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Bankruptcy no friend to struggling U.S. retailers

Nick Brown
Thursday, 19 Dec 2013 | 6:09 PM ET

Some 92 years after it was founded, discount clothing chain Loehmann's this week filed for bankruptcy protection for the third, and likely final, time.

Intensifying competition and limited access to capital left the chain, founded in Brooklyn by Frieda Loehmann, with no choice, said its chairman, Michael Appel.

Liquidators have offered to buy Loehmann's assets, and if a better offer doesn't surface, the retailer's next sale will be its last.

Filing for Chapter 11 protection from creditors no longer provides retailers with the fresh start it once gave stores like Macy's. These days, it often means the end of the line, according to a study by the law firm Cooley LLP.

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Amendments to the federal bankruptcy law in 2005 made it much harder for retailers to restructure and emerge from bankruptcy under the same ownership. They also give less wiggle room to keep or break store leases, said Cooley's Larry Gottlieb, a bankruptcy lawyer and retail sector expert.

The amendments, lobbied for by landlords tired of having tenants in protracted Chapter 11 cases, were aimed at shortening the time a retailer can spend in bankruptcy.

But the changes have pushed the pendulum so far in the other direction that most retailers don't have time to restructure, and end up selling assets or liquidating, said Gottlieb, who organized Cooley's study.

Given those bleak restructuring prospects, lenders who finance retailers through bankruptcy, concerned with protecting their own collateral, often provide only short-term loans, compounding the time crunch.

It all adds up to a landscape in which retailers "will do anything" to avoid bankruptcy, Gottlieb said. Too often, that means holding on even as value erodes, ultimately yielding less recovery for stakeholders, he said.

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It also means retailers sometimes file for bankruptcy only when they've run out of other options.

Loehmann's had sought a buyer for its assets prior to bankruptcy and filed for Chapter 11 after finding no good offers and deciding to liquidate. For Loehmann's, like for many retailers, the bankruptcy process is more or less "over from the start," said Charles Tabb, a professor at the University of Illinois College of Law.

"The practical reality (for retailers) can be, basically, if you don't already have a buyer lined up going in, you may just not have enough time and money" to survive, he said.

LANDLORDS DRIVE RULE CHANGES

Cooley's study examined 45 large bankruptcies in the retail sector - 20 filed before the 2005 amendments took effect, and 25 filed after. In the pre-2005 group, half of the companies restructured their debt and emerged from bankruptcy, while 35 percent liquidated and 15 percent were sold.

In contrast, since the amendments, only 12 percent of the companies restructured, almost half liquidated and 40 percent were sold out of bankruptcy.

Retailers' stakeholders have also fared less well recently. Before the 2005 changes, unsecured creditors - those without collateral for their debt - recovered an average of 33.6 cents on the dollar, but later bankruptcies yielded a mere 16.3 cents on the dollar, Cooley said.

The findings echo a similar study by Fitch Ratings in April that analyzed 20 large retail bankruptcies since the amendments. Fitch found that more than half - 55 percent - liquidated.

That percentage dwarfs liquidations in other sectors. Of the 86 bankruptcies across all industries followed by Fitch's database over the last decade, only 17 percent - or 14 companies - liquidated. Of those, 11 were retailers, Fitch found.

Before 2005, businesses routinely spent years in bankruptcy while deciding which leases to keep or abandon, and which business models would keep them going after emergence.

The 10 retailers studied by Cooley that successfully restructured before 2005 spent an average 19 months in bankruptcy.

Landlords, fed up with the long cases, successfully pressed Congress for changes as part of sweeping legislation in 2005 known as the Bankruptcy Abuse Prevention and Consumer Protection Act. The law gives just 210 days for bankrupt companies to decide what to do with their leases.

With tenants idle in bankruptcy, landlords find it hard to sell malls or find replacement tenants, said Robert LeHane, a partner at Kelley Drye & Warren, who represents landlords.

But LeHane acknowledged that the pendulum has perhaps swung too far, giving retailers too little time to fix their businesses. He said a 12-to-15-month lease rejection timeframe might be reasonable.

Tabb, though, said it is often bankrupt retailers' lenders, not landlords, that provide the biggest squeeze.

He said lenders that keep retailers open in bankruptcy typically provide funding that lasts only a limited time, perhaps 90 or 120 days, to ensure adequate time to run going-out-of-business sales within the 210-day limit.

Too often, that simply isn't enough time, said Gottlieb, whose firm has represented creditors in bankruptcies of Eddie Bauer and Gottschalks Inc.

"It's ridiculous," he said. "It can't be done."

Gottlieb in June testified before a commission examining further changes to bankruptcty law. Sponsored by the American Bankruptcy Institute, a trade group for bankruptcy lawyers, financial advisers and other restructuring specialists, the commission plans to propose legislative changes to Chapter 11 by the end of next year. It remains to be seen how much pull the group will have in Congress.

Among the biggest post-2005 casualties were Borders Group Inc, Circuit City Stores Inc, Movie Gallery Inc and Sharper Image Inc. Blockbuster Inc, which was sold, is shedding the last of its brick-and-mortar stores.

The numbers paint a stark picture for retailers, one in which Chapter 11 is not so much a restructuring as a hurried sale process or, failing that, a firesale liquidation.

Indeed, there is evidence that retailers are trying to stay out of bankruptcy. A 2011 study by the UCLA-LoPucki Bankruptcy Research Database showed that retailers accounted for just 9 percent of large, public company bankruptcies since the 2005 amendments, down from 14 percent before the changes.

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