Improving the

Odds of Success for Retail Bankruptcies

BY DAVID M. GUESS, SHAREHOLDER, GREENBERG TRAURIG LLP

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RETAIL

Have a PlanPositive financial projections are nice, but what will win the hearts and minds of those whose support a retailer needs to succeed—its lenders, landlords, vendors, and potential new owners—is a comprehensive and credible business plan that not only tackles the issues that brought the retailer down but that sets it on the path of stability and growth. Creditors need to be shown that this retailer has something special and is not like the many others that filed bankruptcy without much of a plan and ended up liquidating.

A retailer cannot file bankruptcy on a wing and a prayer or on the hope that a white knight that just happens to have a plan will swoop in to buy the company. To encourage lenders to lend, landlords to grant concessions, vendors to ship, and new owners to invest, the successful retailer must give these constituencies a reason to believe that the retailer is worth far more than the sum of its parts. The business plan is critical to this.

Control the MessageA successful retail bankruptcy requires extensive preparation. Management turnover; leaks about the hiring of restructuring and bankruptcy attorneys, CROs, financial advisors, and investment bankers; and rumors of nonpayment of lenders, landlords, and vendors, if not handled carefully, can result in a bankruptcy filing being forced on the retailer before it is ready for it.

Should they learn that a retailer may file for bankruptcy, lenders may require that letters of credit be cash collateralized and may reduce the availability of credit, landlords may enforce remedies promptly, vendors may change payment terms and demand security deposits, and employees may leave for seemingly greener pastures. To avoid this fallout in the lead-up to a potential bankruptcy filing, the best course of action is to limit knowledge that a bankruptcy filing is a possibility to those who need to know.

Last year saw over 9,300 retail store closures—more than any other year on record and a 60% increase

over the roughly 5,800 closures in 2018. Whether one believes the industry is in the midst of the “retail apocalypse” or that what’s happening is merely a matter of survival of the fittest, it is a safe bet that there will be several dozen sizable retail bankruptcies in 2020.

Retail bankruptcies are notoriously difficult. Retailers that file bankruptcy are far more likely to be forced to liquidate and cease operations or refile bankruptcy than debtors in other industries. There are, however, steps retailers can take to improve the odds that they come out the other side.

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At a minimum, the retailer should identify the worst leases—those with above market rents or relating to underperforming stores—and reject them on day one of the bankruptcy to reduce unnecessary cash burn.

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If news that can be interpreted badly does leak—such as the abrupt departure of a CEO or CFO—the retailer should be prepared to set the record straight and put matters into context so that it controls the story instead of being controlled by it. Yes, a bankruptcy might be a possibility, but often retailers are simultaneously considering other non-bankruptcy options on a dual track, such as a merger or refinancing.

Analyze LeasesThe 2005 amendments to the U.S. Bankruptcy Code limited the time debtors have to act on leases. The default is 120 days to assume or reject a lease, which a Bankruptcy Court can extend to a maximum of 210 days without landlord consent.

While some landlords may agree to extend that time frame beyond 210 days, perhaps in exchange for the payment of “stub rent” or a waiver of preference claims, there is no assurance that all or even most landlords will do that, particularly if they have another tenant willing to pay more waiting in the wings. To be assured a comfortable amount of time to liquidate store inventories before the 210th day if the bankruptcy case turns south, debtor-in-possession (DIP) lenders to retailers require expedited milestones for a sale or a plan of reorganization.

None of this leaves much time to make decisions or engage in extensive

negotiations on leases. Again, a retailer should not rest its hopes on a white knight buyer figuring out the leases in perhaps a fraction of the time that the retailer has to do so. The retailer should offer a turnkey solution by doing a comprehensive analysis of store profitability and the extent to which leases need to be amended to reflect market rates. The retailer can offer this information to potential buyers, who can then make their own, far more informed decisions.

