Will 2017 Be the Year of the Retail Bankruptcy?

Reprinted with permission from the March 13, 2017 edition of the New Jersey Law Journal © 2017 ALM Media Properties, LLC. All rights reserved.

Although we are less than three months into the year, it seems that 2017 is trending to be the year of the retail bankruptcy. Since the beginning of the year, The Limited, Wet Seal, Easte Mountain Sports and Bob’s Stores all have filed Chapter 11 petitions, and signs indicate more well-known retailers likely will follow suit. See The Limited Stores, Case No. 17-10124 (Bankr. D. Del.); The Wet Seal, Case No. 17-10229 (Bankr. D. Del.); In re E. Outfitters,Case No. 17-10243 (Bankr. D. Del.). Each bankruptcy case no doubt has its own unique set of facts. Several themes, however, recur in retail bankruptcies that are important to revisit given the filing trend. Specifically, this article highlights issues relating to gift cards, consignment arrangements and “going out of business” sales, which often arise during a retail bankruptcy case.

Gift Cards

When a well-known retailer files for bankruptcy, there are frequently significant liabilities outstanding with respect to unredeemed gift cards that were purchased prior to the petition date. For example, two weeks before RadioShack’s bankruptcy filings, approximately $44 million in unused gift cards was outstanding. See In re RadioShack Corp., Case No. 15-10197 (Bankr. D. Del. Feb. 5, 2015), Docket No. 7. Similarly, on the petition date of American Apparel’s first bankruptcy case, the company estimated an outstanding gift card balance of approximately $5.1 million. See In re Am. Apparel, Case No. 15-12055 (Bankr. D. Del. Oct. 5, 2015) Docket No. 10.

Although retailers in Chapter 11 often seek authority from the bankruptcy court to continue to honor “customer programs,” including allowing gift card holders to use their gift cards post-petition, not all retailers seek such relief. In American Apparel and RadioShack, for example, the debtors requested authority to continue honoring outstanding gift cards; however, no such relief was sought in The Limited.

Additionally, courts are inconsistent in their treatment of such gift card holders. In The Sharper Image bankruptcy cases, the claims of gift card holders were entitled to priority treatment, subject to a court-approved claims process. See In re The Sharper Image Corp., Case No. 08-10322 (Bankr. D. Del. June 9, 2011), Docket No. 2243. In the Borders bankruptcy cases, however, certain gift card holders who did not timely file proofs of claim were denied distributions altogether. See In re BGI Inc., f/k/a Borders Group Inc., 476 B.R. 812, 825 (Bankr. S.D.N.Y. 2012). In Borders, the gift card holders argued that they did not receive actual notice of the bar date for filing proofs of claim, and therefore their late-filed proofs of claim should have been allowed. The court rejected this argument, finding that the gift card holders were not “known” creditors for whom actual notice was required. Id. at 820-23.

Upon the bankruptcy filing of a retailer, holders of gift cards should be mindful of the company’s intentions to continue to honor gift cards. Consumers who miss the opportunity to use their gift cards must file a proof of claim if they want to participate as a creditor in the bankruptcy case.

Consignment

A consignment arrangement arises where a vendor delivers goods to a buyer/consignee, but retains title to those goods pending a sale of the goods to a third party.

In the bankruptcy case of a retailer, consignment vendors may assert that a portion of their claims is entitled to priority under section 503(b)(9) of the Bankruptcy Code on the basis that goods are “received” by the debtor when title passes from the consigner to the retailer. See 11 U.S.C. §503(b)(9) (providing administrative priority status for the “value of goods received by the debtor within 20 days before the” petition date). In the case of In re Circuit City Stores, 432 B.R. 225 (Bankr. E.D. Va. 2010), however, the bankruptcy court relied on the definition of “receipt” in the Uniform Commercial Code (UCC) to hold that, for the purposes of section 503(b)(9), goods are “received” by a debtor on the date that it takes physical possession of them. Id. at 230 (rejecting argument that section 503(b)(9) claims are tied to the date on which title passes from the consignor to the consignee); see also In re Plastech Engineered Prods., No. 08-42417, 2008 WL 5233014, at *3 (Bankr. E.D. Mich. Oct. 7, 2008) (“It is the goods and not the value that must be received by the debtor to trigger §503(b)(9).”) (emphasis in original).

