Last year went down in history as the year of the “retail apocalypse,” with 27 large U.S. retailers filing for bankruptcy. But this year could be even worse for retailers, especially ones running low on cash or close to the edge of breaking lender covenants — in other words, whether they realize it or not — are flirting with bankruptcy. Even worse, a Chapter 11 has also often meant the liquidation of many retailers, as in the recent announcement by Toys ‘R’ Us Inc.
The latter is due in part to the 2005 changes in the U.S. Bankruptcy Code allowing no more than 210 days for companies in bankruptcy to reject leases. In retail, where most real estate today is leased rather than owned, and where it typically takes at least 90 days to conduct inventory-clearance sales and at least another two to three weeks to start such sales, that means retailers already in bankruptcy effectively have only about 120 days to decide whether to reject leases. That very short time window is undoubtedly one of the main reasons why many retailers, once they filed for Chapter 11, have quickly found themselves falling into liquidation. In fact, since the Great Recession no fewer than 43 big retailers have had to liquidate.
However, last year five major retail companies, including Gymboree Corp. (an AlixPartners client), were able to emerge from bankruptcy as going concerns. In fact, among all major retailers — those with over $50 million in liabilities — filing for bankruptcy last year, 2017 saw the lowest percentage of companies liquidated, 30 percent, since 2009. And this ratio could well improve, since seven of the cases filed in 2017 have yet to be resolved.
In a nutshell: With hard-earned experience, there now seems to be — among many constituents involved in such processes — more knowledge and insight about best practices, and more openness to working together to achieve win-win outcomes.
In the case of Gymboree, for instance, by engaging its term lenders with a restructuring proposal a full 11 weeks before its bankruptcy, the company was able to file with the three hurdles that are absolutely critical to clear in any bankruptcy already addressed: 1.) the support of vendors; 2.) financing for during the Chapter 11 period — aka debtor-in-possession, or “DIP,” financing; and 3.) a formal restructuring-support agreement, or “RSA,” between the company and its lenders, which outlines the all-important post-Chapter 11 capital structure of the business.
By addressing these hurdles early and thoroughly, companies — and their stakeholders — can buy themselves valuable time for when the bankruptcy clock starts ticking and, also, reduce their overall time in Chapter 11. In our research of the five retailers that successfully emerged from bankruptcy last year — Payless ShoeSource Inc., Rue 21 Inc., True Religion Apparel Inc. and Perfumania Holdings Inc. as well as Gymboree — we found that all had RSAs requiring emergence from Chapter 11 within just three to four months.
On the other hand, a lot of the situations resulting in liquidations in recent years were likely not as strategic. The fact is, once that bankruptcy clocks starts ticking, it seems to move at warp speed — with 120 days seldom being long enough to evaluate all stores, decide what to do with inventories, renegotiate leases, etc.
So, the lesson is: Take care of as many of issues as possible before filing. And that includes dealing with what might be considered “non-core” — at least in terms of bankruptcy-court protections — participants, as they can often derail the process from the sidelines. For instance, press reports say that the Toys ‘R’ Us bankruptcy filing last September occurred much sooner than expected because nervous (and perhaps under-communicated-to) vendors unilaterally reduced product shipments.
What are some other things for retailers to keep in mind should they encounter trouble in today’s very troubled times? Here’s a short playbook for how to successfully go into, and emerge from, a retail Chapter 11:
- Focus on store-footprint issues: Given the 120-day limit, negotiations in these critical areas tend to favor landlords, not to mention the time it takes to document any new deals struck. Moreover, because most retailers use their inventories as collateral for borrowing, it’s critical to think through the implications that aggressive sales promotions might have on your inventory levels and therefore on your ability to borrow. The good news: Bankruptcy courts, with landlord consent, have sometimes approved — as in the case of Gymboree — a post-bankruptcy extension for both documentation and final inventory liquidations.
- Get that RSA: A good restructuring-support agreement will require a lot of negotiation of business projections and capital needs upon exit from bankruptcy, including a plan that captures all impacts from inventory liquidations, store closings, lease renegotiations and other actions. That’s a complex undertaking, but the alternative is often a lot of rude surprises.
- Engage vendors: As noted above, a retailer’s suppliers can sometimes drive it into bankruptcy, or even liquidation. Proactively engaging vendors with a thoughtful plan can go a long way toward achieving mutual benefit. One thing to consider: Setting aside a meaningful liquidity buffer to cover any operational shortfalls, which can alleviate many vendor concerns.
- Communicate, communicate, communicate: No matter which constituent you’re dealing with, work for a shared understanding of alternatives and outcomes. For instance, in the case of another recent AlixPartners client, BCBG Max Azria, circumstances didn’t permit the kind of planning described above. However, strong stakeholder engagement did still lead to a successful restructuring process of the business.
It’s vital that retailers today know not only their rights but also the “inside game” of bankruptcy — even if it’s “just in case.” With so many competing interests — including those of lenders, landlords and vendors — it’s rare that any deal is ever final until all parties are considered. But by starting early, staying focused and gaining consensus at each step along the way, retailers can greatly increase their chances of not becoming another statistic in this so-called apocalypse.
Jim Mesterharm is head of the turnaround and restructuring practice in the Americas for the global consulting firm AlixPartners LLP and Spencer Ware in a director in that practice.
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