These greatly enhanced risks in an increasingly troubled retail industry demand vigilance in negotiating, structuring and maintaining relationships for retail suppliers and creditors, as well as monitoring credit risks and credit exposure on an ongoing basis.

The retail industry is undergoing a major, seemingly transformative, upheaval. Traditional brick-and-mortar stores are in the midst of an “apocalypse,” as some commentators characterize it, with the emergence of e-commerce accelerating the seemingly unavoidable demise of brick-and-mortar retail.[1] More than 3,500 retail store locations have or are expected to close their doors, and many industry mainstays are rapidly losing their places among the key contenders of the retail market.[2] Further foreboding of this imminent upheaval, retailers as a whole are filing for bankruptcy at a record pace.[3] Even more consequential, the industry has lost nearly 90,000 retail jobs since October 2016, and nearly 500,000 retail jobs since 2001.[4]

Shifting consumer preferences and increasingly accessible mobile-based shopping platforms are largely behind this phenomenon. Instant access to the products consumers desire has deterred shoppers from visiting brick-and-mortar stores, moving many to the brink of bankruptcy, unable to bear the expenses—and competitive disadvantages—associated with maintaining a physical presence.[5] Currently, there is an average of 46 square feet of retail space in the United States for every single person.[6] Compared to the zero square footage of retail space that internet shopping and e-commerce require, the cost differential becomes clearly evident.[7] While having such a wide network may be advantageous in efforts at driving sales and even serving as locations for online order pickups, these retail giants are becoming increasingly more aware that a larger footprint generates economic stress and requires short-term pressures for sales growth to keep up with the costs of maintaining such a footprint. One leading retailer, for example, currently operates over 700 physical stores. Some locations, however, have become more valuable as real estate than for the revenue they generate from retail sales, and, thus, store closings are in process. Two retailers with equally large physical footprints have elected to shrink their footprints by closing 269 and 175 physical retail stores, respectively.[8]

This economic squeeze leaves retailers facing minimal profits, mounting debt and an oversupply of goods.[9] It is also causing a ripple effect throughout other facets of the industry. In addition to the obvious impact on jobs and the economy, such a demise quickly impresses financial stress on other sectors such as commercial real estate.[10] These oftentimes bankrupt retailers ultimately terminate their leases and leave vacant large swaths of malls and shopping centers.[11]

Concerns for Suppliers and Creditors

Retailers’ growing inability to move products is increasingly forcing them to choose between refusing shipments or failing to pay on accounts, thereby damaging relations with suppliers that may have been cultivated over the course of decades, or accelerating an oftentimes unavoidable restructuring. The same concerns resonate in the relationships between retailers and their creditors as well.

These issues combine to result in a sometimes inevitable filing for bankruptcy protections. In fact, chapter 11 filings for retailers are well on their way toward the highest totals since the Great Recession, with 14 retailers already filing this year and 10 more in jeopardy of doing the same.[12] These numbers rival those of the entirety of 2016, which saw 18 retailers file for bankruptcy protection.[13] Further, more and more retailers are finding themselves on Moody’s distressed debt lists, with rising interest rates and plummeting profit margins largely to blame.[14]

Considering the uncertainty inherent in these foreboding times for the retail industry, suppliers and creditors must be wary of any potential adverse effects. It is essential for suppliers and creditors to acknowledge, understand and address areas of significant financial stress or overexposure in their relationships before they reach a point of substantial loss or magnify their existing potential loss. The following best practices for suppliers and creditors provide guidance to avoid problematic situations or at least mitigate them.

Best Practices for Suppliers and Creditors

Initial and ongoing analysis of the retailer’s creditworthiness and payment history are, of course, basic. Those basics need, however, to be strictly maintained in this troubled environment. Likewise, comprehensive and forward-looking contract drafting is essential to enhancing collection and mitigating losses. Clear language defining events of default and specific remedies can avoid or mitigate the consequence of future distress. Moreover, specific situations and rights allowing for termination of the contract should also be included.

In the circumstances that many suppliers and creditors find themselves today, however, contracts have already been drafted and relationships have already been grounded in years of dealings. As such, suppliers and creditors should closely, and consistently, monitor retailers’ performance, as well as be mindful of any warning signs of financial stress, a practice that should continue through the balance of any relationship. Late payments for supplies delivered, requests for alternative billing practices, changes in key management and deteriorating accounts receivables all may represent early warning signs that a retailer is feeling the effect of the failing retail market. In the event that such signs start to amount to legitimate concerns, suppliers and creditors have the right to demand adequate assurance of the retailer’s continued performance under the contract. Such assurance may come in the form of guaranties, letters of credit, security interests and other financial remedies.

It is apparent that retailers are increasingly filing for bankruptcy protection. Upon such a filing, the rights of their suppliers and creditors will be greatly restricted, giving rise to a number of concerns and practices for those suppliers and creditors to exercise. Concerns related to the assumption, assignment, or rejection of their contracts, asserting and properly filing claims for amounts owed, and other related issues all arise upon a bankruptcy filing. These and many other issues will need to be addressed, and any supplier or creditor is therefore well advised to retain counsel in an effort to fully protect its interests. A number of those remedies, some of which affect the priority of payment, require timely action to avoid inadvertent waiver of those remedies.

For example, a supplier may face a situation where it learns of the retailer’s bankruptcy as its goods are in transit. If the debtor has yet to actually receive physical possession of the goods, the supplier retains its rights to stop the goods in transit notwithstanding a retailer’s bankruptcy filing.

In limited circumstances, if a supplier has provided goods on credit to a retailer that has thereafter filed for bankruptcy acts timely, it may secure payment in full rather than be left with a general unsecured claim. Such remedy is to file a reclamation claim pursuant to Bankruptcy Code Section 546(c) to reclaim the goods. In order to file such a claim, the supplier must meet a number of conditions, such as transmittal of an initial demand letter, proof of sale and proof of the debtors’ current possession of the goods. Thereafter, a court may enter judgment in favor of the supplier, ordering certain relief such as the actual return of the goods or their cash equivalent, granting a security interest in the goods or other assets of the debtor, or other appropriate relief. Since the reclaimed goods must still be in the retailer’s hands, timely exercise of reclamation rights is essential.

Similarly, Bankruptcy Code Section 503(b)(9) confers upon a supplier the right to assert an administrative expense claim for the value of any goods sold and delivered to a bankrupt retailer within 20 days of the retailer’s filing. Such a claim is granted priority of payment, thus increasing the likelihood of at least a portion of any amounts due and owing to the creditor, if not full payment.

In summary, these greatly enhanced risks in an increasingly troubled retail industry demand vigilance in negotiating, structuring and maintaining relationships for retail suppliers and creditors, as well as monitoring credit risks and credit exposure on an ongoing basis.