Even better, the retailer can begin the process of renegotiating leases and cure claims early in the bankruptcy case, perhaps with the help of a professional commercial lease negotiator, so that potential buyers can simply step in without having to do much work on leases at all. This may make an acquisition more attractive, as the extent to which rent can be reduced and cure claims must be paid is known and potential buyers—already spread thin given all of the due diligence and other workstreams necessary to acquire a retailer out of bankruptcy—are spared having to guess about that and expend resources to analyze leases and cure claims and negotiate with the retailer’s many landlords. At a minimum, the retailer should identify the worst leases—those with above market rents or relating to underperforming stores—and reject them on day one of the bankruptcy to reduce unnecessary cash burn.

In addition to sorting out the leases, the retailer’s bankruptcy counsel should

carefully consider venue options. For example, some jurisdictions are more hostile to critical vendor motions than others, and the absence of a robust critical vendor motion could be the difference between a retailer having sufficient vendor support and surviving bankruptcy, and liquidating due to a lack of vendor support, with vendors refusing to accept new orders or provide trade credit, or requiring significant security deposits to ship.

Similarly, if the retailer has an important, nonexclusive license for intellectual property that it needs to keep through bankruptcy, that may point it to file in one jurisdiction as opposed to another, as the law in some jurisdictions is that the retailer loses the license unless the licensor agrees it can keep it. These are but two of many examples of why one venue may be preferable to another.

Show Early ResultsThe most successful retail bankruptcies not only involve intensive preplanning and analysis, but show results on day one through the filing of a sale motion that includes an asset purchase agreement with a stalking-horse bidder or the filing of a Chapter 11 plan of reorganization under which the retailer will come under credible new ownership. At a minimum, the retailer should try to file at least a term sheet for a sale or Chapter 11 plan. By doing so, the retailer immediately sets itself apart from “Hail Mary” retail bankruptcies, in which a retailer files bankruptcy without outlining a credible, near-

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term exit; sets up a naked auction and finds no buyers; and liquidates.

Of course, stalking-horse bidders and new equity investors don’t just fall out of the sky. Months before the bankruptcy, the retailer should hire an experienced investment banker to solicit interest in the business. The retailer should also engage in discussions with its existing owners, managers, and lenders, as often the most likely person to believe in and invest in a retailer is someone who is already deeply invested. Existing owners and lenders then have the opportunity to turn around or further enhance their existing investment.

Be TransparentAbsent open lines of communication, financial failure and bankruptcy can sow paranoia among a company’s creditors. To fight that tendency and turn detractors into supporters, a retailer’s management and its professionals need to have open lines of communication with lenders, landlords, and vendors.

Once a creditors’ committee is appointed, this will largely take the form of working with and sharing information with the committee.

Management presentations and calls with management can lead creditors to stop seeing management as the presumptive cause of the retailer’s woes and instead as a team that not only understands the problems but also knows how to fix them.

Often the managers that put the retailer into bankruptcy are not the same people whose mistakes, sometimes made over a number of years, led to the bankruptcy. That may not be obvious to creditors at first blush, however. Bringing on a credible and experienced CRO and financial advisors early can also facilitate increased communication and trust.

Transparency has its limits, of course, as a touch of uncertainty may engender positive results. For example, a retailer (or its proposed buyer) may plan to keep most stores open through the bankruptcy process. However, if it makes that known, landlords might not be willing to grant favorable lease amendments, which could result in more store closures than hoped for.

In contrast, by teeing up both underperforming stores and stores on the bubble for early going-out-

of-business sales and potential lease rejections, a retailer might bring more landlords to the table, resulting in saving more stores than expected. Landlords may also demand to know the profitability of each leased store, and the retailer must decide whether providing that information strengthens or weakens its negotiating position.

Find the Right BalanceSome retailers, in preparation for filing bankruptcy, employ strategies to build up and conserve cash—a war chest—to help them survive the bankruptcy case for as long as possible. Such strategies include:

• Borrowing to the limit under existing loan facilities just before the filing

• Refusing to accept deliveries from vendors within approximately 20 days before filing bankruptcy to limit exposure to priority Section 503(b)(9) claims

• Failing to pay landlords rent on the first of the month and filing bankruptcy shortly afterward, which, in certain jurisdictions, can result in the retailer not having

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David M. Guess is a shareholder in the Orange County, California, office of Greenberg Traurig LLP. He represented Wet Seal, PacSun, Sport Chalet, Eastern Mountain Sports, and Bob’s Stores as debtor’s counsel in their Chapter 11 cases; the secured lender and asset purchaser of Souplantation and Sweet Tomatoes; and the asset purchaser of Hot Dog on a Stick. Guess has particular experience in retail, restaurant, real estate, hospital, and skilled nursing facility bankruptcies, bankruptcy appeals, and fraudulent transfer litigation arising from failed LBOs and spinoffs.

to pay the landlord on a current basis any rent for the retailer’s first partial month in bankruptcy

A perhaps even more flagrant example involves retailers boosting gift card sales shortly before filing bankruptcy, conceivably expecting that some of the cards will never be used.