Consignment issues also appear in the bankruptcy cases of retailers where a retailer seeks to sell consigned goods free and clear of consignment vendors’ interests in the goods. In Sports Authority’s bankruptcy cases, for example, numerous consignment vendors opposed proposed sales on the basis that they retained title to the consigned goods under their consignment agreements with the debtors (i.e., the consigned goods were not property of the bankruptcy estate). See, e.g., In re Sports Authority Holdings, Case No. 16-10527 (Bankr. D. Del. Mar. 2, 2016), Docket Nos. 9, 102, 106, 549. Although the issue of ownership ultimately was not decided by the bankruptcy court due to a settlement, the dispute highlighted that in order for a consignment vendor to ensure that its interests are protected in a bankruptcy filing by its consignee, the vendor must satisfy the requirements relating to consignment arrangements set forth in Article 9 of the UCC, notwithstanding language in its underlying consignment agreement. See id., Docket No. 2434.

Vendors that have a consignment arrangement with a struggling retailer should reconsider their delivery methods to protect against an argument by the retailer in a bankruptcy case that the vendor’s claim is not entitled to priority under section 503(b)(9) of the Bankruptcy Code. Moreover, those vendors should take all necessary steps to properly perfect their interests in the consigned goods under Article 9 of the UCC.

Going Out of Business Sales

The “going out of business” (GOB) sale is a frequently used mechanism in retail bankruptcies to maximize the value of inventory located at a retailer’s unprofitable locations. GOB sales, however, are subject to various restrictions, both in and outside of bankruptcy, that are essential for a retailer to understand before utilizing this strategy.

For example, GOB sales are subject to strict regulation by federal, state and local authorities and potentially restrictive real property lease provisions. Bankruptcy courts, however, tend to lean in favor of a debtor’s duty to maximize value for the benefit of the estate. Thus, bankruptcy courts almost unanimously grant relief from certain restrictions and impediments to permit a retail debtor to conduct a GOB sale. See, e.g., In re The Great Atl. & Pac. Tea Co., No. 10-24549 (Bankr. S.D.N.Y. Mar. 10, 2011), Docket No. 1004 (permitting GOB sales that did comply with certain “Liquidation Sale Laws”); In re Goody’s, No. 09-10124, 2009 WL 7812260, at *6 (Bankr. D. Del. Jan. 15, 2009) (permitting GOB sales notwithstanding certain restrictive lease provisions, including “go-dark” provisions).

The GOB sale process in the bankruptcy court is transparent and subject to court approval. The entity proposed to conduct the GOB sale (known as the “agent”) and the terms of that agent’s engagement (known as the “agency agreement”) are filed with the bankruptcy court. In fact, to conduct a GOB sale the retailer must file a sale motion seeking comprehensive relief including, among other things, approval to enter into the agency agreement with the agent. See, e.g., In re Alco Stores, Case No. 14-34941 (Bankr. N.D. Tex. Oct. 14, 2014), Docket No. 35. In connection with this approval, there often is a competitive bidding process during which a “stalking horse” agency agreement sets the baseline against which other competitive bids to liquidate the retailer’s assets are evaluated through an auction process. See, e.g., In re Circuit City Stores, No. 08-35653 (Bankr. E.D. Va. Jan 12, 2009), Docket No. 1460.

In any store closing situation, there are various competing interests. The bankruptcy court attempts to balance the interests of landlords, creditors, competitors, the agent and the public and impose reasonable restrictions on GOB sales while allowing a debtor to maximize the value of its inventory.

Conclusion

The bankruptcy case of a retailer is far from predictable. Indeed, various factors will dictate how the bankruptcy case of a retailer materializes, including, among other things, the jurisdiction in which it files, the contractual arrangements in place with its vendors and the deals it strikes with its creditors. As such, retailers filing for bankruptcy in 2017 should anticipate their cases to address certain of the issues highlighted above, as well as new issues unique to their businesses.