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Vendors could feel more of a squeeze in the latest round of retail bankruptcies.

While vendors are always lower in the priority hierarchy to get repaid in retail bankruptcies, the timing of the Chapter 11 filings of the likes of J. Crew Group and Neiman Marcus Group during the coronavirus pandemic mean that vendors may face more of a struggle than usual.

That’s in part because debtor-in-possession lenders may be setting their sights on a wide range of assets, in order to mitigate the risk of lending to retailers that are plowing through cash while stores are closed during the COVID-19 crisis.

The retailers that have gone into Chapter 11 have universally described the stark hit to their revenues from the crisis, highlighting what they see as the high risk to the lenders providing them with bankruptcy financing.

Lenders could target more of retailers’ so-called unencumbered assets — that is, any assets that debtors can use freely, that other creditors don’t have liens on, attorneys said. DIP lenders often evaluate assets like a company’s inventory, accounts receivable, even the value of its name and any trademarks, and real estate, to the extent the retailer owns it. 

In the COVID-19 era that has cratered retailers’ revenues and complicated the appraisal of any assets, lenders may look for more ways to secure their loans and make recoveries — pushing vendors farther down the priority list.

“The DIP financiers are much more critical with respect to their diligence, and are much more likely to be asking for terms that they wouldn’t necessarily have asked for before,” said Eric Sleeper, who heads the bankruptcy practice at Barton LLP. 

“As credit markets start to dry up, you see that it’s because the credit risk is enhanced, so undoubtedly the ones that are extending credit are going to want stronger terms,” he added. “The DIP financiers are at the highest end of the priority scheme in a bankruptcy, so if they tighten up terms, it’s going to fall on somebody, and it’s going to fall further down the chain.” 

Neiman Marcus, which filed for bankruptcy last week, said store closures in March had led to an “immediate reduction in cash flow of approximately 65 percent to 75 percent,” while J. Crew, which also filed for Chapter 11 last week, told the court that its March revenues sank by about 46 percent from last year. 

The revenue declines, combined with the uncertain duration of store closures, pose significant risk to lenders, retailers’ advisers have argued. At Neiman’s first day hearing on Friday, Tyler Cowan, managing director in the restructuring group at Lazard Frères & Co. LLC, investment bank advising Neiman’s, emphasized the risk to lenders in light of the company’s expected cash burn in the coming months. Neiman’s, which entered the proceedings with $100 million in cash, expects to spend more than three times that amount before its anticipated reopening in July or August, Cowan told the court.  

Meanwhile, J. Crew has asked the court for permission to delay paying its $23 million in monthly rent obligations, citing its “limited revenue generating options” during the pandemic. 

What all this means for lenders and creditors is still being worked out, though a picture may soon emerge.

For one, DIP lenders are likely to seek more unencumbered assets as collateral for their loans, which could mean real estate, or other assets that could be monetized down the line. Such assets may become more important to lenders especially as the value of retailers’ inventory declines while stores are closed, attorneys said. 

“Almost every asset has greater uncertainty right now,” said Donald Kirk, the head of Carlton Fields P.A.’s bankruptcy group and business litigation group. Kirk spoke generally, and did not comment on any retailers specifically. “With inventory, I think you have to assess how quickly it turns over, and when it’s going to be sold.”

For instance, J. Crew’s proposed DIP financing collateral included a lien on the proceeds of avoidance actions, which are lawsuits against creditors who were paid by the company within 90 days before it filed for bankruptcy.  

The recovery from avoidance actions would typically go to unsecured creditors, as they’re among the only free assets that unsecured creditors have to look to for recoveries, said James Holman, a co-chair of Duane Morris LLP’s business reorganization and financial restructuring practice group. 

“That’s why this can be a particularly grueling issue for unsecured creditors, taking away the one thing that could provide some recovery for them,” he said. “I think [lenders] have more leverage now, as far as lien protection, because the businesses that are filing [for bankruptcy] right now are basically dormant.” 

Such collateral requests will likely be the subject of objections and negotiations after creditors’ committees are appointed in the bankruptcy cases as they proceed.

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