In the robust financing environment of 2017, commercial bankruptcies leveled off from credit-crisis highs. Through the first three quarters of 2017, commercial bankruptcies totaled 17,371, a significant decline from the 2009 peak year, when 45,510 commercial bankruptcies were filed in the first three quarters of the year.1 As commodity markets have risen significantly from January 2016 lows, the energy and production cycle has come to a halt. But not all sectors have been so lucky. Despite increases in consumer spending since the recession, brick-and-mortar retailers, in particular, have been crushed.2
There were more than 300 retail filings through early June 2017, a significant uptick from 2016.3 The retail restructuring activity and financial distress cut across industry subsectors and included: (i) different product categories, including clothing (e.g., Aèropostale, Quicksilver, Gymboree, BCBG), supermarkets (e.g., A&P II, Central Grocers), and leisure and sporting goods (e.g., Sports Authority, Golfsmith); (ii) different size/scale retailers (e.g., Toys R Us, as well as local and regional players); and (iii) different retail platforms (e.g., mall-based and stand-alone).
Is this a sign of the times in an “Amazon world,” as the popularity of online shopping coupled with the costs associated with maintaining brick-and-mortar retail locations lead to an industry-wide shift? Is this the end of traditional brick-and-mortar retail?
One common theme in retail restructurings, stretching back before this most recent cycle, is the small proportion of going concern reorganizations. Since 2006, more than half of retail bankruptcy filings with more than $50 million in liabilities resulted in liquidations.4 The low percentage of going concern reorganizations in retail bankruptcy is not just a factor of business issues but is also exacerbated by specific provisions of the U.S. Bankruptcy Code. One such provision is Section 365(d)(4), which gives a debtor 120 days to assume or reject unexpired nonresidential real property leases. That period may be extended an additional 90 days by the Bankruptcy Court but may not be further extended absent the consent of the applicable landlords.
Asset-based lenders, while often willing to cooperate in a distressed scenario, typically hold first lien security interests in inventory and are focused on protecting their ability to sell that collateral to protect themselves if a deal falls apart. Accordingly, ABL lenders have demanded extremely tight time frames for achieving milestones in the context of postpetition financing. These milestones typically work backward from the deadline to assume or reject unexpired leases, since the ABL lenders need to be able to get into the stores to liquidate their inventory while the company is still in possession of the stores (i.e., prior to the expiration of the Section 365(d)(4) deadline).
Moreover, ABL lenders typically demand time on the back end for an extended liquidation process to maximize value—the shorter the liquidation process, the greater the discounting necessary to clear all the inventory. This means that retailers and other stakeholders and investors in retailers generally need to strike a deal early and stick to it to reorganize as a going concern. Without a prepetition deal that is implementable, retailers will need other sources of financing, as there is simply no time to meet the milestones that ABL lenders demand.
The recent successful reorganizations of several large retailers prove that a going concern reorganization is still possible, even in an Amazon world. The Gymboree Corporation, rue21 Inc., and Payless Holdings LLC, among others, all implemented prenegotiated restructurings through the Chapter 11 process over the summer of 2017, emerging with rationalized store footprints and deleveraged capital structures. However, as each of these cases followed the same theme—prenegotiated restructurings with fulcrum creditors that were implemented in an expedited time frame—they provide more evidence of the need for speed in retail reorganizations.
As the statistics demonstrate, going concern retail reorganizations are the exception, not the rule. For companies that are unable to negotiate going concern reorganizations with their creditor constituencies prepetition, it is essential to secure adequate financing to sustain the business during the Chapter 11 cases to stave off a liquidation. As a general matter, piecemeal liquidations may not maximize value for stakeholders. Moreover, liquidations result in even more empty stores for landlords and mall operators, perpetuating a vicious cycle of lower foot traffic and even more distress in brick-and-mortar retail.
One novel mechanism for landlords to maintain value in a pending liquidation, where the store lease footprint may be wiped out entirely, is to take control of all or a portion of the reorganized entity. This is exactly what happened in Aéropostale’s (Aéro’s) Chapter 11 cases. In Aéro, a group of landlords teamed up with a group of liquidators and a licensing firm to bid on certain of Aéro’s assets and avoid the outright liquidation of the whole chain, allowing Aéro to keep 229 stores open and save 7,000 jobs.
