Anatomy of a Retail Bankruptcy – Part II

November 2010

How likely is a retailer to recover from bankruptcy?

Over the past couple of years, we’ve seen more retailers that file for Chapter 11 protection, in order to reorganize their operations and refinance their debt, wind up in liquidation than ever before.  Most recently, Movie Gallery, Inc., Gems TV (USA) Ltd., and Swoozie’s Inc. have fallen victim to this unfortunate fate.

Why do more and more retailers end up liquidating as opposed to reorganizing after filing for bankruptcy?
Two amendments to the U.S. Bankruptcy Code in 2005, in particular, have reduced the likelihood that retailers will successfully reorganize while in bankruptcy.  First, lenders have included provisions in DIP Financings that have significantly reduced the time retailers have to restructure their operations in bankruptcy.

Lenders no longer feel assured that they will have sufficient time to conduct going-out-of-business (“GOB”) sales to maximize the value of their inventory collateral in the event the reorganization fails.  To protect themselves, lenders seek to “fast track” the retailer’s time in bankruptcy.  Lenders typically encourage or require GOB sales prior to the expiration of the 210-day maximum period to assume or reject leases to ensure there is sufficient time to liquidate the retailer’s inventory before the retailer loses its leases.  Post-petition financing arrangements usually require that inventory must be liquidated in advance of the 210-day period.
Second are the Section 503(b)(9) provisions, which grant the seller of goods an administrative priority claim for goods received 20 days prior to the bankruptcy filing.  This increase in new administrative claims has made it harder for retailers to reorganize since administrative claims must be paid in full before a company can confirm a bankruptcy plan.  Before this provision was added, these goods would only have been deemed unsecured claims.

In addition, certain secured lenders and utility providers require the bankrupt retailer to provide adequate protection in the form of cash collateral or additional and/or replacement liens to protect the value of the lender’s interest in the property being used by the retailer.  This puts a huge strain on the retailer’s ability to operate with proper working capital levels while in bankruptcy and to complete a successful reorganization.

Also, the greater a bankrupt retailer’s secured debt load, the longer it will take and the more difficult it will be to obtain sufficient financing to reorganize.

These are just a few of the culprits making it difficult for bankrupt retailers to complete a successful reorganization and to continue in existence. What do you think the biggest challenge is for retailers emerging from bankruptcy?