Chapter 11 bankruptcies are often perceived as solely reorganizations, especially since Chapter 7 is limited to liquidations under the supervision of a disinterested trustee. However, sales and liquidations are also permissible uses of Chapter 11 and are frequent outcomes in retail cases.
Reorganization
Retailers often use Chapter 11 to reorganize by cleaning up their balance sheets, reducing their lease portfolios, and streamlining operations (e.g., Belk, Rue21). One way that’s done is by a pre-bankruptcy agreement—often in the form of a Restructuring Support Agreement (RSA)—that sets the terms by which lenders restructure certain debt and perhaps advance additional financing to support the company’s continued operations amid various required milestones (deadlines) to keep the debtor on track. Frequently, an RSA is structured so that the pre-bankruptcy lenders become the majority equity holders through a debt-for-equity swap and is often criticized as predetermining a plan.
Sale as a Going Concern
Many companies enter bankruptcy looking to sell their business (e.g., Forever 21, JC Penney) under Section 363 of the Bankruptcy Code. These “363 sales” may occur by way of a private sale or a public auction process. In an auction process, a debtor may have a “stalking horse” bidder—a buyer that sets the floor and is generally granted certain bid protections, such as an expense reimbursement of a break-up fee if they are not the successful bidder. Before the debtor can implement a sale timeline and bidding, notice, and hearing procedures, they must provide parties in interest with notice and seek court approval. “363 sales” are free and clear of liens, claims, and encumbrances, but lease assumption and assignment requirements (Bankruptcy Code Section 365) still apply. While public auction sales are subject to higher or better offers, private sales are not, but they can be challenged based on other possible bids.
Liquidation
A retail bankruptcy may begin as a liquidation (e.g., Modell’s) or pivot to one during the case (e.g., Pier 1). In either scenario, the company will conduct inventory clearance sales, the stores will close, and the leases will be rejected (or potentially assigned, typically on a limited basis). Store closing sales are usually conducted by specialized inventory liquidators retained by debtors to maximize the value of the inventory. Many landlords enter into “side letter” agreements with the liquidators to govern the conduct of these sales, which are negotiated out of court and not filed.
Chapter 11 Plan
This is the document that concludes a Chapter 11 case unless it is dismissed or converted to Chapter 7 (there are no plans in Chapter 7). It is a contract between the debtor and their creditors that governs parties’ rights and obligations. There are differences between a plan in a “regular” Chapter 11 case as opposed to one under Subchapter V (the small business version of Chapter 11), including by when the plan needs to be filed, whether a disclosure statement is required, and who may file a plan. Future issues of Bankruptcy Basics will delve more deeply into the increasingly important Subchapter V.
Later this month, Issue 5 of Bankruptcy Basics for Retail Landlords will build on this piece by providing a comparison of Chapter 11 and Chapter 7.