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New Fung Group Report Says More Retail Bankruptcies Will End in Liquidation than Reorganization

Once upon a time, bankruptcy protection was like a magic wand for ailing retailers, one they could wave to buy some time to put their businesses back together again.

But now, filing for Chapter 11 doesn’t provide quite the same protection it did before, and changes to the U.S. Bankruptcy Code have played a starring role in diminishing retail reorganizations. A fact that Fung Business Intelligence Centre said in a report released Sunday, titled “The Departure of Retail Reorganizations: Bankruptcy No Friend to Struggling Retailers,” has been largely overlooked.

“Today, retailers almost invariably begin the Chapter 11 process with little hope of emerging as a stand-alone entity,” the report noted.

Capital constraints, competition and weak consumer demand have all contributed to rampant liquidations, but since the U.S. shorted the timeline in 2005 for companies to either get a sale or a reorganization plan approved, more retailers are forced into throwing their hands up.

The current law allows retailers 210 days to decide what to do with their leases, whereas before the timeline could be as long as the landlord allowed.

Lenders who finance bankrupt retailers tend to err on the side of providing short-term loans to protect themselves, and since it can take up to 90 days to hold a going-out-of-business sale, lenders are often looking to choose between liquidation and reorganizing in as little as 120 days.

And that, coupled with the economic conditions of recent years, has been bad news for retail.

For the 18 months ended June 30, 2015, an AlixPartners study found that in looking at companies with more than $50 million in liabilities, 62.5% were liquidated after filing for bankruptcy.

Another study by law firm Cooley LLP looked at 45 of the biggest retail bankruptcy cases—20 filed before the bankruptcy code change and 25 filed after.

Half of the companies in the pre-2005 group restructured their debt and came out of bankruptcy, 35 percent were liquidated and 15 percent were sold. Of those filing after the limiting change, only 12 percent were restructured, nearly half liquidated and 40 percent were sold out of bankruptcy.

When Anna’s Linens entered Chapter 11 in June 2015, its lender gave it five days to skirt liquidation, so naturally, the retailer had little other choice than to sell off the merchandise in its 261 stores and liquidate, the report noted.

“The 210-day limit set by BAPCPA often leaves a debtor with less than three months after filing to evaluate store leases, restructure debt and design a plan that passes the creditor’s best-interest test.’ As a result, most prepetition lenders refuse to provide more postpetition financing than necessary to fund an immediate sale or liquidation process,” according to the report.

Jack Butler, who led Kmart’s restructuring (one of the biggest U.S. retail restructurings ever), said it would have been “challenging” to restructure the retailer in today’s environment. Kmart spent 455 days in Chapter 11.

The American Bankruptcy Institute called on Congress in September to extend the lease-rejection deadline to a full year but Congress has yet to take any action.

“Bankruptcy filings will likely continue throughout 2016 as shifts in consumer shopping habits, coupled with the rise of e-commerce and fast fashion, render many retailers overstored and financially unstable,” according to the report.

It took just the first six months of 2015 to record the same number of bankruptcy filings as in all of 2014.

Business on the brink should consider cutting their company footprint—more than half of the retailers that emerged from bankruptcy in the AlixPartners study closed more than a quarter of their stores—and feeling out potential buyers prior to filing for bankruptcy.

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