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Charlotte Russe Restructuring: Turnaround Blueprint or Retail Anomaly?

“Significant deleveraging, cost savings, improved free cash flow, and maturity extension combine to position company for renewed momentum and growth.” These words — found in Charlotte Russe’s recent press release — are rarely uttered in the beleaguered retail environment these days.

Yet on February 5, 2018, Charlotte Russe, the San Francisco-based teen clothing retailer, announced that it successfully completed an out-of-court restructuring, which reduced term loan debt from $214 million to $90 million, cut interest expense by approximately half, and extended the maturity date five years. In return, the term-loan lenders received 100% of the company’s equity. The company also obtained material rent concessions from its landlords. Given the torrent of recent retail bankruptcy filings, the announcement was a welcome exception in the all-too-familiar turnaround turned liquidation world of retail bankruptcies.

Charlotte Russe is now positioned to reinvest in its brick-and-mortar locations and online presence unlike many other retailers, such as Sports Authority, who were hindered by crushing debt service obligations. But is Charlotte Russe’s out-of-court restructuring a blueprint for other troubled retailers to follow or is this an anomaly? Let’s look at some of the primary benefits of an out-of-court restructuring versus a bankruptcy filing.

Advantages of Out-of-Court Restructurings
• Quicker process: Speed is important when liquidity is on the line. Charlotte Russe was able to negotiate and close the restructuring agreement in a matter of months. Although the average length of a retail bankruptcy case has shortened since the enactment of certain changes to the Bankruptcy Code in 2005, any bankruptcy case is likely to last for a minimum of several months longer than the time necessary to complete an out-of-court restructuring.

• Less disruption and goodwill impairment: The out-of-court restructuring likely also resulted in less disruption to the company and the avoidance of goodwill impairment frequently associated with a bankruptcy filing, which can be a scarlet letter in the eyes of customers, employees, and vendors.

A bankruptcy filing is in the public record and requires frequent and detailed disclosures, whereas an out-of-court restructuring can be completed confidentially with a smaller group of constituents and less impact on employee morale.

• Lower costs: Although the cost of the company’s out-of-court restructuring is guaranteed to be material, clearly bankruptcy is the more expensive option. Between various professionals’ fees and other related costs, the price of a bankruptcy filing can be enormous.

For example, in the Payless bankruptcy case, professional fees and expenses for, among others, attorneys, financial advisors, and investment bankers exceeded $28.8 million for the initial four months of the case.

• Control and avoiding liquidation: While negotiating the out-of-court restructuring, the company’s management team and equity holders remained in control without oversight from a judge or the host of relevant parties in a bankruptcy, such as the unsecured creditors’ committees and the United States Trustee. In bankruptcy, even the most basic business activities, such as paying wages, are subject to approval by the judge and are customarily addressed in “first day” motions.

Further, while almost all retail bankruptcy cases are filed with the intent to reorganize pursuant to a bankruptcy plan or sell the company as a going concern, liquidations frequently follow. According to an October 2017 AlixPartners report, since 2006, almost half of all retail bankruptcy cases have ended in liquidation.

Advantages of Bankruptcy Proceedings
• Automatic stay and goodwill: Many retailers need the “breathing spell” afforded by the automatic stay under Section 362 of the Bankruptcy Code. A distressed retailer simply may not have the liquidity needed to complete an out-of-court restructuring; oftentimes, critical vendors will begin reducing terms, exacerbating the situation.

Or a major lawsuit may be threatened that could critically harm the company. The automatic stay under the Bankruptcy Code operates as a broad injunction that prevents creditor actions and allows a distressed retailer to focus on its turnaround strategy under court supervision.

• Ability to obtain financing in bankruptcy: Although contrary to what many unfamiliar with bankruptcy may assume, it is often easier for a distressed retailer to obtain financing while in bankruptcy rather than before a filing. The Bankruptcy Code is designed to facilitate loans to debtors while also balancing the interests of pre- and post-bankruptcy lenders and other interested parties.

The most common outcome is that lenders receive a “super-priority” lien on the assets of the debtor in bankruptcy. With this background, many prepetition lenders provide “defensive” financing in bankruptcy to protect their collateral position relative to other lenders.

• Impairing creditors without consent: Generally, creditors outside of a bankruptcy case cannot be forced to accept less than what they are owed. Thus, all out-of-court restructurings are consensual and create challenging negotiating dynamics with holdout risk. A retailer must convince its creditors to accept less than what they are owed and approach these creditors when there is still enough time to finalize the restructuring, but close enough to a bankruptcy filing to create leverage in the negotiations.

But under Section 1129(a)(8)(A) and other sections of the Bankruptcy Code, similarly situated creditors can be forced to accept less than what they are owed so long as, for a particular class, at least a majority in number and two-thirds in amount vote to approve a particular repayment proposal set forth in a plan of reorganization.

Particularly in situations where a retailer has a complex capital structure with multiple tranches of debt — the norm in the current market—a retailer may be forced to file for bankruptcy to administer an orderly process with a significant number of stakeholders.

Shedding burdensome contracts: Bankruptcy allows a retailer to reject burdensome contracts under Section 365 of the Bankruptcy Code, including, critically, lease agreements that are no longer desirable because they are at above-market rents, at undesirable locations, or otherwise unattractive. Following rejection, the landlord is typically left with an unsecured claim, which is capped under the Bankruptcy Code and may only recover pennies on the dollar.

• Tax benefits — and goodwill: Subject to a review by tax professionals of the specific scenario, in general, a company in bankruptcy is more likely to be able to take advantage of certain tax benefits in bankruptcy compared with an out-of-court restructuring, including avoiding liability for cancellation of indebtedness income and preserving net operating losses to offset future taxable income.

• Asset sales: If a distressed retailer decides that selling certain assets is the best course of action, doing so in bankruptcy under Section 363 of the Bankruptcy Code can allow the retailer to sell such assets free and clear of liens, subject to satisfying certain requirements, and also insulate the purchaser from certain subsequent legal attacks. In distressed scenarios, purchasers tend to prefer a court order “cleansing” the assets it desires to purchase.

As retailers continue to face strong headwinds in the market, out-of-court restructurings are likely to occur due to the speed, reduced disruptions, lower costs, confidentiality, and control they afford existing management and ownership.

But they are less likely to be used by retailers with complex capital structures, that need to institute operational rather
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