payment on the first mortgage $1800. Monthly payment on the second mortgage $1688.
  2. Equipment purchase contract:  Monthly payment: $2,933. Interest rate: 12%. Current balance: $105,848. Remaining months: 57. Equipment value: $20,000.
  3. Space Lease 1: $5000 a month.
  4. Furniture lease: $750 a month.
  5. SBA loan monthly payment $1266.
  6. Credit cards. Monthly payment: $1501. Interest rate: 15%. Current balance: $100,000. Remaining months: 144.

Total monthly payments: $14,938.

Total debt: $855,848 plus $30,000 in past due rent plus the $75,000 that will be owed once again to Discover since Discover will have to disgorge the payment received as it was an avoidable preferential payment. Total: $960,848.

Now, let’s apply the rules under the SBRA.  And remember, these are rules, not wishes or starting points for negotiation.  They are rules. 

Owner’s new monthly payments:

  1. Let’s start with the home loans.  Because the house is worth less than the combined value of both loans, the second mortgage can be bifurcated into secured and unsecured portions. $100,000 of the second mortgage is secured. $100,000 is unsecured. Because the loan was used entirely for the business, the SBRA says that the terms of the loan can be modified. So we would propose modifying it as follows:  The unsecured portion of the second mortgage, $100,000, would be relegated to the pool of creditors that includes the SBA loan of $150,000 and the credit cards of $100,000.  The total unsecured debt, then, equals $350,000. For purposes of this hypothetical case study, assume that these unsecured creditors only receive $75,000 through the plan. We would propose modifying the $100,000 portion that is still secured as follows: extending the payment term to 30 years in reducing the interest rate to 3%.
    1. Monthly payments.
      1. Old monthly payment on the first and second: $3488.
      1. New monthly payment: $2222.
      1. Monthly savings: $1266
    1. Total debt.
      1. Original debt amount: $500,000.
      1. New amount owed: $400,000.
      1. Amount of debt reduction: $100,000 minus this debts share of the pool of money for unsecured creditors: $17,647. Total debt reduction $82,352.
  2. Equipment purchase contract.  Under the SBRA, amount owed on secured debt is reduced to the value of the equipment, interest rate at 6% and the payment term can be extended.  Applying these rules,
    1. monthly payments.
      1.  Old monthly payment: $2933.
      1. New monthly payment: $387. 60 months.  $20,000 owed.
      1. Monthly savings: $2545.
    1. Total debt.
      1. Original debt amount: $105,848.
      1. New amount owed: $20,000.
      1. Amount of debt reduction: $85,848 of debt wiped out.
  3. Space Lease: Under the SBRA, the owner can choose to assume, assume and assign or reject a lease. Although the owner could sell the lease, the owner wants to stay in the present location. Owner elects to assume the lease. Immediately after filing, motion filed asking the court to do three things: defer rent for 60 days; have the deferred rent of $10,000 treated as an administrative expense, paid over five years; and, have the six months of past due rent due to Covid forgiven on the grounds of force majeure, impossibility of performance and frustration of purpose. All requests granted.
    1. Monthly payment: $5000.
    1. Principal reduction: the $30,000 of past due rent forgiven after bankruptcy court judge applies state law and finds that since the restaurant owner could not generate income due to the pandemic and governmental action, payment of rent is excused for those six months.
  4. Furniture lease:  Owner elects to reject this lease. No further amounts owed.
    1. Old monthly payment: $750.
    1. New monthly payment: zero.
    1. Savings: $750.
  5. Credit cards, unsecured portion of home loan and the SBA loan.  Unsecured creditors. They will share pro rata in the $75,000 that Discover pays back since the payment to discover was not only a preference it was also an avoidable preference.
    1. Original monthly payments:
      1. Credit cards: $1501.
      1. SBA loan: $1266.
      1. Payment attributed to $100,000 bifurcated second mortgage: $844.
      1. Total: $3611.
    1. New payment through reorganization plan: $625. Plan calls for payment of the $75,000 over 10 years.
    1. Monthly savings: $2986.
    1. Original debt: $350,000. Add in the $75,000 increase to the amount owed to Discover credit card after they disgorge the preferential payment for a total of $425,000. Amount paid to all unsecured creditor $75,000.
    1. Total debt savings: $350,000.
  6. The preferential payments. The payment to discover of $75,000 was a preference. It was a lump sum payment on a pre-existing debt. No new value was received. The payment was not in the ordinary course of business. No other defense applies. Discover will be required to disgorge this money. This will be the pool of money from which the unsecured creditors are paid pro rata. The payment to brother was also a preferential payment. However, since client reborrowed $40,000, that money would be considered new value reducing the preferential payment to $10,000. The costs of litigating to get the $10,000 back exceed the benefit. Decision made not to seek recovery of the $10,000.

In sum, then, the reorganization plan would result in the following savings:

  • Principal reduction:
    • Home loan principal reduction: $82,352.
    • Equipment loan principal reduction: $85,848.
    • Unsecured debt principal reduction: $350,000.
    • Rent forgiveness: $30,000
    • Total principal reduction: $548,200.
  • Monthly payment reduction:
    • Monthly payment before reorganization under the SBRA: $14,938.
    • Monthly payment after reorganization: $8235.
    • Monthly savings: $6703.

Imagine the restaurant owner’s personal income from the business and net equity when the debt payments and amounts remain the same and restaurant income goes back up.

To find out more about the other powerful tools available under the SBRA to protect a business you enjoy and a way of life that you have worked hard to achieve, sign up to attend one of our webinars or call to schedule an appointment to discuss the particulars of your case. The initial consultation, up to one hour, is at no charge. The webinars are free, and include a 20 minute question and answer session at the end.  We would also refer you to the blog and video blog sections of our website for discussions on other topics and points of interest, including case studies where we apply the individual principles covered in these building block videos to real life fact patterns.

Picture of Steven E. Cowen, Esq.

Steven E. Cowen, Esq.

Attorney Steven E. Cowen attended the University of San Diego School of Law, graduating at the top of his class, cum laude, in 1987. He was also a member of the law review. Mr. Cowen is a member of the State Bar of California and a member of the National Association of Consumer Bankruptcy Attorneys. He is fluent in English and Spanish. Steve has successfully handled over 2,000 bankruptcy cases in Southern California.

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