Second Rite Aid Bankruptcy Underscores Importance of Vendor Role

Rite Aid’s return to bankruptcy within a year after completing its prior Chapter 11 shows that when critical vendors aren’t prepared to move forward with business as usual, even a carefully crafted plan risks failure.

The pharmacy chain exited its first bankruptcy in August 2024 after striking deals with lenders, bondholders, and creditor committees in a hard-fought restructuring that lasted nearly a year.

Judge Michael B. Kaplan of the US Bankruptcy Court for the District of New Jersey approved Rite Aid’s plan, but the company never fully normalized relationships with major vendors once it emerged.

The second Chapter 11, filed May 5 and under which the company will sell off its assets, is the result of overly optimistic expectations of how vendors would behave post-bankruptcy, said Ivan M. Gold of Allen Matkins Leck Gamble Mallory & Natsis LLP, who represents Rite Aid landlords.

“You cannot expect that vendors after the first bankruptcy are going to forget what just happened,” Gold said. “They’re going to be understandably conservative, understandably bearish.”

‘Suffocating’ in Bankruptcy

Rite Aid’s former CEO and Chief Restructuring Officer, Jeffrey Stein, said in a deposition last June that the company was “suffocating” from the bankruptcy’s costs and administrative burdens.

“There are companies in other industries that I’ve been a party to that, other than the annoyance of the cost and the distraction, can operate perfectly fine in bankruptcy,” Stein said during the deposition. “This is not one of those companies. This is not one of those industries.”

Rite Aid had “no support from its trade creditors” and limited funding for its inventory, putting enormous pressure on comparable store sales while cutting into liquidity and requiring more financing, Stein said.

Kaplan shared Rite Aid’s concerns in a hearing that same month, saying the case was “extended beyond anybody’s wildest expectations.”

While Rite Aid expected its front-end sales to decline about 5% in fiscal 2025 due to “bankruptcy-related disruptions,” they were projected to grow by about 9% “due to normalization” in fiscal 2026, according to its reorganization plan.

Systemic Weaknesses

Kaplan, in approving the plan last year, recognized that Rite Aid faced eight months of negotiations and obstacles that left it near liquidation, including an over-leveraged capital structure, tort litigation, regulatory investigations, retail operational issues, and lease obligations.

“I would certainly offer this Chapter 11 case for consideration as an example of the strengths of the bankruptcy court as a viable centralized forum providing financially distressed companies with opportunities to address enterprise-threatening litigation and wide-ranging financial hurdles,” the judge said at the time.

Rite Aid spent about $355 million in professional fees and expenses in its prior bankruptcy, including $125 million for financial adviser Alvarez & Marsal North America LLC and almost $57 million for bankruptcy counsel Kirkland & Ellis LLP, according to court papers.

Courts sometimes are inclined to approve deals that have key stakeholder support even if a more careful analysis of plan feasibility is needed to avoid repeat filings, known colloquially as Chapter 22, said Edward Altman, a professor emeritus at New York University’s Stern Business School who studies bankruptcies.

“There are weaknesses in the system, no question about it. And one of the weaknesses is Chapter 22,” Altman said. “Can it be improved? I believe so, by doing a more careful job on feasibility—one that doesn’t rest on vested interests to have the firm come out as quickly as possible.”

Reality Sinks in

McKesson Corp., Rite Aid’s biggest drug supplier, absorbed a $725 million charge on its balance sheet via unsecured claims in the first bankruptcy, according to public records.

The pharmaceutical distributor gave Rite Aid favorable future pricing terms as part of the restructuring plan, but it cut the time Rite Aid could pay its bills from roughly 20-30 days to 7-10 days based on performance.

McKesson also required its future trade credit obligations to be secured with a second lien on Rite Aid’s assets, placing that debt behind first-lien lenders.

Second-lien bondholders, instead of converting most of their debt to stock, received new third-lien debt behind the first-lien lenders and McKesson.

Rite Aid’s feasibility projections were based on economic terms its management said were reasonable but subject to “material change,” according to court papers.

But “Rite Aid’s reality quickly became very different than what we all expected,” said attorney Alice Eaton of Paul, Weiss, Rifkind, Wharton & Garrison LLP during a May 7 hearing.

She cited health-care and retail industry challenges, unforeseen issues with nonpharmacy vendor trade terms, liquidity access, and changes in consumer behavior, including low- and fixed-income customers who shifted away from purchasing high-margin household goods at the store.

Vendor Meltdown

Gold noted that fabric retailer Joann, which also filed bankruptcy for a second time less than a year after emerging from its first, also faced post-bankruptcy vendor relationships problems and financial projection issues.

Most of Rite Aid’s front-end vendors refused to loosen payment terms and kept about 40% of their deposits, leading to inadequate cash flow to restock shelves, Rite Aid said. Declining inventory hurt Rite Aid’s borrowing ability, further restricting liquidity as it hit its critical fourth quarter when pharmacies generally have their highest sales, Eaton said.

By February, in-stock rates fell to 55%, Rite Aid said.

A second bankruptcy in two years is a “very short time” to refile and a “failure of both the professionals who filed the first case and the judge who confirmed the plan,” said Lynn LoPucki, a law professor at the University of Florida Levin College of Law.

LoPucki questioned why Rite Aid didn’t consider shifts in consumer behavior before proposing its earlier plan, in light of the quick negative reaction from its suppliers.

“Basically, Rite-Aid got a plan confirmed, but their suppliers didn’t believe it would work,” LoPucki said.