Business

Why a chapter submitting doesn’t essentially imply your favourite retailer goes away

The endless headlines lately about this, that, or the other retailer heading toward Chapter 11 bankruptcy protection are enough to give any shopaholic agita.

This week, after J.Crew and Neiman Marcus each filed for Chapter 11 bankruptcy protection, social media was flooded with lamentations about the end of beloved retailers and where they had gone wrong. But the filings weren’t the end of anything: Both companies, choking on debt for years, will continue to operate, with healthier balance sheets now, and no immediate plans for store closings.

There is a popular misconception that Chapter 11 filings mean the end of a business, in retail and beyond. And it’s easy to see why: Many companies like Barneys New York, Toys ‘R’ Us, The Sports Authority, and CIT ultimately liquidated.

But countless others over the years—from General Motors to American Airlines to utility PG&E to retailers like grocer Fairway and even Macy’s (its Chapter 11 filing was in 1992)—have come out of bankruptcy to fight another day. And that’s ultimately the goal of seeking court protection.

“The whole purpose of Chapter 11 is to give a company a chance for a restructuring,” says David Berliner, bankruptcy and restructuring advisor at BDO. “If a company has good prospects for continuing in business, the balance sheet is fixed. The goal is wiping out debt to make it manageable.”

In the case of J.Crew, its debt of $1.7 billion (enormous in relation to annual sales of $2.5 billion) will be converted into equity, so its creditors become its owners. Neiman shed 80% of its debt, giving it a clean slate with which to invest and update its business rather than spend hundreds of millions of dollars on interest.

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And for retailers that need to slim down, bankruptcy protection is way to break some contracts, notably store leases, at lower costs.

So chin up: If your favorite store is filing for Chapter 11, it may just be the thing that saves it.

How bankruptcy works

Chapter 11 filings are named for a section of the U.S. Bankruptcy Code. A Chapter 11 filing is a form of bankruptcy that involves the reorganization of a debtor’s business affairs, debts, and assets to give it time to try to fix its business with creditors unable to claim its assets, hence the use of the term ‘protection.’ 

The U.S. government says that “A chapter 11 debtor usually proposes a plan of reorganization to keep its business alive and pay creditors over time.” Most filings are voluntary but occasionally, creditors get together and force a company into bankruptcy proceedings.

This ultimately doesn’t help a company if its business fundamentals are collapsing. Barneys’ massive debt was only one of many problems it had. The Sports Authority missed the boat when it came to e-commerce, and Toys ‘R’ Us’ outdated stores made it irrelevant to shoppers—all factors a bankruptcy filing cannot fix on its own.

In contrast, Neiman Marcus and J.Crew are hardly thriving, but their sales declines have been modest, suggesting there is room for them in the market.

A company under bankruptcy protection has to run everything by the court: the sale of any assets, divisions, property, entering or breaking leases, fees to lawyers. Everything.

Such a company also lines up debtor-in-possession (DIP) financing to have money that creditors can’t try to take that can be used to fund everyday business expenses, such as paying salaries and suppliers.

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A pre-packaged plan to emerge from bankruptcy protection is the ideal scenario. Under a ‘pre-pack,’ a filing comes after creditors and the company have agreed on a plan, subject to court approval, as they did in the case of Neiman Marcus. It makes for quicker emergence from Chapter 11 and less conflict and drama.

Survival via bankruptcy auction: Many brands still have a lot of life in them and attract bidders in a bankruptcy auction ready to keep them alive. Earlier this year, Simon Property Group, the largest U.S. mall operator, was part of a group that bought Forever 21, and in 2016, it was in a consortium that bought Aéropostale. Some companies specialized in licensing, notably Authentic Brands, buy intellectual property in bankruptcy court. That is how the Barneys New York name will live on as small sections at Saks Fifth Avenue stores and in stores overseas.

Chapter 7: If a Chapter 11 filing doesn’t work out, a company may file for Chapter 7 once things look hopeless that the company can continue. This simply means liquidation and deciding which creditors will get paid in what order when assets are sold off.

Chapter 22: The number 22 is a bit of bankruptcy court humor and refers to any company that has sought Chapter 11 protection twice. That illustrious group in recent years has included Gymboree and Payless ShoeSource.

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—Goldman Sachs doubts there will be a Round 3 of PPP loans for small businesses
—Listen to Leadership Next, a Fortune podcast examining the evolving role of CEO
—WATCH: Why the banks were ready for the financial impact of coronavirus

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