The shutting down of economy has compelled many retailers to go bankrupt. However, the bankruptcy process itself has become a victim of the lockdowns as brands are not able to realize its benefits due to their stores being closed and legal system slowing to a crawl. Top fashion brands and retailers in the US like Neiman Marcus, and a handful of smaller ones like True Religion, John Varvatos have all file for bankruptcy during lockdown. A filing by J.C. Penney is expected soon. Credit agency Moody’s is expecting the default rate for retail and apparel companies to grown now and next year, from around 6 per cent before COVID-a9 hit the world to 17.2 per cent. Meanwhile, J. Crew and Neiman Marcus filed for Chapter 11 bankruptcy protection, with plans for how they could emerge from the process with healthy finances in the space of a few months.
Financial experts point out filing for bankruptcy can protect retailers from economic uncertainty for a few months. Companies may be able to count on their investors to keep them afloat by exchanging debt for increased ownership stakes, explains Susheel Kirpalani, partner at law firm Quinn Emanuel. The investors gambling that their stakes would be able to generate higher returns than the portion of their loans that they would collect from a bankrupt retailer.
Earlier, companies filing for bankruptcy had to indicate if they would be able recover their losses within six months or should their creditors urge a bankruptcy judge to force liquidation. COVID-19 has made this process even more unpredictable, as it has derailed even the most meticulous recovery plans.
Liquidating assets for DIP funds
When a corporation files for Chapter 11 bankruptcy, it typically follows one of three scenarios: liquidation, reorganization or sale though some level of liquidation is likely to take place in every case. In each scenario, the company needs finances to keep operating while it works through the bankruptcy process. This money is known as a debtor-in-possession, or DIP, loan, typically backed by a retailer’s assets. To secure these DIP funds, retailers normally liquidate some of their assets which guarantee their lenders at least some of their cash back.
An opportunity to generate returns
For some hedge funds with existing stakes in struggling retailers, bankruptcy is a way to acquire these companies at bargain prices, such as in the case of J Crew and its hedge fund debtor, Anchorage Capital. They see the plunging valuation of these brands and struggling mall retailers as a way to generate returns that exceed the securing finances they provide to these bankrupt brands.
Some bankruptcies are triggered by businesses unable to pay their bills and are compelled to liquidate. These suppliers find themselves at the back of the line for repayment, behind DIP lenders.
A reason to be optimistic
For some of these retailers, bankruptcy is the only path to join the ranks of survivors. For instance, Neiman Marcus and J Crew both successfully refinanced their debt and are on the restructuring trajectory, rather than liquidation. The current uncertainties in the retail industry and the temporary impossibility of liquidation, gives stakeholders a reason to be optimistic about recovery, according to Jonathan Treiber, Chief Executive, Retail Management RevTrax. However, this requires the lenders to be much more flexible than before.