Discount shoes giant Payless could soon become the latest retailer to make a second trip to bankruptcy court in quick succession.
Last month children’s apparel retailer Gymboree filed its second Chapter 11 in two years. American Apparel, Wet Seal and Radio Shack are other prominent retailers that recently filed Chapter 11 for a second time, which bankruptcy practitioners call “Chapter 22.”
The repeat bankruptcies are a sign the original restructuring may have been rushed through too quickly or didn’t do enough to solve the retailers’ industry-wide and company-specific problems.
The number of recent Chapter 22s may also deter other retailers from turning to bankruptcy courts to reorganize, Jared Ellias, professor of bankruptcy law at UC Hastings School of Law in San Francisco, told Bloomberg Law. These companies may instead go straight to liquidation or turn to out-of-court workouts.
“One of the easiest ways to waste time and money in Chapter 11 is to use the process only to effect a change in ownership but not to take the time and protections afforded by the bankruptcy process to fix underlying operations,” Ted Gavin, a turnaround consultant and the president of the American Bankruptcy Institute, told Bloomberg Law.
Chapter 22 isn’t new. Studies have shown that since the modern bankruptcy code was enacted in 1978, up to 20 percent of Chapter 11 cases will end up filing again, Bruce Markell told Bloomberg Law. Markell is a former bankruptcy judge who now teaches bankruptcy law at the Northwestern Pritzker School of Law.
Chapter 22s tend to come in cycles, Markell said.
Now we’re seeing a cluster of retail Chapter 22s, Gavin said.
They aren’t limited to the retail industry. Mortgage lender and servicer Ditech filed Chapter 11 Feb. 11, almost exactly a year after consummating a Chapter 11 plan from its 2017 filing—but bankruptcy scholars and practitioners are noticing a pronounced trend with retail companies.
There are also examples of “Chapter 33,” where a company files three Chapter 11 cases.
Donald J. Trump’s failed Atlantic City casinos even filed a “Chapter 44"—four trips to the bankruptcy court setting a record, according to Professor Jonathan Lipson of Temple University–Beasley School of Law, Philadelphia. (By the final case, Trump was no longer in control of the company, however.)
First Time Not Solving Problems
The purpose of Chapter 11 is to provide a debtor the opportunity to reorganize and get a fresh start so that it can contribute positively to society and the economy, Gavin said.
But lately bankruptcy may be moving too fast, he said. “If you don’t put time into the first case to really fix the underlying problems of a business, then it’s going to find its way back in,” he said.
Companies are coming out of bankruptcy with either too much debt or an unsustainable business plan, Ellias said.
If a company hasn’t changed the fact that it’s a money-losing venture, it will find its way back, Gavin said. And that ultimately comes at the expense of all stakeholders, because bankruptcy can be a significant expense.
Will the Plan Work?
To confirm a Chapter 11 plan, the party proposing the plan has to prove that it’s feasible and that there’s not a likelihood that the company will later be forced to liquidate.
One academic blames repeat filings on bankruptcy judges confirming plans that aren’t going to work out and are likely to be followed by liquidation.
Lynn LoPucki, a bankruptcy scholar at UCLA School of Law who manages a database tracking large publicly traded companies in Chapter 11, said that judges don’t have the power to refuse to confirm a plan because if they did there would be a mass exodus of cases being filed in their court, as bankruptcy professionals look elsewhere for someone to approve their plans.
Others take a less cynical view. Judges see a chance to save thousands or tens of thousands of jobs by confirming a plan and allowing a company at least a chance to survive, Ellias said.
It was arguably the hope of saving 50,000 jobs that saved Sears from liquidation, Bloomberg reported Feb. 11.
Problem With Retail
Chapter 11 reorganizations used to be the result of litigation and negotiation between the companies, banks, employees and trade vendors, Markell said.
But now the parties with the power to control what happens are often lenders with liens on all the company’s assets, including hedge funds that bought up debt or organized acquisitions by leveraged buy-outs.
These entities don’t necessarily have the same interest in seeing the company become successful operationally, Markell said.
And these creditors push for faster—and therefore less expensive—reorganizations that often end up in a sale or acquisition by the creditors.
Will Sears Be Back?
Sears has basically bought a reprieve from liquidation by its sale to Eddie Lampert’s ESL Investments. But besides shutting some stores, reducing some of its massive debt, and changing ownership, it hasn’t really done anything to address the root causes of what led to Sears’ economic woes.
“It’s madness that Sears is back without even having a CEO,” Ellias said.