Earlier this month, teen clothing retailer Aéropostale filed for Chapter 11 bankruptcy protection, seeking to immediately close 154 of its over 800 stores located throughout the United States and Canada. Many of these stores are located in smaller shopping malls, which have been hit the hardest by the shift to online shopping.
The continued march of retail bankruptcies since 2015 includes Sports Authority, Vestis Retail Group, Inc. (the operator of Sports Chalet, Eastern Mountain Sports, and Bob’s Stores), Radio Shack, American Apparel, Quicksilver, Wet Seal, Delia’s and PacSun.
Many of these companies, including Aéropostale, have encountered difficulties stemming from burdensome leases for stores that keeps them from pivoting consistent with industry-wide shifts in consumer preferences away from traditional brick-and-mortar retailers towards online sellers. Traditional retailers often face higher occupancy costs and employee-related expenses than online retailers. “Overstoring,” a problem that occurs when a retailer has too many physical locations or locations that are too large, is a problem for many brands. Bankruptcy offers retailers the unique opportunity to reject burdensome leases and reduce their store footprint.
A Significant Challenge Facing Retailers in Bankruptcy
For many retailers, bankruptcy does not offer a panacea. Few retail bankruptcies since 2005 have resulted in a successful restructuring of the business. Most have resulted in the company conducting “going-out-business” (“GOB”) sales followed by liquidation of the business.
Congress may share in the blame for the failure of most retailers to emerge successfully from bankruptcy. Prior to 2005, retailers had an initial 60 days to review their unexpired real property leases before deciding whether to assume or reject a lease, but this period could be extended with bankruptcy court approval. Bankruptcy judges retained the discretion to grant multiple extensions, routinely allowing retailers many months, and even years, to continue to evaluate leases while implementing restructuring initiatives.
In 2005, Congress amended the Bankruptcy Code to set strict time limits on a debtor’s decision whether to assume or reject a lease. Now, retailers have 120 days to conduct an initial review of unexpired real property leases, but the bankruptcy court only has discretion to grant one 90-day extension. Further extensions are available only with the consent of the landlord. Obtaining consent from potentially hundreds of individual landlords often presents an insurmountable challenge for retailers and may require premature decisions on the viability of the business.
In reality, most retailers have even less time than the statutory 210-day period to make these critical business decisions. Many retailers rely on debtor-in-possession financing to fund the bankruptcy process and lenders recognize that GOB sales generally take at least 120 days and must be completed at the retailer’s current locations. In order to protect their collateral, lenders often require retail debtors within 90 to 120 days after bankruptcy filing to find a strategic buyer or propose a reorganization plan or else commit to GOB sales and face liquidation of the business.
This has made it extremely difficult for middle-market retailers (and even many large retailers) to implement restructuring initiatives before being forced to conduct a GOB sale, often before completing more than two retail cycles in bankruptcy. Aéropostale, which leases all of its store locations, may not be in a position to evaluate the performance of its remaining stores during the next winter holiday season, or possibly even the “back to school” season, before being forced to commit to a GOB sale if it is unable to find a strategic buyer or propose a reorganization plan.
Possible Future Amendments to the Bankruptcy Code
Many advocates have called for amendments to the Bankruptcy Code to better balance the need for additional time for retail debtors to navigate the bankruptcy process, while still recognizing the interests of landlords, who face risks associated with leases being rejected. For example, the American Bankruptcy Institute has called for increasing the time period within which to assume or reject a nonresidential lease to one year, which may allow retailers up to two additional business cycles before forced to commit to a GOB sale.
Online retailers continue to gain market share, with the number of consumers browsing and buying online projected to reach 270 million by 2020. As a result, traditional, brick-and-mortar retailers likely will continue to seek bankruptcy protection in an attempt to shed burdensome liabilities and overhaul obsolete business models. If the increase in retail filings continues, calls for bankruptcy reform will likely grow louder.