Retail Bankruptcies Add To Economic Woes

June 4, 2008
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A combination of tightening credit, increasing debt and decreasing sales is sending a lot of U.S. retail chains into a bankruptcy tailspin. And as chains shutter stores, they’re changing the landscape of suburban malls and shopping strips, leaving malls without their anchors and landlords with a growing number of vacant spaces to fill.

Consumers have cut back on discretionary spending because of the credit crunch, the housing market slump, and increasing gas and food prices. Plagued by declining sales, midsized chains such as The Sharper Image, The Bombay Co., Levitz Furniture and Lillian Vernon have sought bankruptcy protection, blaming weak holiday sales and a struggling economy for their demise.

Retailers that serve the less-than-well-heeled consumer are taking a hit, while high-end retailers don’t appear to be getting squeezed, noted Attorney Patrick Mears, a partner at Barnes & Thornburg. Mears is co-chair of the firm’s finance, insolvency and restructuring department.

Obviously, those bankruptcies have a ripple effect on the economy in terms of job losses, decreased work for suppliers and higher retail vacancy rates. Too, retail landlords hold mortgages, and they rely on rent payments to service their mortgages.  

The big story now is the bankruptcy of national home goods retailer Linens ’n Things. On May 2 the company filed for Chapter 11 in Delaware and announced its plans to close 120 underperforming stores. In an affidavit, CFO Francis Rowan said that the subprime crisis, plus the debt load the company took on after being acquired by a private hedge fund in 2006, has really crushed the company. SEC records show that as of Dec. 29, 2007, Linens ’n Things had $1.74 billion in total assets and $1.42 billion in liabilities. Locally, the company has stores in Kentwood, Walker and Grandville. All three are slated to close.

When a retail chain files for bankruptcy, normally what it will do is to either reject the leases of its underperforming stores or try to sell the store leases to a buyer, Mears said

“Then they’ll try to keep what they consider the profitable stores and continue to operate those,” he said. “They may shift their focus, too. They might find in the course of the bankruptcy that certain product lines are fine and others are not, so they’ll get rid of those. They would then propose a plan of reorganization that would call for the emergence of a newly structured company with a lower debt load and a healthier balance sheet to come out of bankruptcy.”

Some retailers are downsizing in an effort to ride out the economic storm. Over the next 12 months, for instance, Foot Locker will close 140 stores, and Ann Taylor has targeted 117 stores for closure. But there’s a problem with downsizing that makes bankruptcy almost a better alternative, Mears said. Linens ’n More, for example, wants to shutter 120 stores. One way of doing that is to sell the store leases, but right now nobody is buying. The other alternative would be to get a termination of the leases. If a store is two years into a 10-year lease, the landlord might want payment for all the rent he’s going to lose. The company could try to negotiate a settlement on the lease for a reasonable amount, but often, that isn’t possible, Mears said.  

“However, if a company files for bankruptcy and rejects a lease on an unprofitable store, the amount of the claim the landlord is going to have against the debtor in bankruptcy is going to be a much smaller amount than what they would normally have under state law,” Mears explained. “Under state law, the landlords are entitled to greater damages. There’s a provision in the bankruptcy code that specifically limits the claims of landlords.” 

There’s some indication that the subprime crisis is heading to Europe. The British Consumer Confidence Barometer fell in April to its lowest level in more than 15 years. The consumer confidence index, which had declined sharply in March, fell further in April, from 65.9 to 62.3. The Confederation of British Industry reported that poor weather, an early Easter and a slowing economy led to the worst month (April) for retailers since November 2005. Germany is being hit too, Mears said, but not quite as hard as England.

“The concern in Germany is with inflation. The growth in its economy has slowed significantly in the past three months,” Mears observed. “German economists are concerned that the subprime crisis is going to migrate to Europe and affect Germany. The group that will probably be hit the hardest is the retail industry, because consumers will decrease their spending.” LQX

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