13. COMMITMENTS AND CONTINGENCIES

Indemnification Agreement and Tail Policy

On March 25, 2020, in connection with the Merger, Chanticleer, Sonnet and Amergent entered into an indemnification agreement (“Indemnification Agreement”) providing that Amergent will fully indemnify and hold harmless each of Chanticleer and Sonnet, and each of their respective directors, officers, stockholders and managers who assumes such role upon or following the closing of the Merger against all actual or threatened claims, losses, liabilities, damages, judgments, fines and reasonable fees, costs and expenses, including attorneys’ fees and disbursements, incurred in connection with any claim, action, suit, proceeding or investigation, whether civil, administrative, investigative or otherwise, related to the Spin-Off business prior to or in connection with its disposition to Amergent. The Indemnification Agreement expires on March 25, 2026.

In addition, prior to closing of the Merger, the Spin-Off entity acquired a tail insurance policy in a coverage amount of $3.0 million, prepaid in full by the Spin-Off entity, at no cost to the indemnitees, and effective for at least six years following the consummation of the disposition, covering the Spin-Off entity’s indemnification obligations to the indemnitees (referred to herein as the “Tail Policy”). No claims have arisen to date, and the Company does not anticipate that any potential liability would exceed the insured amount.

Legal Proceedings

Litigation related to leased properties

During 2022 and 2021, the Company was in arrears on rent due on several of its leases. As a result, the Company has pending litigation related to seven sites of which four have permanently closed. The outcome of this litigation could result in the permanent closure of additional restaurant locations as well as the possibility of the Company being required to pay interest and damages, modify certain leases on unfavorable terms and could result in material impairments to the Company’s assets. The Company has four judgements against it in the amount of $0.8 million for defaulting on leases. See Leases section below for discussion of past due rent on abandoned locations.

No amounts in addition to contracted rent that is due have been accrued as of December 31, 2022 or 2021 in the accompanying consolidated balance sheets as management does not believe the outcome will result in additional liabilities to the Company; however, there can be no guarantees.

During 2022, our LBB locations were notified by the Department of Labor (“DOL”) of an audit concerning tip pools at 15 of our LBB stores in and around Portland, OR metropolitan area. In January 2023, the DOL reported that its audit resulted in one significant finding, that the Company improperly permitted “supervisory” in-store employees to participate in the tip pool. DOL assessed a penalty of approximately $972,000 (equal to $486,000 in inappropriately paid tips multiplied by two pursuant to the statute’s liquidated damages provision). DOL offered to reduce that number in half to $486,000. The Company has fought back against the finding, asserting that the alleged supervisors did not have sufficient supervisory responsibility to be deemed a “supervisor” under the statute. Currently, settlement discussions are in progress. DOL has reduced its amount to just under $170,000. The Company has offered $25,000 to resolve the matter. It is difficult to predict at what amount the case may resolve. If it does not resolve, DOL can choose to file the case in litigation or send right-to-sue letters to each impacted employee and former employee. Currently, we do not believe it is likely that DOL will pursue litigation, having indicated that they would be discussing that option and opting not to pursue anything at this time. If the case were to proceed to settle, we expect it would do so between the $25,000 and $170,000 amounts currently on the table. The Company has recorded a charge of $25,000 as management believes this is the most likely outcome.

From time to time, the Company may be involved in other legal proceedings and claims that have arisen in the ordinary course of business are generally covered by insurance. As of December 31, 2022, the Company does not expect the amount of ultimate liability with respect to these matters to be material to the Company’s consolidated financial condition, results of operations or cash flows.

Leases

The Company’s leases typically contain rent escalations over the lease terms. The Company recognizes expense for these leases on a straight-line basis over the lease terms. Additionally, tenant incentives used to fund leasehold improvements are recognized when earned and reduce our right-of-use asset related to the leases. These incentives are amortized through the right-of-use asset as reductions of expense over the lease terms.

