Retailers run a win-or-die sprint when they file for bankruptcy

When Anna's Linens Inc. entered Chapter 11 in June, its lender gave the chain just five days to avoid liquidation, making the family-run business an extreme example of a U.S. bankruptcy landscape that's increasingly tilted against retailers.

The home-furnishings company could never complete a sale that fast. So Anna's sold the merchandise in its 261 stores, fired its 2,500 employees and disappeared.

Failure is now the norm for shopkeepers trying to reorganize: 55 percent of large brick-and-mortar retail bankruptcies end in liquidation, a recent study found, compared to 5 percent for other industries.

Along with Anna's, Borders Group Inc., Circuit City Stores Inc. and Linens 'n Things Inc. had to shut their doors in recent years. That's in part because bankruptcy law changed in 2005, letting landlords give retailers just 210 days after filing for Chapter 11 to decide whether to drop their leases. It's also because the lenders providing emergency loans to troubled stores are now issuing even more stringent terms for their money, as Anna's found with its five- day ultimatum.

The law "doesn't give any chance to anyone to use the bankruptcy process the way I believe it was designed," said Holly Etlin, a managing partner at AlixPartners LLP and one of the authors of the study, which was released last month.

The report didn't look at how stores fared prior to the law change. But lawyers who worked on large retail bankruptcies before 2005 say their clients may not have survived under today's rules.

"Numerous successful Chapter 11 reorganizations of retailers prior to 2005 would have had a more difficult time or possibly may not have been able to reorganize at all because of the 2005 legislation," said David Heiman, lead bankruptcy attorney for Macy's 1990 reorganization.

If retailers miss the deadline, the courts give the landlord priority to demand repayment for the money they're owed, over the lenders who provide emergency financing during a bankruptcy.

These debtor-in-possession lenders normally expect to be at the front of the repayment queue, so to keep that spot, they now typically shorten their own deadlines for a retailer to reorganize or liquidate, putting them back ahead of the landlord. In Anna's case, Salus Capital Partners LLC provided the money it needed to stay afloat when it ran into trouble with a bank it had previously relied upon. In exchange for the July 2014 loan, Anna's agreed to hire a liquidator while looking for a buyer. While it got interest and had the outlines of a deal in hand, five days wasn't enough time to close the deal.

'Wasn't enough time'

Salus spokesman James Hart said in an emailed statement that the firm gave Anna's the "liquidity it needed to execute a turnaround plan" almost a year before it filed for bankruptcy.

"Anna's had a good name," the retailer's attorney, David B. Golubchik, said. "There wasn't enough time."

With DIP lenders shortening their deadlines to stay ahead of the landlords, companies now often have 120 to 150 days to revamp their business, find a buyer, close underperforming stores and convince creditors to take less than full payment. That's not enough time, the American Bankruptcy Institute has concluded.

The ABI has called on Congress to extend the lease- rejection deadline to a full year, though the proposal has yet to be taken up. One of the people who convinced ABI to push for the reform is Jack Butler, who led the biggest U.S. retail restructuring ever: Kmart.

Kmart's legacy

"It would have been very challenging to have successfully restructured Kmart in today's environment where lenders and other stakeholders want solutions in the first several months of a retail bankruptcy case to meet calendar milestones," Butler said.

Mall owners and other landlords fought for time limits because Kmart - and Macy's a decade earlier - took years to decide which leases to cancel and which to keep. That makes it difficult for landlords who don't know whether they'll need to find new tenants should the bankrupt company decide to close shop.

Before 2005, retailers could spend years in bankruptcy. The holding companies behind Macy's filed in 1990 and spent almost two years reorganizing about $8 billion in debt.

In contrast, RadioShack Corp. wrapped up the bulk of its bankruptcy in just four months. As its debts mounted, Heiman - who founded Jones Day's restructuring practice - developed a strategy for the long-suffering consumer-electronics retailer to cope with the stringent deadlines. By the time it filed in February, the company had a plan in place to close about half its stores and sell the rest to shareholder Standard General LP.

'One shot'

The judge let RadioShack hire a professional liquidator to shutter the closing stores while the Standard General deal was wrapped up, said Greg Gordon, the Jones Day partner who handled the bankruptcy.

"We knew we only had one shot in a very limited period of time," Gordon said.

Another revision in 2005 upped the pressure on retailers: Any debt a chain incurs to stock its stores in the 20 days before a bankruptcy filing must be repaid in cash. That takes priority over almost everything including bank loans, DIP loans and secured bonds.

That's what helped kill Circuit City, which filed for bankruptcy in November 2008. The consumer-electronics chain planned to close some stores and either sell the rest or exit bankruptcy as a leaner, independent operation.

'Slide into liquidation'

But time ran out and the company shut down.

The "slide into liquidation was certainly hastened by the $350 million" in supplier debt it built up just before bankruptcy, according to the AlixPartners study.

Another victim was Borders, which filed in 2011 as Amazon.com Inc.'s rise challenged traditional booksellers.

Then-president Mike Edwards was convinced that all Borders needed was time, but lenders imposed a quick deadline to prove he had a viable business model or find a buyer.

Borders was making progress but was forced to liquidate, Edwards said. "It would have taken a year or two to execute the strategy."