Aéro, a mall-based retailer, filed Chapter 11 in May 2016 with $225 million of funded debt obligations. At that time Aéro operated approximately 800 stores in the United States. Aéro’s filing was driven by a combination of factors, with Aéro also claiming that its largest supplier wrongly drove it into Chapter 11 in a disguised loan-to-own scheme. Following unsuccessful litigation launched against its prepetition term lenders, who were affiliated with its largest supplier, Aéro undertook an auction process in Chapter 11.
In September 2016, a buyer consortium consisting of landlords General Growth Properties and Simon Property Group, licensing firm Authentic Brands, and liquidators Gordon Brothers and Hilco submitted a winning bid valued at $243 million. Under its bid, the consortium agreed to take up to 229 U.S. store locations plus Aéro’s e-commerce business.
The success of the buyer consortium reflects the opportunity that restructurings can provide to entities with different roles and motivations, to the extent they are willing to cooperate with each other. In the case of Aéro, the landlords could operate the remaining stores and avoid further closings at their malls, the liquidators could make a profit by disposing of inventory in stores that were closed, and the operator could work with the landlords to operate the go-forward stores. The sale closed on September 15, 2016.
The Chapter 11 cases of BCBG Max Azria Global Holdings LLC and certain of its affiliates provide another example of the power of collective action in retail bankruptcies. BCBG, a women’s apparel retailer, filed Chapter 11 in February 2017 with $460 million of funded debt. During the pendency of its Chapter 11 cases, BCBG pursued a sales and marketing process to sell either all or a portion of its assets or equity interests to a third party.
As part of its marketing process, BCBG reached out to more than 130 potentially interested parties. BCBG received several nonbinding indications of interest in April 2017 and bids in May 2017. While BCBG did not receive bids to acquire its equity interests or substantially all of its assets, it instead received bids from a going concern operator and a potential acquirer of its intellectual property, which BCBG was able to pull together to effectuate its overall restructuring. After reviewing the bids and engaging in further conversations with certain bidders, BCBG determined to work with Marquee Brands LLC, which was interested in acquiring its intellectual property, and GBG USA Inc., which was interested in acquiring its retail and wholesale operations.
The sale transaction was implemented pursuant to a Chapter 11 plan of reorganization, which allowed BCBG and its stakeholders to bring finality to the Chapter 11 cases. The sale consisted of three main components: (i) Marquee purchased BCBG’s intellectual property and certain other assets; (ii) GBG purchased certain of BCBG’s businesses and related assets, including up to 43 of its existing retail store locations; up to all of its existing partner shops, including certain Canadian operating locations; its existing wholesale business, e-commerce business, and inventory and purchase orders; and (iii) BCBG, under the supervision of a plan administrator, set to liquidate and wind down the stores and assets not purchased and distribute the proceeds to creditors. The implied value of the sale transactions was $162.5 million, comprised of approximately: (a) $125.6 million of cash proceeds; (b) $7.6 million of assumed liabilities; and (c) $19.3 million of cash proceeds from store closing sales and accounts receivables.
With its acquisition of certain of BCBG’s intellectual property assets, Marquee obtained the opportunity to leverage its global brand management platform to grow BCBG and related brands into new product categories, distribution channels, and geographies. Similarly, with the acquisition of certain of BCBG’s operating assets, GBG obtained the opportunity to market, promote, sell, and distribute products bearing the BCBG brand name. GBG also received the opportunity to operate the BCBG’s wholesale operations, select retail stores, and its e-commerce platform.
The benefit (and necessity) of cooperation among investors in a bankruptcy proceeding is demonstrated by the separate agreements between Marquee and GBG, pursuant to which Marquee agreed to license its acquired intellectual property assets to GBG for use in the operation of the go-forward business in exchange for a royalty. This cooperation allowed for a value maximizing transaction for the purchasers and BCBG. BCBG’s plan of reorganization was overwhelmingly supported by its creditors and became effective on July 31, 2017.
As distress continues to spread through the retail world, continued attempts to reach expeditious resolutions that can be implemented in Chapter 11 can be expected. Novel approaches, like those seen in Aéro and BCBG, may be mimicked, modified, or adjusted, as brick-and-mortar retailers and other parties explore ways to maximize value while ensuring a continued brick-and-mortar presence.