In recent months, the US has seen a staggering increase in the number of retailers, both large and small, filing for bankruptcy. Among others, Dots, Alco Stores, Radio Shack, Deb Shops, Wet Seal, and Delia’s have each filed for bankruptcy protection in the past six months alone.
There can be little doubt that these retailers and countless others, face tremendous challenges given consumers’ shift in preference to online shopping with expedited shipping over visiting a bricks-and-mortar store. The prevalence of smartphones, tablets and other technological advances has made online shopping easier than ever; e-commerce sales continue to increase by double digits each year. As a result, physical stores, with their correspondingly high rent and employee costs, face a significant challenge: how to overcome declining foot traffic in retail shopping malls and convince the busy consumer to actually come into the shop.
A rise in retail bankruptcies
The stark rise in retail bankruptcies demonstrates that these challenges have been insurmountable in certain cases. Once a company enters bankruptcy, the weary retailer is not necessarily hopeful at the possibility of reorganization; rather it finds itself competing in a grim short-term race to find a potential suitor. Most retailers have capital structures that leave little or no free assets which are not subject to the liens of senior creditors. Since most retailers are financed through asset-based loans secured by receivables and inventory, the inability to fully capitalize on potential leasehold value leaves little for these entities to reorganize themselves with. Consequently these filings are usually followed by the company going out of business and eventually undergoing liquidation.
Bankruptcy abuse prevention and Consumer Protection Act 2005
Compounding this problem is the Bankruptcy Abuse Prevention and Consumer Protection Act 2005 (BAPCPA), which sets time limits for a debtor to affirmatively assume or reject an unexpired lease. Under the law, debtors now have only 120 days to decide whether to assume a given lease, with a potential 90-day extension that may be granted under a rather stringent legal standard. Prior to this change in law, the Bankruptcy Code set no time limits on a debtor to assume or reject a lease, provided it kept paying rent in the interim. These capital structures, together with the limited time to deal with leases, have made retail restructurings more challenging.
The overhaul in the law regarding leases was in response to a strong lobbying effort by commercial landlords to provide a tight window for retail debtors to secure a white knight purchaser. But the outcome of this change has hit retail debtors hard, eliminating the luxury of one or two extra retail cycles. As a result, nearly all of the recent retail bankruptcy cases have ended with “going out of business” sales at most or all of the debtor’s stores.
This result is not to anyone’s benefit, aside from liquidation firms. Notably, it is particularly detrimental to landlords, who are likely to suffer a financial loss from a rejection damages claim (damages arising from the rejection of a lease by a tenant in bankruptcy) while also dealing with a storefront that may stand empty for a long period of time while weakening the appeal of surrounding properties as well.
Proposed Chapter 11 reforms
In response, the American Bankruptcy Institute (ABI) recently unveiled proposed chapter 11 reforms which recommend an extension to the ability of the debtor to assume or reject an unexpired lease to one year after the petition date. In doing so, the Institute noted that for large retail chains in particular, the 120 days (or 210 days following extension) is grossly insufficient to review and make informed decisions regarding a debtor’s hundreds, or perhaps thousands, of real property leases. Indeed, according to recent studies, this short timeframe means that debtor-in-possession (DIP) lenders rarely provide more financing than would be sufficient for the first few months of the case, and include restrictive covenants that direct an immediate liquidation, effectively allowing the lender to pull the plug after only a few short months. ABI argues that extending the deadline to one year would provide a retail debtor with the necessary time to determine if going concern value exists in the marketplace.
Of course, the Institute’s recommendations are not law and thus have no impact on the recent flurry of retail debtors entering bankruptcy. But even if such a change would have resulted in the revival of only one of the recent retailers, it would come with a great reward to the thousands of employees of that retailer. Indeed, the one-year period would still be shorter than the potentially unlimited time period previously provided under the Bankruptcy Code before the BAPCPA amendments. It may well be the appropriate balance point between the concerns of landlords and the growing number of retail debtors.