Anatomy of a Retail Bankruptcy – Part I

Distressed retailers have been impacted by the tightening of bank credit and trade vendors who have become reluctant to provide credit, except on the strictest of terms. Without access to credit, even otherwise well-run retail operations may experience financial distress and ultimately wind up in bankruptcy. Shortened timeframes and less available cash to consummate a plan in bankruptcy, is leading more distressed retailers to sell or liquidate rather than to reorganize. As a result, retailers are discouraged from filing bankruptcy cases until there is no other possible alternative.

Specific Issues in Retail Bankruptcy that Reduce the Available Cash or Time to Reorganize

Retailers must provide utilities (e.g. electric, gas, water, telephone) with adequate “assurance of payment” as of the bankruptcy date, generally in the form of a security deposit, within 20 days of the petition date. Courts have interpreted this provision as requiring a retailer to provide each utility with a cash deposit generally ranging from 2 weeks to 2 months of service, calculated based on the retailer’s historical average usage. The required payments to utilities at the very beginning of a bankruptcy case have a severe impact on a retailer’s liquidity, particularly for retailers with numerous locations requiring multiple utility services.

Creditors have a 45-day period to reclaim goods from the retailer. If a creditor sells goods to a retailer in the ordinary course of the creditor’s business, it may reclaim such goods (subject to the prior rights of the secured lender) which may reduce inventory, thus reducing availability while also negatively impacting sales as less product is available to be sold.

Section 503(b)9 or “20-day” administrative claims for vendors can also negatively impact availability. Although these claims are paid upon emergence under a reorganization scenario or added to the administrative claims if the bankrupt retailer liquidates, companies and/or lenders usually accrue for these costs during proceedings and include them in the availability block which further reduces available liquidity.

Retailers have a 210-day outside limit (120 days plus a 90-day one-time extension) to assume or reject their commercial real estate leases. However, the law does allow the Bankruptcy Judge to grant an extension if the landlord agrees to it. Macroeconomic conditions have also reduced the value of retail store leases. Since most current retail store leases were written when retailers were expanding, the terms are relatively expensive.  As such, there are fewer store locations with valuable leases.

Given these obstacles, how likely is a retailer to recover from bankruptcy? Stay tuned for Part II.