Retail Bankruptcy Issues in 2020: What You Need to Know
It’s a new year, the time of fresh starts and big dreams, but the “retailpocalypse” doesn’t seem to have taken notice. Earlier this week, Pier 1 Imports announced plans to close up to 450 locations—nearly half of its 942 stores—conduct layoffs, and cut expenses. According to Bloomberg, Pier 1 is preparing for Chapter 11 bankruptcy.
If Pier 1 files for Chapter 11, it will become just the latest in a long string of retail restructurings and liquidations that have taken place over the last several years. At a time of growth in the overall economy, there were 23 major retail bankruptcies in 2019 (including brand names such as Gymboree, Barney’s New York, and Forever 21), compared with 17 in 2018, according to CB Insights.
Issues Impacting Retailers
There are many factors that have contributed to distress across the retail landscape. One of the most significant is the seismic shift in consumer behavior over the last decade. The rise of e-commerce, generally, and the dominance of Amazon, in particular, have wreaked havoc with the business models and balance sheets of traditional brick and mortar retailers.
Traditional retailers are parties to expensive leases in shopping malls and other retail centers that are seeing less foot traffic. On the other hand, Amazon and other online retailers are able to invest in warehousing, distribution, and logistics in order to cater to customers who increasingly prefer to shop from the comfort of their own homes.
Lower revenue and burdensome real estate expenses are contributing to the wave of retail bankruptcies, particularly for those retailers (and there are many of them) who are servicing large amounts of debts. Over the last two decades, a number of retailers were acquired through leveraged buyouts led by private equity firms. These transactions saddled retailers who were taken private with large, and, in many cases, unsustainable debt loads. For example, in 2005, Toys “R” Us was acquired by a syndicate of private equity firms in a leveraged buyout. Toys “R” Us had approximately $2 billion in debt pre-acquisition, and $5 billion in debt post-acquisition. In 2017, Toys “R” Us filed for bankruptcy.
Retail Restructuring Options
Chapter 11 bankruptcy offers a corporate debtor a “breathing spell” and opportunity to reorganize. For most retailers, one of the most important benefits of Chapter 11 is the opportunity to evaluate the business’ portfolio of real property leases and determine which ones to either assume or reject. Leases related to underperforming stores can be rejected and damages are treated as general unsecured claims. By eliminating underperforming stores and limiting the financial fallout from doing so, a retail business should be in a better position to reorganize and emerge from Chapter 11 as a leaner and more profitable business.
In reality, retailers have struggled to effectively reorganize in bankruptcy. According to a study conducted by Alix Partners in 2016, 55% of all retail bankruptcy cases result in liquidation. One of the reasons for high liquidation rates is that, following the 2005 amendments to the Bankruptcy Code, retailers have less time (210 days to be exact) to make the decision to assume or reject leases. As a result, lenders—who control the purse strings via DIP financing—often push debtors to decide whether to liquidate or reorganize quickly so that underperforming store liquidation sales can be conducted prior to the 210-day assume/reject deadline. The “decision” often equates to a lender mandate to pursue a path that results in liquidation. There is simply not enough time to fix the business if the senior lenders determine that liquidation can make them whole (or close to it).
For a struggling retailer, Chapter 11 is not the only option—another path is to pursue an assignment for the benefit of creditors (“ABC”). An ABC is an insolvency proceeding governed by state law rather than federal bankruptcy law. In some states, the right to pursue an ABC is rooted in the common law, in others it’s governed by statute. In Michigan, MCL § 600.5201 sets forth the procedural requirements for a company making, and an assignee accepting, an assignment for the benefit of creditors.
Generally speaking, in an ABC, a company (the assignor), transfers all of its rights, title, and interest in its assets to an independent fiduciary (the assignee). The assignee then liquidates the assets and distributes the net proceeds to the company’s creditors.
Unlike a federal bankruptcy proceeding, which can be time-consuming, expensive, and involves lots of oversight, a common law ABC allows for flexibility and quick action. While an ABC may not be appropriate for a massive retail case of the variety we’ve addressed previously in this article, under the right circumstances it can be an effective tool for a retail business. Case in point: We recently led an ABC process for a retail business in Michigan that concluded in a going-concern sale of the business.
There is no end in sight for the “retailpocalypse.” Accordingly, retailers, as well as their lenders, suppliers, and landlords need to be thinking about the options available to them should reorganization or liquidation become necessary.
If you have any questions, please contact David Dragich at firstname.lastname@example.org or 313.886.4550.