Friday, March 23, 2018

Is the Retail Apocalypse Overstated? (How to Deal with a Retail Bankruptcy)

By Bill Siegel

There were just shy of 7,000 store closures of major U.S. retail chains in 2017.  Many of these closures were skewed toward apparel retailers and regional malls.  Yet, there are positive signs.

  • Regional malls, which were once heavily weighted with apparel retailers, are now becoming more diversified, offering grocery stores and mixed-use space including entertainment and leisure.

  • Strip centers are showing positive results by replacing apparel with grocery and low-cost retail. 

  • High-end regional malls are increasing their occupancies with leisure and premium retail, despite an increasing number of retail-related bankruptcies.


Even though there are analysts who say that e-commerce has largely impacted the brick and mortar stores, other analysts say that some of this recent market contraction is healthy in light of the fact that retail had greatly over expanded in the past decade and supply significantly exceeded demand.  The good news is that sales from brick and mortar stores have increased in some outlets:  average retail sales per store and average sales per square foot across the U.S. rose last year.

Less is More?

Maybe the solution for the brick and mortars is less (fewer tenants) with more diversity.  Even if this is the solution, there are risks.  Many of these brick and mortars carry significant debt loads, which may need to be restructured -- hopefully with consent of their lenders and vendors.  The restructuring may require a conversion of all or a portion of the debt, especially the financing portion, into equity.  It all remains to be seen.

Large box retailers like Macy's, Sears and J.C. Penney, have restructured and downsized by closing stores and cutting costs.  A number of specialty retailers are currently negotiating with creditors and already have or will file bankruptcy.  Some of the bankruptcies will result in consensual plans of reorganization approved by the bankruptcy court, some will result in liquidation, and others will result in the retailer being sold as a going concern to third parties.

What to Anticipate with Bankruptcies

Though the market has changed, many of these bankruptcies such as Toys “R” Us and Claire’s are carrying too much debt as a result of prior years’ leveraged buy-outs, and/or over expansion financed by debt.  Thus, these big box retailers are unable to adjust to the disruption, whether from loss of sales, carrying too much debt, or both.  If they are lucky, they can convince their lenders, who are holding secured or unsecured claims, to restructure the debt.  In some instances, these lenders will convert all or a portion of their debt into equity, especially if the debt is unsecured.

To accomplish this task, creditors may require that the retailer file bankruptcy, so that the restructuring efforts are supervised by a bankruptcy court.  If the parties cannot agree, or the retailer is unable to confirm a plan of reorganization over the objection of certain classes of creditors, then in all likelihood, the retailer will have no choice but to:

  • liquidate in a Chapter 11 bankruptcy pursuant to a liquidation plan, or

  • convert the case to a Chapter 7 liquidation, with a Chapter 7 trustee being appointed to oversee the liquidation.


In many of the retail bankruptcies, the retailers are either trying to remain as a going concern and simply restructure their debts or to market themselves as a going concern to third parties. Under either scenario, the retailer will choose to assume the leases it (or the purchaser) desires to retain and reject those leases of underperforming stores.

What Landlords Should Understand

In instances where the leases may be assumed and assigned, or remain with the reorganized retailer, landlords may be requested to renegotiate the lease terms.  Depending on the market and the landlord’s ability to find a replacement tenant, the landlord may have no choice but to restructure the lease.  If the retailer is proposing to assume the lease and/or assume and assign the lease to a third party, the bankruptcy court can order such assumption and/or assignment -- subject to the landlord receiving “adequate assurance of future performance.”  

Adequate assurance is a term of art in bankruptcy.  Under these circumstances, the landlord should demand that all defaults be cured and for “adequate assurance” that the purchaser can perform under the lease.  Sometimes this means requesting an additional security deposit or a letter of credit securing future performance.  Ultimately, it all depends on the market and how much leverage the landlord has.  Even when being requested to restructure the lease, there may be certain bank covenants that limit the landlord’s ability to restructure the lease, or that may require the lender’s consent.

In instances where the retailer is filing bankruptcy to shed underperforming leases, the retailer will seek an order to reject those leases.  The rejection constitutes a breach of the lease and results in damages that are capped by the Bankruptcy Code.  

Whether prior to or during the bankruptcy process, assuming the market is soft and the retailer is a draw to the mall or shopping center, landlords should be encouraged to renegotiate.  Again, there may be limits on the landlord’s ability to meet the retailer’s demands.  In other instances the landlord may want other creditors (especially lenders of the landlord) restructure their debt. At the end of the day, it’s a team effort.

In instances where the retailer is simply liquidating, there is little if anything the landlord can do but to market the property and file a claim in the bankruptcy court for damages.  In fact, one can only look at Toys “R” Us as an example.  Toys “R” Us operated more than 700 stores in the U.S.  The company’s liquidation will cause millions of square feet of space to open up in a market flooded with vacancies. The success of landlords to fill this space may very well depend on location.

Impact for Vendors and Suppliers

Vendors and suppliers are generally most at risk.  If a vendor has any leverage, demanding cash on delivery may be an option. But more often than not, the retailer is not in a position to pay cash on delivery.  If bankruptcy is filed, it is important for the vendor to get on an approved “critical vendor” list – (approved by the Bankruptcy Court) if the retailer needs the vendor.  This should give the vendor some assurance that the post-petition lender, otherwise known as the debtor in possession (DIP) lender, will pay its bill.  Depending on the leverage the vendor has, the vendor may also want insist on a waiver of any Chapter 5 preference or fraudulent transfer claims, which are essentially “claw back” claims under the Bankruptcy Code.  

The one protection a vendor does have is an opportunity to assert an administrative claim for any unpaid claims arising from delivery of goods or services within twenty (20) days from the date the bankruptcy petition is filed under Section 503(b)(9) of the Bankruptcy Code.  An administrative claim has the same priority as professional claims and claims arising from products or services delivered post-bankruptcy.

The important thing to consider when dealing with a struggling retailer is that there are lots of moving parts; circumstances change day to day.  If creditors, whether secured or unsecured, are unwilling to work together, it’s not a good sign and liquidation may be just around the corner.  Unfortunately, even if creditors are willing to work together, in those instances in which the market has substantially declined or there is simply too much debt –the retailer may not see reorganization as a viable option.  Liquidation may be the only choice.  
 

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