Some of the Company’s leases include rent escalations based on inflation indexes and fair market value adjustments. Certain leases contain contingent rental provisions that include a fixed base rent plus an additional percentage of the restaurant’s sales in excess of stipulated amounts. Operating lease liabilities are calculated using the prevailing index or rate at lease commencement. Subsequent escalations in the index or rate and contingent rental payments are recognized as variable lease expenses. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. As part of the lease agreements, the Company is also responsible for payments regarding non-lease components (common area maintenance, operating expenses, etc.) and percentage rent payments based on monthly or annual restaurant sales amounts which are considered variable costs and are not included as part of the lease liabilities.

Related to the adoption of Leases Topic 842, our policy elections were as follows:

Short-term policy

The Company has elected the short-term lease recognition exemption for all applicable classes of underlying assets. Leases with an initial term of 12 months or less, that do not include an option to purchase the underlying asset that the Company is reasonably certain to exercise, are not recorded on the balance sheet.

Supplemental balance sheet information related to leases was as follows (in thousands):

SCHEDULE OF OPERATING LEASE INFORMATION

Lease term and discount rate were as follows:

As of December 31, 2022 and 2021, we performed an analysis of the recoverability of our right-of-use assets. Based on the analysis, we recorded an impairment of approximately $1.8 million and $0.7 million for the years ended December 31, 2022 and 2021, respectively, which is included in asset impairment charges in our consolidated statements of operations. The impairment recognized during the year ended December 31, 2022 was primarily the result of changing consumer habits resulting in poor performance and the ultimate closure of certain stores, and the impairment recognized during the year ended December 31, 2021 was primarily the result of the impact of the COVID-19 outbreak in the United States, which had a significant impact throughout the hospitality industry. Negative impacts to the operating results and cash flows varied significantly at the store level, where some stores operated at a reduced capacity and several stores were permanently closed.

During the years ended December 31, 2022 and 2021, approximately $0.3 million and $0.4 million, respectively, of lease liabilities were derecognized due to the Company negotiating the cancellation of its obligations under certain lease agreements, which is included in gain on extinguished/settled lease liabilities in our consolidated statements of operations. The cancellations resulted from the COVID-19 pandemic. As of December 31, 2022 and 2021, the Company had lease liabilities of $6.8 million and $3.1 million, respectively, related to abandoned leases. These lease liabilities are included in current operating lease liabilities, accrued expenses and accounts payable in our consolidated balance sheets.

During the year ended December 31, 2022, the Company amended certain leases and changed its assumptions regarding the exercise of a renewal option, which have been accounted for as lease modifications. The operating lease assets and liabilities were remeasured at the modification dates, resulting in an increase of $0.6 million during the year ended December 31, 2022 to both the right-of-use assets and lease liabilities. There were no lease modifications during the year ended December 31, 2021.

Rent expense of approximately $2.6 million and $2.4 million was incurred during the years ended December 31, 2022 and 2021, respectively, of which approximately $0.1 million was variable in each year.

Maturities of our operating lease liabilities as of December 31, 2022 are presented below (in thousands):

SCHEDULE OF MATURITIES OF OPERATING LEASE LIABILITIES

Certain additional amounts of lease liabilities for leases in default have been presented as current liabilities. The above schedule reflects the original contractual maturities.

PPP Loan

As discussed in Note 9, the Company received two PPP loans totaling $4.1 million, which were established under the CARES Act and administered by the U.S. SBA. On November 15, 2022 and December 16, 2022, the Company received notice from the SBA that the first and second PPP loans, respectively, had been fully forgiven with accrued interest.

Presently, the U.S. SBA and other governmental communications have indicated that all loans in excess of $2.0 million will be subject to audit and that those audits could take up to seven years to complete. If the U.S. SBA determines that the PPP loans were not properly obtained and/or expenditures supporting forgiveness were not appropriate, the Company would need to repay some or all of the PPP loans and record additional expense which could have a material adverse impact on the business, financial condition and results of operations in a future period.

RRF

As discussed in Note 4, Pie Squared Holdings received an approximately $10.0 million grant under the RRF, and the Company assumed the risks and rewards related to the grant through the acquisition of Pie Squared Holdings. If it is determined that Pie Squared Holdings obtained the grant improperly or the disbursement of such grant monies was not for “eligible uses,” then the Company would be responsible for the ramifications of such actions including the repayment of the $10.0 million of grant monies, among other items.