JCPenney’s bankruptcy filing on May 15 is one of the latest in a string of high-profile retailers, including Neiman Marcus, seeking bankruptcy protection in the wake of the Covid-19 public health emergency. Many other retailers may soon follow suit given the virus’ economic consequences and the industry issues many retailers have long faced.
Fashion, cosmetics, and personal care retailers may be particularly hard hit as they often rely on in-store experiences for sales. Experiences like spritzing fragrances, testing creams, running hands over fabrics are gone in the age of stay-at-home orders, a stagnating economy, record unemployment, and nearly nonexistent foot traffic.
However, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and recent bankruptcy rulings may provide retailers, including small businesses, with much needed relief, albeit in certain temporary ways.
Filing for Bankruptcy as Sales Fall
Neiman Marcus and JCPenney may be the tip of the iceberg as many retailers face plummeting sales. According to the Commerce Department, April retail sales fell by 16.4% year-on-year, far worse than predicted. Clothing stores were particularly hard hit, with sales falling 89% from a year ago.
Bankruptcy can provide relief in challenging times for businesses facing new economic realities. Chapters 7 and 11 are the primary bankruptcy avenues for businesses. While Chapter 7 involves liquidation, businesses may reorganize or sell their assets as going concerns under Chapter 11.
Most often when a retailer commences a Chapter 7 case, it ceases sales and other operations. Often, liquidation results in the business’ termination. An appointed trustee takes control of remaining operations and all assets, which may include accounts receivable and litigation claims. All proceeds not distributed to secured creditors are used first to pay the costs of the bankruptcy process, then to pay other debts, and lastly sometimes to make distributions to equity holders.
Thinking they can keep their doors open, most household-name businesses and others commence Chapter 11, which can keep customers shopping while the business creates and implements a “plan” to pay off its debts and often restructure its operations.
Benefits of the CARES Act for Small Businesses
The CARES Act has modified previously existing bankruptcy options to create further potential benefits for small businesses filing under Chapter 11.
Effective March 27, 2020, the CARES Act temporarily modified the Small Business Reorganization Act of 2019 (SBRA) to provide certain businesses a faster, less expensive, and more tailored approach to Chapter 11. Previously, the SBRA had crafted a streamlined Chapter 11 process referred to by its legislative location, “Subchapter 5.” However, the benefits of this process were limited to debtors with total secured and unsecured debt up to $2,725,625.
The CARES Act temporarily increased the debt limit for Subchapter 5 to $7.5 million. The result is that substantially more small businesses will qualify for reorganization under Subchapter 5’s new debt cap, allowing these businesses to seek to reorganize in the streamlined fashion that was once only available to companies under the pre-CARES Act cap.
Some benefits of reorganization under Subchapter 5 include:
- Streamlined reorganization plan submission and confirmation process when contrasted with other Chapter 11 cases.
- Exemption from quarterly trustee fees.
- Creditors’ committees are not appointed, and consequently there is less administrative cost.
- No absolute priority rule, and instead unsecured creditors receive a pro rata share of the business’s income over a three- to five-year period, benefitting existing equity holders.
These changes alone can measurably reduce the time, expense, and reputational impact of small company Chapter 11 reorganization efforts. But the CARES Act changes are expected to be available for a limited time. The temporary increase to Subchapter 5’s debt limit lasts only for one year from the enactment of the CARES Act, March 27, 2021. The debt limit will then return to $2,725,625, unless the nearly tripled debt limit is extended.
Recent Bankruptcy Rulings Support Struggling Businesses During Covid-19
Once in Chapter 11 bankruptcy, even if not under the streamlined Subchapter 5 processes, several recent bankruptcy courts have assisted retailers facing severe cash flow pressure during the Covid-19 crisis.
Paying rent is one such pressure. Under the Bankruptcy Code, businesses are generally required to remain “current” on rent in their commercial leases from the date of the bankruptcy case going forward, subject to a possible grace period for the first 60 days of the case.
Yet the bankruptcy court in In Re Pier 1 Imports Inc., relieved the debtors of their obligation to pay rent on a current basis, extending the grace period beyond the 60 days.
The court reasoned that the pandemic made it impossible for the debtors to generate sufficient revenue to pay rent on a current basis, even after reducing costs. Landlords were entitled to accrue administrative expenses for unpaid rent, not to current payment of rent.
The court noted it has not yet decided “whether the government-mandated closures” might excuse performance “due to impossibility, impracticability, or frustration of purpose.” Not surprisingly, the landlords have appealed.
Elsewhere, at least two other bankruptcy courts have granted similar relief. In Re Modell’s Sporting Goods Inc., No. 20-14179 (VFP) (Bankr. D.N.J., March 27, 2020); In re CraftWorks Parent LLC, No. 20-10475 (BLS), Docket No. 217 (Bankr. D. Del. March 30, 2020).
Other retail debtors dependent on in-person customers have likewise asked for similar rent relief. It is expected that the trend of debtors requesting, and courts likely granting, such relief will continue.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Sara Chenetz is a partner at Perkins Coie LLP, who represents clients with varied interests in bankruptcy, restructuring, workout, and litigation matters. Chenetz has served as first chair in multiple trials, arbitrations and mediations, in addition to serving as a court-appointed Chapter 11 trustee in bankruptcy cases in California and Nevada and as a mediator in bankruptcy cases in California and New York.
Tommy Tobin is an associate in Perkins Coie LLP’s Seattle office, where he focuses on complex commercial litigation and class action matters involving statutory, constitutional and regulatory issues in a range of industries, including food and beverage, health care, and pharmaceuticals.
Carrie Akinaka is an associate at Perkins Coie LLP, with a varied litigation practice. Akinaka supports a Fortune 5 retailer in employment and product liability actions, major real estate clients in multimillion-dollar mediations, and a multinational food company in class actions and appeals in the U.S. Court of Appeals for the Ninth Circuit.