Retail can be a fickle world. True Religion’s $300 jeans were so in vogue in 2005 that Fergie immortalized the brand in a chart-topping Black Eyed Peas song.
Last year, True Religion was on trend in a different way. It was one of 50 major brands to file for Chapter 11 protection, according to S&P Global Market Intelligence, as a way to adapt to a changing retail landscape.
From Toys R Us to Payless Shoes to Gymboree and Radioshack, last year’s list of retail bankruptcies has risen from the 47 reported in 2016.
In fact, more than half of all store closures across the U.S. were a result of bankruptcy, according to JLL research, and many more retailers could follow suit this year. But rather than a death sentence, a well-planned bankruptcy could be the lifeline to recovery for an embattled brand.
Toys R Us, for example, plans to use its bankruptcy filing as a way to re-emerge on the cutting edge of the retail world, closing underperforming stores and transforming others into “interactive spaces.” Mall-based retailer chain Perfumania plans to use Chapter 11 protection to reorganize around its better-performing stores, closing 64 of its 226 outposts during the process.
“What we like to say is: Roar into bankruptcy. Don’t collapse into bankruptcy,” says Tom Mullaney, JLL Managing Director, Restructuring Services. “It is really important to be proactive and use bankruptcy as an offensive weapon, not a reactive and defensive weapon.”
Launching a successful bankruptcy filing
Bankruptcy is a legitimate business strategy to deal with excessive amounts of debt and liquidity issues, Mullaney says – a “plan B” when things don’t work out.
When it comes to companies facing liquidity issues, the most successful bankruptcies start with a proactive debtor. It is best to act early by hiring an advisor, building up and preserving liquidity, and creating a restructuring plan. Mullaney cites the Sizzler International bankruptcy that he worked on in 1994 as the best example he has seen of using bankruptcy as a pro-active, strategic restructuring tool.
“We even arranged to have a huge increase in TV advertising the week after we filed to show the consumer that despite what they read in the paper that morning about Sizzler, we were still open for business. The Sizzler management team did a terrific job in negotiating the bankruptcy process, and is still in business around the world today, 22 years later”.
If there are relatively few creditors, an out-of-court, private restructuring is often the best route as they are far cheaper and less disruptive for employees and customers. But if there are dozens or hundreds of creditors, avoiding a formal filing is not usually possible, Mullaney says.
Unlike bankruptcies in most other industries, store-based retailers usually have tens, hundreds or even thousands of leases and, under the bankruptcy code, only 120 days and one 90-extension during which to choose those to keep.
“That’s where retailers really have to be on their game and ahead of the curve: the ‘assume or reject’ deadline is on you in a flash,” Mullaney says.
That means that on day one of the filing, a retailer should know which leases it intends to keep or reject and which it may keep if the landlord cuts a deal. And that requires a significant amount of pre-filing analysis.
“Sadly, many retailers keep hoping and hoping that things will turn around, but so often they do not and they find themselves like a patient who has lost so much blood that they can hardly lift their head from the gurney. It’s important to get ahead of that curve.”
Finding value in leases
Despite the complexity, leases can be a source of value for debtors. Below-market leases or those at the top malls and shopping centers that have no vacancy can be particularly valuable when sold.
In deciding whether to keep a store at a good location or sell the lease, Mullaney recommends performing a “dead verses alive” analysis, which compares the cash flow a store is likely to generate in the future with the proceeds that can be achieved by selling the lease.
Even new and recently purchased companies should keep the potential future risk of bankruptcy in mind and, in particular, avoid cross-defaulted leases, personal guarantees and large letters of credit – all of which come back to haunt debtors in bankruptcy proceedings.
“Lenders assume all the time that something could go wrong, and they think in advance of what their plan B might be,” Mullaney concludes. “Borrowers should also war game in advance how things could go wrong, and they too should have a plan B.
“Hopefully, they will never need it, but it is amazing how often ostensibly solid companies have to file for bankruptcy. Just look at some of the big names in American industry that took to the bankruptcy courts – companies like United Airlines, Loews Theatres, Pepsi Cola, Texaco and many, many others.”