What lies ahead for New York city restaurants: a navigational framework for surviving the pandemic
While every sector will face challenges from the all but certain impending recession, the restaurant and bar industry in New York City is uniquely challenged going forward. Few industries inherently depend on human gathering in the way that the restaurant industry does. Restaurants were forced by the city & state governments to discontinue on premises food and beverage service and thereby deprived the vast majority of their normal revenue. Additionally, the existence of restaurants and bars as places for gatherings of the public to eat and drink, directly contradicts the recommendations of health agencies to keep a 6-foot distance between people.
The Paycheck Protection Program
Those fortunate business owners who were able to complete their application for a loan under the federal Paycheck Protection Program (“PPP”) before the $349 billion was completely depleted have taken an important step towards mitigating the imminent economic despair. The hastily created program, however, poorly serves the restaurant industry in a few ways.
The program allowed for loans to businesses up to 2.5 times one month of their payroll. These loans can be entirely forgiven if the borrower (1) maintains the number of employees it had in 2019 (a 12-month average); (2) maintains the salaries for its employees and (3) spends 75% of the funds received through the loan towards compensation of employees. If you have fired some or all of your employees since you were forced to discontinue on premise service, you can rehire to the 2019 number by June 30, 2020 in order to meet the first requirement. If you fail to meet the requirements, though, the loan will not be forgiven, and your business will be required to pay all or a prorated amount of the loan at 1% interest which must be paid in two years.
While the intentions of the legislation were noble, its requirements were shortsighted and ill-suited for restaurant owners for several reasons.
First, restaurants - more so than most industries - will not be back in operation any time soon. The New York State governor has extended the directive that restaurants limit their transactions to takeout and delivery until at least May 15. There is no realistic way that most restaurants can be expected to return their staff to 2019 numbers by June 30, 2020.
Even in the unlikely case that the state lifts its ban of on-premise service by May 15th, the general public will almost surely be hesitant to frequent restaurants as they did prior to the pandemic. Whenever New York State does lift the ban, that will likely come with rigid occupancy limitations which will further prevent restaurants from operating at anything close to 2019 capacity.
Secondly, even if restaurants were in a position to rehire their staff on June 29, 2020, if they have not spent 75% of their loan funding on salaries, the loan will not be entirely forgiven. Given that the loan amount was a calculation of 2019 monthly salaries, and given that the doors will likely be closed to on premise service through May (and perhaps through June or all of summer), restaurants could only put 75% of the funds towards payroll if they paid employees for staying home. This is a lot to ask of restaurateurs who will face numerous other financial demands -- most significantly from their landlords.
While Congress is currently debating the parameters of an additional $450 billion PPP infusion, one simple change the Small Business Administration (“SBA”) could make is to reduce or even eliminate the requirement that 75% of the funds are spent on payroll. The SBA has the authority to reduce and arguably even eliminate the requirement without the permission of Congress, as that requirement is not in the statute but was subsequently implemented as a regulation.
Again, the intentions of the legislation were principled, but the statute’s effect on the food and beverage industry highlights how some sectors are better suited for its requirements than others and that the elimination or reduction of the 75% requirement would better serve the business owners allowing them to remain in business following the pandemic and remain as employers in the future.
Rent and Other Lease Obligations
The largest expense of a restaurant’s budget is rent and the majority of the calls I received in the week leading up to April 1, sought advice as to what restaurants were expected to pay on the first of the month. While clients consistently asked what to tell their landlords, universally, they lacked the ability and had no intention of writing a check on the first of the month. Possible arguments to be made in defense of a landlord’s action regarding your lease may include the doctrines of impossibility & force majeure defenses; the application of force majeure to the COVID-19 pandemic is fraught with nuances and should be explored with the assistance of counsel.
Furthermore, the practical realities of this unprecedented and complete halt on the economy, demand that landlords engage with restaurant tenants discussing some forgiveness of rent during this period.
Despite the familiar “greedy landlord” cliché, and the lack of balance in most leases, the vast majority of building owners in New York City are rational business people, aware of the current state of affairs and understand that irrespective of any government intervention everyone, including building owners are going to have to sacrifice for their own long-term survival.
If the landlords take a rigid stand and seek to evict each of their commercial tenants that have failed to pay, they will encounter an inefficient court system which will most certainly be more favorable to tenants; they will find their portfolios have become primarily vacant and that there is an insufficient market of entrepreneurs willing to invest the startup costs of a new restaurant to fill those spaces.
While many New York City landlords have been prepared, in the past, to withstand a number of vacancies as they held out for the rent they demanded, they have been willing to do this while the value of their Manhattan and Brooklyn buildings continued to increase at exponential rates. Those rates of increase will simply not continue in the short and medium term. They were also able to withstand such vacancies – in the Soho neighborhood for example– because they could rely on the revenue they took in from their myriad other properties. So, with the potential level of restaurant failures on the horizon, Manhattan and Brooklyn building owners will simply not have that luxury. Landlords are forced to recognize that the most rational option is a good faith temporary renegotiation of the terms of the lease, or some other reprieve.
While discussions between landlords and tenants will be necessary, government intervention at the local, state and federal levels remains indispensable to mitigate the effects of the recession. It remains unsettled what form government intervention will take, but the general framework will likely include federal assistance to the banks allowing for forgiveness of mortgages, allowing landlords to accept the mandatory forgiveness of unpaid rent.
Although the possible benefit of federal legislation will not eliminate restaurant owners’ current challenges, it is incumbent upon you, the restaurateurs, and their counsel, to monitor the efforts of the government.
We recommend you contact organizations like the National Restaurant Association, which is currently advocating for the restaurant industry to the different levels of government. Your support of such associations will strengthen their influence during the debates on pending legislation. I also urge you to contact our firm to discuss a strategy going forward.