Retail bankruptcies and the circle of life

BY Kenneth A. Rosen

The last several years have seen numerous chapter 11 bankruptcies with the most recent being The Sport Authority. It may seem counterintuitive, but bankruptcies are a sign of vibrant industry and give rise to new opportunities for those who know where to look.

The Sports Authority is the most recent example, but other bankruptcies the past few years have included Border’s, RadioShack, Circuit City, Loehmann’s, Coldwater Creek, Mandee Shops, Frederick’s of Hollywood, Body Shop, Cache, Dots, Love Culture, Alco Stores, Ashley Stewart, Deb Shops, Syms/Filene’s, Fortunoff’s and Anna’s Linens.

Today there is a new breed of lender to retailers. No longer are the only options for financing traditional lenders such as JPMorgan Chase, Citibank or Wells Fargo. Hedge funds have entered the lending business and so have specialty lenders that are more comfortable lending to retailers- and particularly comfortable with the risk of having to liquidate retailers. In addition, in the last two decades we have seen more retailers acquired by hedge funds as portfolio companies. Such owners have a greater willingness to acknowledge when a company is broken and when the cost of repair is not worth it. Therefore, they just cut their losses and move on to the next investment. Finally, as the cost of chapter 11 bankruptcies (professional fees, especially) has increased and the likelihood of a successful restructuring has declined (perhaps due to fierce competition), more retailers are being liquidated than are being reorganized.

We see more retailers today making a valiant attempt to find a buyer as a going concern; but, then commencing a chapter 11 case wherein the goal is a speedy liquidation.

Liquidating a chapter 11 debtor’s inventory now is a big business. Liquidators fiercely compete for the right to conduct “GOB” sales. The purchase price of the debtor’s inventory may go up at auction in increments of one-tenth of a cent. It is not uncommon that inventories will yield close to 100% of the debtor’s cost. Part of the reason is “augmentation.” A liquidator can be permitted by the Bankruptcy Court to bring in additional inventory to the debtor’s stores just for the liquidation and going out of business sale. And, the Bankruptcy Court can authorize a liquidation sale or going out of business sale at the retail sites despite prohibitions in leases to the contrary.

Retail liquidations provide opportunities for other retailers and for suppliers to retailers. Liquidators must line up a flow of merchandise very quickly. The time between when the liquidator wins an auction and when the liquidator commences sales can be just a few days. So, suppliers of goods can reach out to the major liquidators (often known well in advance of the auction) in order to offer goods to the liquidator contingent upon the liquidator winning the auction. This is an opportunity for the supplier to sell goods – especially goods manufactured for the debtor or for retailers similar to the debtor. Of course, one retailer’s bankruptcy is another retailer’s opportunity to buy debtor-owned goods in bulk at prices well below cost. Chapter 11 debtors, their banks and liquidators all like an opportunity to sell early and in bulk.

The purchase and sale of leases of retail space in bankruptcy cases today is a big business. Despite a lease having language in it stating that the lease is not assignable, or is not assignable without the landlord’s consent, the Bankruptcy Court has the power to permit the assignment of the lease. The Bankruptcy Court also will review any use restrictions in light of the assignee’s intended use and decide if the intended use violates a use restriction. And, note that Courts, banks and creditors committees usually favor assignments if they result in sale proceeds that increase the recovery to creditors- which means that close calls may be decided in favor of the debtor and assignee rather than the landlord.

Retail bankruptcies present an opportunity for a retailer that is anxious to enter a market to achieve almost instant critical mass by purchasing a group of leases all at once while avoiding the expense and time of seriatim lease negotiations over time to ramp up. The savings of management time and negotiating costs (legal fees) can be substantial even if the leases are purchased at a price equal to market rents. The Bankruptcy Court can enter an order protecting the assignee from disputes over arrears, over use of the premises and against claims by third parties — which also is of substantial value.

Once a retailer files a chapter 11 bankruptcy petition, it has a finite amount of time before it must either affirm the lease or else reject the lease. “Rejection” simply means that the debtor is allowed to disavow its obligations under the lease. The typical time period is nine months from the date of bankruptcy. But, a secured lender will be very conscious of the time that it would take to sell off its collateral in the stores. As a result, the lender may require that an inventory liquidation program begin far in advance of the nine month anniversary so as to be out of the stores by the nine month anniversary.

No prudent debtor would assume a real estate lease unless it knows that it definitely will be continuing in business or that it has an assignee lined up to purchase the lease. Consequently, each day that the bankruptcy case grows older, the debtor (and its creditors) grows more anxious to find someone who will pay for an assignment of the leases. The opportunity that this presents to a potential acquirer is that the debtor’s options to the acquirer’s offer may decline with the passage of time. And, no debtor or secured creditor ever wants to pass up getting something in favor of risking getting nothing. “A bird in the hand….” Further, bulk bids for multiple leases are extraordinarily tempting even if on an individual basis the leases justify a higher aggregate price.

There is more to a retailer than inventory and real estate leases, though. Intellectual property (trademarks, copyrights, patents, logos, customer lists) can have value and may be purchased separately from the inventory. The “Loehmann’s” and “Coldwater Creek” names are good examples. A former competitor’s intellectual property may be valuable to a buyer that has a similar customer base as that of the bankrupt retailer. We also have seen examples of intellectual property being acquired for internet and catalog usage. Not 100% of the public knows that a retailer filed a bankruptcy petition or that the retailer actually was “dark” for a period of time. They just know that they recognize the name.

And, warehouse/distribution machinery and systems that have very little value if removed often can be acquired at a fraction of their purchase price. Better yet, a buyer may be able to acquire the underlying lease for the premises and step into a turnkey warehouse/distribution center.

Finally, timing is everything. No landlord wants a dark hole – especially during the fourth quarter of the year. As a result, landlords may provide concessions to an assignee that can move expeditiously in getting open. The flip side of that coin is that the purchaser of a lease will pay less if it cannot open in time to capture a major season.

While it always is distasteful to prey on a carcass, the parties with a stake in the outcome of the debtor’s bankruptcy usually welcome a buyer’s interest and the purchase price of the assets purchased may be a bargain.

Kenneth A. Rosen is chair of Lowenstein Sandler's Bankruptcy, Financial Reorganization & Creditors' Rights Department. He focuses on Chapter 11 reorganization, out-of-court workouts, financial reorganization, and litigation.


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