Chapter 22: Why Some Retailers Emerge from Bankruptcy Only to File Again
As of August 31, 16 retailers have filed for Chapter 11 bankruptcy in 2017. Four of those sixteen retailers are filing for “Chapter 22”, meaning this is their second time declaring bankruptcy. Chapter 22 cases show that the first bankruptcy failed and that the firm and its advisors were too optimistic regarding the firm’s viability out of bankruptcy. The chart below summarizes the four Chapter 22 filings over the past year:
1 Emergence from 1st to 2nd filing.
In all of these Chapter 22 cases, the companies’ attempts to improve core operations were not successful. The restructuring of these companies after the Chapter 11 filings did not go far enough to address their various operational problems — instead the efforts focused on improving the appearance of their balance sheets. This was likely due in part to the secured creditors’ desire to expedite the Chapter 11 process to minimize costs.
Inability To Adapt
One of the central reasons why these firms were unable to improve operations was their inability to adapt to changing consumer preferences and competitive landscapes, while still being overburdened with debt. Radioshack’s product assortment was generally antiquated and did not match the products sought by their customer base. American Apparel, Wet Seal and Bob’s Stores did not draw enough foot traffic to return to profitability, in part because competitors offered more desirable products at a better value.
Closing unprofitable stores without changing the underlying economics and developing a consumer-focused strategy is an ineffective way to emerge from bankruptcy for retailers. Inefficient supply chains with slow design, manufacturing and shipment processes make retailers unable to quickly change their products to match current trends. The typical 4-wall EBITDA analysis views the historical results of each store in a vacuum and does not fully consider changing competitive dynamics that could affect future results — like if a competitor recently opened or plans to open a location near a historically profitable store. Also, the 4-wall EBITDA analysis does not consider what is happening with other primary drivers of traffic within the shopping center. For example, customer traffic and future profits would likely be lower if a large department store or other tenants close stores in a mall.
Short Lease Renewal Time
Currently, bankrupt retailers have only an initial 120 days to assume or reject leases and can only receive one additional 90-day extension without landlord approval. One reason why retailers have to rush their decision as to which stores should assume or reject leases is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BACPA). Before BACPA, bankrupt retailers could essentially seek as many extensions that a Bankruptcy Court would approve. This enabled bankrupt retailers to keep stores open through at least one holiday season and take their time to determine if these stores should continue operating. Bankrupt firms were able to wait until after the holidays to decide which stores to close so that the sales associated with holiday season spending could be used in their analysis. BACPA, however, eliminated this option to continue to extend the decision as to whether to assume or reject leases.
In addition to the short lease renewal timeline, retailers typically face pressure from secured lenders who force shorter rejection timelines to ensure that their collateral, often their inventory, is liquidated before the 210 days. Without current sales data from an additional holiday season, retailers are unlikely to properly forecast the future operating results of all their locations, and may end up with the wrong mix of stores as well as more underperforming stores than expected.
As the saying goes, history tends to repeat itself. With this in mind, potentially bankrupt retailers should learn from the mistakes of previous Chapter 22 filings. Aggressive restructuring of operations, including revamping the product assortment, fixing supply chains and implementing a well-planned lease rejection strategy prior to filing are essential to improve the prospects for a successful restructuring. Unless the retailer is prepared to adequately address the core operational issues that led to the original bankruptcy filing, expediting the process to quickly emerge from Chapter 11 increases the likelihood that the restructuring will fail, thereby resulting in a Chapter 22 filing in the near future.
David Berliner is partner and leader of BDO’s business restructuring & turnaround services practice. BDO is an international network of public accounting, tax, consulting and business advisory firms.
(Nick Weber of BDO’s business restructuring & turnaround services practice contributed to this article.)
1 Emergence from 1st to 2nd filing.In all of these Chapter 22 cases, the companies’ attempts to improve core operations were not successful. The restructuring of these companies after the Chapter 11 filings did not go far enough to address their various operational problems — instead the efforts focused on improving the appearance of their balance sheets. This was likely due in part to the secured creditors’ desire to expedite the Chapter 11 process to minimize costs.
Inability To Adapt
One of the central reasons why these firms were unable to improve operations was their inability to adapt to changing consumer preferences and competitive landscapes, while still being overburdened with debt. Radioshack’s product assortment was generally antiquated and did not match the products sought by their customer base. American Apparel, Wet Seal and Bob’s Stores did not draw enough foot traffic to return to profitability, in part because competitors offered more desirable products at a better value.
Closing unprofitable stores without changing the underlying economics and developing a consumer-focused strategy is an ineffective way to emerge from bankruptcy for retailers. Inefficient supply chains with slow design, manufacturing and shipment processes make retailers unable to quickly change their products to match current trends. The typical 4-wall EBITDA analysis views the historical results of each store in a vacuum and does not fully consider changing competitive dynamics that could affect future results — like if a competitor recently opened or plans to open a location near a historically profitable store. Also, the 4-wall EBITDA analysis does not consider what is happening with other primary drivers of traffic within the shopping center. For example, customer traffic and future profits would likely be lower if a large department store or other tenants close stores in a mall.
Short Lease Renewal Time
Currently, bankrupt retailers have only an initial 120 days to assume or reject leases and can only receive one additional 90-day extension without landlord approval. One reason why retailers have to rush their decision as to which stores should assume or reject leases is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BACPA). Before BACPA, bankrupt retailers could essentially seek as many extensions that a Bankruptcy Court would approve. This enabled bankrupt retailers to keep stores open through at least one holiday season and take their time to determine if these stores should continue operating. Bankrupt firms were able to wait until after the holidays to decide which stores to close so that the sales associated with holiday season spending could be used in their analysis. BACPA, however, eliminated this option to continue to extend the decision as to whether to assume or reject leases.
In addition to the short lease renewal timeline, retailers typically face pressure from secured lenders who force shorter rejection timelines to ensure that their collateral, often their inventory, is liquidated before the 210 days. Without current sales data from an additional holiday season, retailers are unlikely to properly forecast the future operating results of all their locations, and may end up with the wrong mix of stores as well as more underperforming stores than expected.
As the saying goes, history tends to repeat itself. With this in mind, potentially bankrupt retailers should learn from the mistakes of previous Chapter 22 filings. Aggressive restructuring of operations, including revamping the product assortment, fixing supply chains and implementing a well-planned lease rejection strategy prior to filing are essential to improve the prospects for a successful restructuring. Unless the retailer is prepared to adequately address the core operational issues that led to the original bankruptcy filing, expediting the process to quickly emerge from Chapter 11 increases the likelihood that the restructuring will fail, thereby resulting in a Chapter 22 filing in the near future.
David Berliner is partner and leader of BDO’s business restructuring & turnaround services practice. BDO is an international network of public accounting, tax, consulting and business advisory firms.
(Nick Weber of BDO’s business restructuring & turnaround services practice contributed to this article.)