Some believe these maneuvers are always advisable, on the theory that the more skin in the game that landlords, lenders, and vendors have, the more likely they are to come to the table during the bankruptcy case. In reality, these strategies could alienate, if not infuriate, lenders, landlords, and vendors whose support the retailer and its buyer may later depend on.

Before resorting to such strategies, a retailer should carefully consider whether they are necessary based on the amount of cash it has, the extent of its anticipated cash burn, and how much DIP financing is available. There are sometimes other ways to reduce the burn and generate cash with less potential blowback, such as immediately implementing going-out-of-business sales on an aggressive timetable, both to generate quick cash and to reduce occupancy and overhead costs.

In a related vein, how much can a retailer realistically afford to litigate with its lenders and others? Retail bankruptcies can be fragile. If a retailer loses the support of its constituencies—for instance, if vendors or potential buyers become spooked by the level of litigation in the bankruptcy case—the retailer could be forced to liquidate. Therefore, a retailer may sometimes decide it’s best to choose its battles carefully.

Don’t DelayTime is not on the retailer’s side. Running a bankruptcy case comes at a cost. The retailer not only has to pay for its own professionals but for the lenders’ and creditors’ committee’s professionals as well. DIP financing is not cheap. And the longer the retailer stays in bankruptcy, the higher the chances are that more vendors become unnerved and more employees leave.

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Continuing press coverage of the bankruptcy, over time, may affect consumer behavior, leading customers to shop elsewhere. In some cases, retail competitors actively seek to use a retailer’s bankruptcy to their advantage through targeted marketing to attract the troubled retailer’s customers and increase their own market share.

Accordingly, time is of the essence, and a retailer should do all it can to close on a sale of its assets or confirm a Chapter 11 plan of reorganization before time runs out and negative consequences arising from an extended stay in bankruptcy force the retailer to liquidate. The retailer also should be sensitive to the calendar. It may be critical, for instance, that a retailer emerge from bankruptcy ahead of the winter holidays, the back-to-school season, or the spring season to take advantage of those heavy shopping periods as a business emerged from bankruptcy instead of one still in Chapter 11.

Keep It RealFinally, the closing of a sale or confirmation of a Chapter 11 plan is not the end; it is only the beginning of the next chapter. What is done in the retailer’s bankruptcy will greatly impact the chances of success for that next chapter. Keying off its business plan, the retailer should have taken advantage of the powers granted to it under the Bankruptcy Code by renegotiating and rejecting leases and other burdensome contracts during

its bankruptcy case, and it should exit bankruptcy with sufficient cash and available financing to weather the journey back to normalcy.

To the extent, for instance, that vendors were not sold on the retailer’s business plan and future prospects during its bankruptcy case, they might not be sold at the retailer’s exit from bankruptcy either. Vendors have been burned before by other retailers’ serial bankruptcy filings, and it simply may take time to convince them that will not happen with this retailer as well.

To avoid a dreaded Chapter 22 bankruptcy, which is not uncommonly a straight liquidation without even an attempted sale, the retailer needs to have enough cushion to give it time to win back over its vendors so that they ship on terms and its customers who may have been lost in the period leading up to and during the bankruptcy. Consistent with the business plan, cash may be needed for store refreshes and rebranding, and to fix the other problems with the business that led to its financial distress. Unless these fundamental business problems are fully and thoughtfully addressed, the odds that a retailer may have to revisit bankruptcy a year or two after its emergence increase.

ConclusionA successful retail bankruptcy requires extensive planning, proactivity, thoughtfulness, and speed. Combined, these elements hold the key to retail bankruptcy survival. J