Wendy's Moves to Seize 314 Restaurants From Bankrupt Franchisee

Wendy's is demanding control of 314 restaurants operated by Meritage Hospitality Group, arguing in court documents that the bankrupt franchisee has "no rights" to run the locations because its franchise agreements were terminated before the filing.

The fast-food chain says Meritage defaulted on its franchise agreements last year and owes $27.4 million in unpaid royalties. Wendy's granted the franchisee an extension on those payments, but the extension expired in August. Meritage never paid. Wendy's terminated the franchise agreements earlier this month, and Meritage filed for bankruptcy this week in response.

"In reality, debtors have no rights to operate because [Wendy's] properly terminated the franchise agreements pre-petition," Wendy's said in its filing. The company added that Meritage holds "no continuing franchise rights" and "should not be authorized to conduct any business activity pursuant to the terminated franchise agreements."

The filing positions Wendy's to reshape the outcome of the bankruptcy. The franchisor is suggesting the restaurants should either revert to Wendy's or be sold to other franchisees. Meritage operates 314 Wendy's locations, mostly across the Midwest and South.

Wendy's acknowledged that a transfer would not happen overnight. If its effort succeeds, Meritage "will need a short period of time to transition the restaurants to Wendy's or other franchisees," the company said in its filing. In that scenario, Wendy's said it is "willing to consider" granting a temporary license to operate the restaurants under the same terms as the old agreement.

The dispute sets up a contentious battle over the operator's future. Meritage carries roughly $155 million in secured debt, most of it owed to City National Bank. Secured lenders typically stand first in line for repayment in a bankruptcy. But franchisors control the franchise agreements, which effectively give them leverage over who operates the restaurants going forward — a structural advantage that could trump the lenders' seniority in determining the outcome.

A second fight is brewing over restaurant closures. The U.S. Bankruptcy Trustee is objecting to a plan to close up to 40 Meritage restaurants in the coming weeks, arguing the closures are "not in the ordinary course" of business and calling the request to close the restaurants "extraordinary." The first stores could shut their doors as early as this week.

"While the U.S. Trustee understands the need to ensure the debtors' operations are economized to increase profitability, the schedule proposed deprives the court and interested parties of the opportunity to review and evaluate the advisability of the proposed closings," the trustee said in its filing.

The stakes are considerable. The case will test whether a franchisor can use pre-petition terminations to reclaim hundreds of locations from a bankrupt operator — and how much say secured lenders like City National Bank have when the brand itself controls the operating rights.