Is COVID-19 the “straw that broke the camel’s back” for many retailers? As retail bankruptcies continue, what we are learning from the first coronavirus crisis-related filings, and how to plan ahead

May 05, 2020

Retail Alert

Author(s): Staci Jennifer Riordan, David A. Kaufman, Robert N. H. Christmas, Christopher M. Desiderio

As the coronavirus (COVID-19) pandemic and economic crisis have taken hold, it is not surprising that retailers (whether teetering prior to the pandemic or crippled as a result of state- mandated closures) are considering bankruptcy as a viable strategy for survival. We discuss steps retailers and their creditors can take to protect their respective economic interests during, and after, the pandemic.

It should come as no surprise that retailers have been experiencing financial distress over the past few years. Even when the economy was firing on all cylinders, retailers were facing rising expenses, changing consumer shopping habits, and stiff competition—leading many iconic retail brands in the U.S. and around the world into bankruptcy. As the coronavirus (COVID-19) pandemic and economic crisis have taken hold, it is not surprising that even more retailers (whether teetering prior to the pandemic or crippled as a result of state-mandated closures) are considering bankruptcy as a viable strategy for survival.

On May 3, 2020, J. Crew filed a “pre-packaged” bankruptcy in which it already reached terms with its largest creditors—71% of its term loan lenders and 78% of those holding its IPCo Notes—for a restructuring of its debt. That resulting deal would convert $1.65 billion of the company’s debt into equity. The company also announced it was changing direction and would not be spinning off its Madewell division through an IPO (Madewell, a denim-focused brand, had been out-performing the parent company). J. Crew is working on plans to reopen its stores and will keep its online business, which it claims accounts for more than 50% of operating revenue. CEO Jan Singer commented, “We look to reopen our stores as quickly and safely as possible; this comprehensive financial restructuring should enable our business and brands to thrive for years to come.” Although rumors regarding J. Crew’s inevitable filing had circulated for years, the cumulative effect of the formidable pressures on retailers along with the pandemic and economic crises proved to be too much to surmount.

Even with the breathing-spell that bankruptcy initially provides, retailers considering bankruptcy will face many critical issues, including:

  • Liquidation sales are difficult if stores closed.
  • Even when reopen, stores may need to be remodeled, and customers may be wary of returning to retail environments.
  • Inventory in stores now may be out-of-season.
  • Real estate may be less valuable.
  • Current bankruptcy law permits only 120 days (plus a possible 90 days in addition) post-bankruptcy for the retailer to determine whether to keep or jettison store leases.
  • Suppliers who provided goods in the 20 days before the bankruptcy (who have a higher priority under current bankruptcy law than they did historically) can be the predominant unsecured creditors—and they must be paid in full before emergence from bankruptcy. Accordingly, many retailers who stockpile inventory before filing are not going to be able to reorganize unless these creditors are willing to compromise (or retailers may have to time their filings to minimize such claims).
  • Having cash and credit is critical. For example, during the Great Recession, Fortunoff (an upscale regional retailer in the New York City area that sold home furnishings and jewelry among other things) made its bankruptcy filing with only approximately 30 days of cash and credit to operate. It could not obtain a larger post-bankruptcy loan on reasonable terms. Fortunoff thus had to (and did) sell its business immediately—or face shutdown and piecemeal liquidation.

The key for retailers will be significant upfront planning, even if bankruptcy becomes unavoidable. Businesses who supply or otherwise engage with retailers will need to carefully consider their options—and not just be reactive—in order to limit losses.

  • Non-assignment provisions in leases are not enforceable in bankruptcy—so landlords may end up with a new tenant if the retailer decides to sell an under-market lease. Active landlord involvement in the bankruptcy case is critical to making certain the enforceable parts of the lease are observed (and no ambiguous language is slipped into the lease assignment order), and that the assignee of the lease has demonstrated financial ability to perform.
  • Careful monitoring of bankruptcy filings and claim deadlines is necessary, particularly for suppliers. There are special protections for suppliers of goods sold and delivered to a customer (including retailers) in the ordinary course of business within 45 days before the customer’s bankruptcy filing, and local court rules may impose short deadlines or alternative procedures for filing such claims.
  • Accounts receivable buildup may occur pre-bankruptcy, but changing the method of payment (say, from check to wire) before the bankruptcy may result in a preference clawback claim, so proper legal advice will be necessary to “thread the needle” regarding payments.
  • Goods consigned to a retailer may become part of general inventory, and the supplier can lose title and secured priority unless Uniform Commercial Code filings have been properly made well before the bankruptcy.
  • Some cases may file on the brink of complete shut-down, resulting in highly depreciated “fire sales” of companies and/or their assets and recovery/claims payments only for the secured lenders.
  • Suppliers who previously struck deals with the retailer in question may have to do business with a new and unfamiliar entity (which may not even have been previously in the retailer’s line of business)—the purchaser of the retailer’s assets.

The fallout from the current pandemic will certainly impact all industries, but this may be the “straw that broke the camel’s back” of industries such as retail, which were already suffering enormous pressure prior to the outbreak. Careful planning by retailers and their creditors is necessary to protect their respective economic interests. Finally, private equity firms and other investors looking to expand their portfolios may be well-positioned to acquire household brand names at steeply depressed prices—offering an opportunity in an otherwise grim situation.

Our Nixon Peabody team will continue to provide updates on this and other issues facing global retailers and solutions to assist them in navigating through these turbulent times.

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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