Byline: Rich Wilner

NEW YORK — The saga of retail Chapter 11s has entered a new chapter.
Mid-size chains, which over the past decade pursued a successful strategy based on gaining market share domination through rapid expansion, are turning more and more today to Chapter 11 reorganization to erase the sins of their gluttonous growth.
But where once mega-retailers filed Chapter 11 to reorganize debt, the mid-size retail chains that dominate the Chapter 11 filings today are less debt-driven and more real estate-driven.
One after another, mid-size chains are filing for reorganization with the sole, or overriding, reason being to escape unprofitable leases. In court papers, executives at these mid-size firms describe an otherwise healthy operation plagued by a cancerous group of money-losing locations.
Without the drag of these unprofitable stores, the executives say, the company would return to a core group of profitable locations.
While many bankruptcy lawyers told WWD the number of real estate-driven Chapter 11s has certainly risen recently, others are not convinced that merely closing unprofitable stores is the answer.
Among the recent real estate-driven retail Chapter 11s are Accessory Place, Jay Jacobs, Gantos, Brendamours, NBO and Warehouse Club.
With Accessory Place, which filed Feb. 3, executives analyzed the 101-store chain prior to filing and identified 44 leases it wished to reject.
According to court papers, the chain will shrink to a 57-store chain and anticipates no expansion over the next three years. It expects to lose money in 1995 but to nearly break even in 1996 and to earn $436,000 in 1997, according to court papers.
In Seattle, Jay Jacobs Inc., a 170-unit juniors and men’s retailer operating under Chapter 11, hopes to close the last of its unprofitable stores by March. The chain filed for court-protected reorganization last May 13 after expansion into California — outside its franchise territory of the Pacific Northwest and Alaska — produced most of the 80 red ink stores, which put a drag on the rest of the operation.
In a thriving and expanding retail and real estate market, chains would have an easier time getting out of bad leases because they would have become, after several years, below market rate and therefore an asset most landlords would gladly take off a retailer’s hands, lawyers said.
But with a slumping economy and stagnant retail economy, lawyers noted, these leases are staying at or above market rate and therefore landlords have no inclination to take them back.
Bart Nachamie, at Todtman, Young, Tunick, Nachamie, Hendler & Spizz here, said, “Certainly filing for Chapter 11 to get out of the leases makes life a lot easier in one respect. The retailer hasn’t reached the stage where it has beaten up on the trade so getting a consensual plan together is a lot easier that way.
“Retailers are learning that Chapter 11 is a good way to get out of store leases,” he said. “Of course, it was always in the bankruptcy code but now, after some large-scale expansion in the 1980s and the drop in both the real estate market and the retail market, this is the only way out for some stores. Without the ability to file Chapter 11 and get out of the lease, entire companies would have tanked.”
One of Nachamie’s clients, apparel retailer The Lodge at Harvard Square, tried to negotiate out of court for roughly a year to get out of leases. It was unsuccessful.
Nachamie said they had about 60 stores but couldn’t convince landlords to take back any leases. It filed a Chapter 11 petition and is down to 16 stores, he said. “About two-thirds of their debt is landlord-related. They lost a fortune trying to negotiate with the landlords out of Chapter 11. Maybe, in hindsight, they should have filed a year earlier,” he added.
Of course, real estate companies are dead set against using the bankruptcy code merely for rejecting leases.
“I think the use of the bankruptcy code for the sole purpose of rejecting leases is a dreadful subversion of the code,” said Milton Cooper, chairman, Kimco Realty Corp., a real estate investment trust with 127 strip shopping centers mostly in the East.
“The intention of bankruptcy is to relieve a company of burdensome debt and to give a debtor a second chance,” he said. “To use the law to gain special advantages over landlords was not the purpose of the bankruptcy code.”
Cory Lipoff, of Jones, Day, Reavis & Pogue, Chicago, has been involved in many real estate-driven Chapter 11 cases. He said the main advantages to retailers are that the bankruptcy code allows stores to breach contracts, limit damages and void any anti-assignment clause within a lease.
Lipoff is heading up the reorganization of Gantos Inc., which closed 50 stores once it filed, and managed the Herman’s Chapter 11 case, which wound up last September and saw the closing of 160 stores in the Rocky Mountains and West.
“Chapter 11 also allows the retailer to conduct going-out-of-business sales at the location regardless of what state or local law dictates,” Lipoff noted.
“I’m not surprised many retailers today, when faced with several stores that are underperforming, are choosing Chapter 11 as a way to cut out some unprofitable locations in an attempt to right the entire company,” he said.
“Retail is a tough business, especially in today’s economy, and I’ve found by working with several retailers that companies can’t afford to operate stores that don’t contribute a profit on a four-wall basis,” Lipoff said.
But not everyone agrees the number of real estate-driven Chapter 11s is as easily handled by simply shutting a number of stores.
Larry Gottlieb, with Siegel, Sommers & Schwartz, doesn’t think all retailers who say they are filing only to get out from under bad leases are facing only real estate problems.
“A lot of times they are saying it’s real estate, but what it usually is is operational problems,” he said. “Even after shutting the stores, retailers are left with big overhead and/or inadequate financing,” he noted.
“And I would ask why the retailer got into the bad real estate problem,” Gottlieb added. “Was it bad management? Has time passed them by? These cases, I believe, are more complex than merely closing leases. On the surface they may look less complex than the mega-Chapter 11 cases, but among the questions that have to be dealt with is: Should this company stay in business?”
Gottlieb, who represents the unsecured creditors committee in the Jay Jacobs case, said the chain is suffering now from expanding all over the place into areas where they didn’t have a franchise.
“But maybe, also, they weren’t merchandising well or they were merchandising for a customer that didn’t exist any more,” he said.
Gottlieb said it is a positive move that Jay Jacobs has gotten totally new management, which has stabilized the company and energized the staff.
“If, as in many other real estate-driven Chapter 11 cases, bad management was a causal factor, at least here new management gives the business a new spark.”
— Fairchild News Service

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