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Why your favorite retailer didn't come back from bankruptcy

It's never good when a company has to resort to bankruptcy as a last-ditch effort for profitability. But for players in the retail industry, things are even more dire.

According to a new study by AlixPartners advisory firm, 55 percent of all U.S. retailers that have filed for bankruptcy over the past 10 years have ended up in liquidation. By comparison, less than 5 percent of nonretail filings over that period have had the same result.

A RadioShack location going out of business in Laguna Hills, California.
Scott Mlyn | CNBC
A RadioShack location going out of business in Laguna Hills, California.

There are several reasons why bankruptcy represents more of a death knell for retailers than those in other industries — the most significant of which relates to changes in the U.S. Bankruptcy Code, according to AlixPartners.

But other factors are at play, including a robust market of liquidation firms; a new breed of lenders who are willing to get involved in the companies' operations; and demand for brands' intellectual property.

"In the old days a retailer would go into Chapter 11… [and] they would get rid of all their bad locations by terminating the leases. They'd come out smaller, leaner, meaner and they would negotiate a repayment plan with creditors," said Ken Rosen, who leads the bankruptcy, financial reorganization and creditors' rights department at Lowenstein Sandler law firm. "We don't see that anymore."

According to AlixPartners' study, changes to the U.S. Bankruptcy Code in 2005 condensed the timeline in which retailers had to garner approval for a sale or reorganization before they were pushed into liquidation.

What was originally put in place for supermarkets — whose fruits and vegetables would rot if they weren't sold quickly — suddenly became a way to cheaply sell off a company's assets, Rosen said.

Whereas retailers used to be able to spend a year or longer in bankruptcy — for example, Winn-Dixie, which exited bankruptcy in 2006 after 18 months — they now have 210 days to decide whether to hold onto or dispose of a store lease.

While that sounds like a tight timeline, it's even tighter in practice. Because it can take 90 days to hold a going-out-of-business sale, senior lenders often attempt to make a decision as to whether they should liquidate or reorganize a debtor in as little as 120 days.

"That just places another hurdle there," said Holly Felder Etlin, who co-authored the study. "I think more than a few of them [over the past few years] could have pulled it together and turned it around."

One of those companies is Linens 'n Things. The home goods retailer sold off its assets and intellectual property after filing for bankruptcy in 2008. But Etlin said if given more time, it likely could have found a buyer.

Instead, the study found that among the 16 retail filings over the last 18 months, only one — Brookstone Holding Corp. — successfully reorganized. By comparison, 10 of the 16 resulted in liquidation, and five were sold.

Adding to the headache is another change to the law, which Etlin said gives "administrative priority" status to vendors' claims for the value of goods sold in the 20 days preceding a bankruptcy. That change is what ended up doing in Circuit City a few years back, as it resulted in $350 million in claims.

In addition to rewritten bankruptcy legislation, a few other factors have changed the face of retail filings, Rosen said. For one, a "very robust" market of liquidators has emerged during the past three years, meaning firms are competing to run retailers' going-out-of-business sales.

Because of this competition, liquidators have offered close to or in excess of 100 percent of the purchase price of a retailer's inventory — making it tempting for lenders to take their money and run, Rosen said.

Another shift is the type of companies that are lending to retailers. Rosen pointed to surfwear brand Quiksilver, which filed Chapter 11 in September. It's working with hedge fund Oaktree Capital, which will likely use its position to gain control of the company.

"Previously when a JPMorgan Chase or Citibank or LaSalle would threaten to shut a company down, wise guys like me would say to the bank, 'Be careful what you ask for,' … knowing the last thing Chase wants is to own and operate a retailer," Rosen said. "But hedge funds are perfectly comfortable owning and operating a business."

There is also demand for retailers' intellectual property. For example, private equity firm Sycamore Partners acquired the defunct Coldwater Creek's intellectual property last year; it has since relaunched the brand as an online and catalog store.

Of course, there are exceptions to every rule. Rosen said American Apparel's Chapter 11 filing is unique in that its decision to turn to bankruptcy would help it shake its litigation costs. In the quarter ended June 30, American Apparel listed $3.6 million in legal, litigation and consulting fees, in part related to its ongoing conflict with ousted founder Dov Charney.

Regardless of what happens with the specialty retailer, Rosen and AlixPartners agree: The trend toward liquidation shows no signs of abating. Etlin predicts that more retailers will file for bankruptcy in the new calendar year, in a shift in timing that is more in line with traditional patterns.

The 2014 holiday season was an outlier in that several retailers did not have sufficient access to capital, and were heavily dependent on credit from suppliers, Etlin said. When that dried up, they were not left with a lot of options.

Both Delia's and Deb Shops filed for bankruptcy before last Christmas.

Overall, AlixPartners noted that retail bankruptcies have been on the rise since 2012, with as many filing in the first six months of 2015 as in all of last year.

"There is no patience for a protracted reorganization anymore," Rosen said. "Chapter 11 is too darn expensive, and I think lenders have alternatives to a long term Chapter 11 that are better."