With each passing day that the coronavirus pandemic wears on, there are new statistics in the news making headlines, not just regarding the health and well-being of citizens all across the country, but also about which latest retailer is filing for bankruptcy. This May, clothing giants JCPenney, Neiman Marcus, and J.Crew all announced they are filing for Chapter 11 bankruptcy protection (not to mention this week’s filing by RTW the parent to New York & Company), which typically involves a reorganization and restructuring of a debtor’s business affairs, assets, and outstanding debts.
Many of these retailers had already been experiencing financial difficulty prior to the onslaught of economic struggle that many businesses have gone through since the pandemic broke out globally in March 2020. In fact, JCPenney filed for bankruptcy protection on May 15, 2020, “…after a prolonged decline over the past 20 years, becoming the latest and largest retailer to fall during the coronavirus pandemic, which has devastated the industry,” as the NY Times so aptly stated. Large clothing companies that have been around for decades have thrived during a period when many buyers were purchasing items in actual stores, whereas within the past several years, even before the pandemic, consumers turned more and more to the convenience of Internet shopping. Yet amid this evolving landscape investors steadily invested life-support into these dying giants with the hopes that brick and mortar stores might retain sufficient revenue in a highly saturated market.
One potential reason for these recent failures is that many larger-scale retailers simply cannot cope with the significant costs associated with operating so many physical stores (JCPenney for instance has over 800 chains nationally). Frankly, the costs of paying rent, replenishing inventory (often for thousands of brands), and paying employee wages and benefits can simply destroy a retailer’s ability to manage a downturn in business. Another possible reason for these recent bankruptcy filings is that many of these retailers have been around for so long that they have had difficulty connecting with younger consumers who purchase merchandise in a different way than before. Neiman Marcus was founded in 1907, some 40 years before J.Crew. As some business reporters and fashion critics have observed, “Each was facing a host of issues before the coronavirus pandemic forced them to close their stores and eventually file for bankruptcy, including trouble adjusting to the rise of e-commerce and a lack of connection with a new generation of shoppers.” No matter the reason, it is clear now that, should other retailers meet the same fate as these behemoths, businesses need to know the specific financial circumstances that may lead them to file for Chapter 11, the ins and outs of bankruptcy law, and how the entire process works, in order to protect themselves moving forward in a post-COVID-19 landscape.
Jared Ellias, a professor of law and the director of the Center for Business Law at University of California, Hastings College has said that “[w]hen a company files for bankruptcy, it’s because it made promises it can’t keep.” Ellias explained:
Usually when you have a big retailer like Neiman Marcus, the promises they can’t keep are the ones they made to lenders that loaned the money, to landlords who give them space that they haven’t been able to use effectively and sometimes suppliers that they order clothes from that they haven’t been able to sell.
When a company understands what actions or steps led them to the point where they are contemplating bankruptcy, then the next step is to know and understand the purpose of filing, which can differ greatly from company to company.
The primary purpose of filing for Chapter 11 is to allow a company to reorganize itself, restructure its debts, and pay creditors over a period of time. Experts have observed, “… you see a company end up in Chapter 11 when they run out of cash… Presumably, these companies tapped into every resource and weren’t able to make enough cash to remain operational. That’s when you turn the page and—bang—Chapter 11.” Allowing a company to file for Chapter 11 enables them to avoid complete closure and discharge certain debts, thus moving forward with a clean slate, and starting over with a revised structure of debts, plans, and assets.
Now that the “why” of filing for bankruptcy is settled, it is important to know when and how undergoing that process should occur. In terms of when, many advisors indicate that there “… is no ‘perfect’ time, but there is a good rule of thumb to keep in mind when you’re asking yourself the question: should I file for bankruptcy? If it is going to take more than five years for you to pay off all your debts, it might be time to declare bankruptcy.” If it is clear it will take a company a considerable amount of time or years to pay their debts and start fresh, then that is a good indicator that now may be an appropriate time to file for bankruptcy.
So, when a company has determined that they will file for bankruptcy, how does that process actually work? In the case of large conglomerate retail stores like J.Crew and Neiman Marcus, an experienced bankruptcy attorney, or team of attorneys, will likely be necessary to begin navigating the very complex process of initiating a Chapter 11 case. These steps include convening creditors’ committees, negotiating plan proposals, and strict reporting requirements, all the while subject to the leverage of voting rights for certain classes of creditors. However, recently, the Small Business Reorganization Act of 2019 (commonly called Subchapter V, or SBRA) has enabled some small businesses to file for bankruptcy in a more efficient and affordable way providing smaller businesses more access to bankruptcy protections.
If a small business with less than $2,725,625 in debts is going down a path of financial trouble, SBRA includes provisions aimed at streamlining the reorganization process for debtors who would otherwise be forced to navigate the more costly Chapter 11 process. These processes include the appointment of a trustee to more actively facilitate the reorganization, fewer discharge limitations, and, arguably the most powerful process, the ability to modify a residential mortgage (this is especially useful for home-business owners). Before the SBRA was enacted, if a small business was struggling and wanted to restructure its debt, the only option would be to file for Chapter 11 under the traditional provisions. This option would, among other things, force small business owners to seek creditor approval on certain matters while often some creditors stood empowered to disrupt the reorganization at many critical points.
If a business owner has no further incentive or intention to keep operating a business, they should consider hiring an attorney to help them wind down operations – however, if they still believe their business has legs and can become viable, filing for Chapter 11 bankruptcy may be the best option. It is usually recommended for businesses, especially in the context of COVID-19, to write a business plan that will be effective in a post-pandemic business world, determine where their future revenue will derive from, understand which types of expenses will help improve their business (such as marketing, social media, or infrastructure), and outline goals that will improve their financial statements. Companies that file should keep in mind the overall impact of filing for Chapter 11 – in the words of an experienced bankruptcy attorney, a “Chapter 11 bankruptcy is designed to fix people’s balance sheets… it allows you to restructure some debt, eliminate other debt. It doesn’t generate revenue for you.”
In early July 2020, New York City entered Phase 3 of the re-opening process, yet it is still not clear what the continuing effects the pandemic will continue to have on the fashion industry, national chains, mass retailers, or small businesses. In the past several months, various large clothing companies have had to make some difficult decisions, and there is a likelihood there may be more examples of that to come, but it is important for all fashion businesses, large or small, to know what their options are, what the bankruptcy process and laws involve, and which goals to keep in mind moving forward.
Elizabeth Vulaj is an attorney admitted to practice law in New York and New Jersey. She practices in commercial litigation and intellectual property, and has written for publications such as Law360, the New York State Bar Association Journal, and the New England Law Review, among many others. She has a B.A. in journalism from SUNY Purchase, an M.A. in journalism from New York University, and a J.D. from the CUNY School of Law.
Suggested citation: Elizabeth Vulaj, Restructuring and More During COVID-19: The What, How, and Why of Chapter 11, JURIST – Professional Commentary, July 14, 2020, https://www.jurist.org/commentary/2020/07/Elizabeth-Vulaj-What-How-Why-of-Chapter-11/.
This article was prepared for publication by Michael Barber, Chief of Staff. Please direct any questions or comments to him at chiefofstaff@jurist.org
