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Op-Ed: Barneys after Bankruptcy: The Charity Option

After Sourcing Journal broke the news of Barneys’ missed direct deposits, the fashion industry has been holding its collective breath in anticipation of the company declaring its second bankruptcy.

However, despite its usefulness in getting past a company’s inability to pay its bills, bankruptcy typically does little to address the systemic challenges facing legacy brands in the digital age. Liquidating a corporation under Chapter 7 reduces a brand’s storied heritage to fixtures and trademarks sold as scrap. Chapter 11 restructures debt without changing the perspective that incurred it.

Even if Barneys successfully secures more loans or finds a new buyer, an influx of capital in itself would likely serve as little more than a mercantile hospice, as evidenced by Dean & DeLuca’s agonizing decline since being bought not long after the acquisition of Barneys.

Although bankruptcy may be all but inevitable at this point, it does provide a mechanism for reviving Barneys’ brand identity while generating new business models for other retailers. Instead of scrambling to preserve the company as a pure for-profit venture, a potentially more productive approach would be to transform the store into a charitable enterprise.

The dinosaur metaphor often applied to old department stores is not exactly apt, but we can liken the current financial pressure on legacy retail to the forces that converted prehistoric plants and animals into the fuel we use today. A Barneys reforged as a space for experiential education and economic development could be a vital resource for the industry’s adaptive redesign.

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It’s a strategy that has worked in other industries, particularly when faced with a seismic market shift.

Amidst Barneys’ first bankruptcy in the mid-1990s, for example, the IRS gave its blessing to the donation of the money-losing Kansas City Royals to a local community foundation, which enabled the team to stay in the city until a local buyer could be found.

In the digital era, newspapers have made headlines for using charity to keep public-spirited journalism alive: just a few weeks ago, the Salt Lake City Tribune announced that it would become a nonprofit, and a foundation now owns the Philadelphia Inquirer and Daily News.

At first glance a store selling Gucci and Celine would seem to be outside charity’s purview, but the practice of blending charity and luxury should be quite familiar to the fashion industry. Exhibit A: the sale of high-end brands at museum stores.

So long as a nonprofit museum exempt from corporate income tax under Section 501(c)(3) of the Internal Revenue Code can make a credible argument that, say, selling a $495 Versace t-shirt is related to its fashion wing or a special exhibit, the ersatz transformation of a museum shop into a Fifth Avenue boutique will typically be tax-exempt.

For Barneys, the shift to a charitable enterprise could be accomplished in several ways. One would be to convert the company into a nonprofit corporation with charitable purposes, such as education, assistance to disadvantaged communities and environmental conservation. Goodwill’s job training and the nonprofit Roundabout Theatre’s exemplary Theatrical Workforce Development Program are two successful models that immediately spring to mind.

Barneys could become a full-scale hub for internships and job training for the full spectrum of employment opportunities associated with a department store, from buyers and salespeople to facilities management, food service, communications, C-level management, and of course, legal issues.

Similarly, Barneys’ reputation for giving floor space to up-and-coming emerging designers could level up to an even greater scale, and expressly adopting a charitable mission would provide an organizational mandate for cutting-edge initiatives in sustainability and public outreach.

None of this would be unprecedented in the nonprofit realm, though the time and effort required to refashion Barneys to meet IRS requirements for securing recognition of tax-exempt status are such that a different corporate structure might be more efficient.

A more streamlined option would be for Barneys stock to be transferred to a charity—which would run it as a charitable venture blending commerce with social benefit.

The fact that by law the directors of a typical business corporation have a duty to maximize shareholder value could possibly raise questions as to how to reconcile maximizing profits with a primarily charitable mission, but this could be addressed in several ways.

One long-term solution would be for the parent charity to convert Barneys into a nonprofit subsidiary after its activities are wholly consistent with charitable tax-exemption. Alternatively, Barneys could continue as a commercial subsidiary but from the outset be reorganized as a New York benefit corporation, a legal form that integrates socially beneficial purposes with the maximization of shareholder value.

Because charity would be baked into the company’s charter, this would also facilitate the retention and addition of other investors, with the charity retaining majority ownership.

As it happens, a suitable nonprofit for taking control of the company already exists: the Barneys New York Foundation. Besides giving money to other charities (a practice likely to subside in light of the company’s current financial straits), the Foundation already conducts professional development initiatives for young people that could be expanded into a more comprehensive program.

The Barneys stores remaining post-bankruptcy could continue to operate throughout their charitable makeover, and the Foundation could conduct a capital campaign to secure additional support, including, ideally, a gift of real estate.

The prospect of seeing Barneys vacate its Madison Avenue flagship is a painful one, but the threat could help spark not only an innovative resource for the fashion industry but also a much-needed effort to reverse a tax rule that has contributed to keeping empty stores unoccupied around the country.

Before the federal tax-exempt organizations law was overhauled in 1969, building owners could deduct the value of space leased to a charity rent-free. Under current law, however, this is generally deemed to be a nondeductible partial interest gift. Banning deductions for rent-free use of real estate might have made sense from the perspective of abstract tax theory 50 years ago, but today the unchecked growth of vacant storefronts has become a serious policy issue.

In this context, discouraging the donation of building space to charities is fundamentally perverse.

Whatever happens to Barneys—and I am under no illusions as to the likelihood that either its current owners or a judge will immediately embrace the idea of making it the world’s greatest experimental department store—laboratories for creative change might be the best hope for the fashion industry to rise above present uncertainties. And transforming companies in crisis enables us to build the future from the best parts of the past.

In business, as in nature, hardship and loss can be the wellspring of new life.

Jeff Trexler is an attorney and associate director of the Fashion Law Institute.