Retailers Filing for Bankruptcy Are Seeing a Long, Unstable Road Ahead

This process had not been prepared for massive store closings due to a pandemic

storefronts from neiman marcus, j.crew and true religion
Less than a handful of retailers have filed for bankruptcy protection, including J.Crew, Neiman Marcus, True Religion and J.Hilburn.
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Key insights:

For distressed retailers weighing bankruptcy, the pandemic complicates what was already a difficult process.

A handful of brands have filed for protection recently, including True Religion, J.Crew Group, Neiman Marcus, John Varvatos and J.Hilburn. More are expected, once retailers are allowed to reopen storefronts, due to expenses accumulated during the lockdown and the need to raise cash through liquidation.

Retailers historically used bankruptcy protection to liquidate inventory to generate cash and reject unprofitable store leases once those liquidation sales are complete, said an industry source, who requested anonymity due to the sensitive nature of negotiations they are involved in. That’s not easy to do when stores are either shuttered or experiencing significant declines in traffic.

Lenders basically have two choices now, the same source said: liquidate and then go through a poor recovery based on the current environment or take ownership and manage the operations until the economy recovers.

As a result, two trends in retail bankruptcy are beginning to emerge. The first sees retailers that have filed for Chapter 11 asking the court for a deferment of administrative expenses such as rent, or effectively asking for a suspension of the case. The second is to swap debt for equity, with the lenders not only taking ownership but also providing debtor-in-possession (DIP) financing, which is typically provided for companies in financial distress, in place of traditional banks.

“There’s sort of two categories of bankruptcy cases now,” said Kenneth Rosen, partner at law firm Lowenstein Sandler. “There are the cases where there’s a lot of institutional debt and then the cases where the company has more traditional bank financing.”

Distressed exchanges

National retailers with well-known names, such as Neiman Marcus or J.Crew, are swapping debt for equity. J.Crew’s Chapter 11 filing on May 4 is the first example of such a debt restructuring under bankruptcy protection since the pandemic began. The lenders are exchanging $1.65 billion of debt for equity in the company.

The two apparel retailers are likely to be joined by others. “We’ve been seeing loads of bondholder groups organize to talk to the bond issuer,” said Rosen.

Among these bondholders as well as holders of the loans are distressed investors eying opportunistic defaults, purchasing pieces of the debt at a steep discount with the idea of eventually taking ownership of the company. Not only do these debt holders stand to gain for essentially buying a company at a bargain, with distressed investing the stand-in for mergers and acquisitions during the pandemic, they also benefit from the interest generated by the financing they end up providing.

These deals are triggered in part because the retailer needs to deleverage so it can reinvest, Rosen said. As is the case of J.Crew and Neiman Marcus, the latter of which is exchanging $4 billion of debt for equity, the lenders are providing the DIP financing to fund operations through the bankruptcy reorganization and beyond.

Such distressed exchanges demonstrate that lenders are confident there will be a business when commerce begins to normalize again, said George Angelich, partner with a specialty in bankruptcy at law firm Arent Fox.

“Bankruptcy affords parties a venue to adjust the rights of creditors and maximize value,” Angelich said. “Bankruptcy is not a destination; it’s a doorway.”

Both Neiman Marcus and J.Crew declined to comment beyond their public statements.

Bankruptcy suspensions

On the other hand, the more likely path for chains with traditional bank debt, particularly regional retailers, is to file for bankruptcy with the intent of liquidating and closing at least some, if not all, of the stores. Modell’s and Art Van Furniture are recent examples of this.

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