What Does It Mean When Retailers and Brands File for Bankruptcy?

What Does It Mean When Retailers and Brands File for Bankruptcy?

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Last week, Aeropostale filed for chapter 11 bankruptcy and announced it would close 154 of its stores across the U.S. and Canada.

“We have chosen to take more decisive and aggressive action to create a leaner, more efficient business that is well-positioned to compete and succeed in today’s retail environment,” Aerospotale CEO Julian Geiger said in a statement.

Aerospotale was once one of the most popular teen brands. But, last year it ranked amongst the top in Piper Jaffray’s semiannual Taking Stock With Teens Survey, which shows where teens are and aren’t shopping. Teen mall brands have struggled in the last few years, as more teens shop online and fast-fashion brands like Zara and H&M dominate the market. Last month, PacSun confirmed it was filing for chapter 11 bankruptcy. In October 2015, after failed attempts to turn the company, American Apparel filed for chapter 11 bankruptcy.

But what does it actually mean when a retailer or brand files for bankruptcy? 

Rick Ross gave a short explanation of bankruptcy during an interview with Angie Martinez (and made it clear that Jay Z and Diddy would never file for bankruptcy). But, here, Marc Roitman, business restructuring attorney at Ropes & Gray, breaks it down in detail and dispels any misunderstanding.

(This interview has been edited and condensed.)

What does bankruptcy actually mean?
I think there are a lot of misconceptions about what it means to file for bankruptcy. People who don’t work in the corporate world and don’t deal with restructuring often assume that bankruptcy means a company is going out of business entirely.

There are different chapters of the Bankruptcy Code. There’s chapter 7 and chapter 11 and there’s also chapter 9, chapter 15…There’s a lot of different chapters and they’re all different things with different meanings. Although also available to individuals, chapter 11 is most frequently considered a business bankruptcy chapter that allows businesses to reorganize and stay in business with less debt on its balance sheet. So, that means that post-bankruptcy the company will not have to pay as much in interest and possibly have reduced expenses.

Chapter 7, which is a liquidation chapter, means that the company that substantially all of the assets of the bankrupt company will be sold through a liquidation sale, with the proceeds distributed to creditors. A company can also liquidate under chapter 11—some companies, in fact, do that. The main difference between chapter 11 and chapter 7 is that the board of directors and management of the company usually stay in control of the company in chapter 11, while a company in chapter 7 is controlled by a bankruptcy trustee, who’s an independent person appointed to run the liquidation.

You mention there are several chapters you can file for. Are chapter 7 and chapter 11 the ones brands and retailers usually file for?
For businesses it’s really just chapter 7 and chapter 11. There’s chapter 9, which lets cities and towns file for bankruptcy, and chapter 13, which is an alternative pay-out plan process available to certain individuals. Chapter 15 is an international restructuring where a foreign company that is in an insolvency proceeding in a foreign country can ask the U.S. Bankruptcy Court to recognize the results of the foreign bankruptcy proceeding. Generally, a U.S. company will file for bankruptcy under either chapter 7 or 11.

If companies file for bankruptcy, at what point does that actually mean they have to close stores? Or is that a matter of choice?
When a retailer files for chapter 7, it will stop operating and close its stores or sell them to another company. In chapter 11, a retailer will have no choice but to close stores where it cannot continue to pay the rent. If it can afford to pay the rent, the retailer will either keep the lease and continue to operate the store, sell it to a qualified buyer, or terminate the lease because the rent is too high or the location is no longer attractive.

Does filing for bankruptcy mean a company is in debt?
Debt is not a bad thing. Too much debt is a bad thing. Having debt doesn’t mean that a company is in distress. Almost every significant company has debt. The question is whether a company is over-leveraged, meaning that it has too much debt. If cash flow can support the company’s debt payment obligations, then a company does not have too much debt. Bankruptcy is often a result of having too much debt. A lot of times, companies are making a lot of money. They have a pretty successful business by most measures and would be profitable, except that their operating profits get eaten up by paying interest on their enormous debt. If they could restructure those debts and reduce their debt burden then they could be a very viable and successful company moving forward. The chapter 11 process often allows operationally profitable, but over-leveraged, companies to continue to operate by reducing the debt burden.

Can a company come back from filing for bankruptcy?
Absolutely, if the company files chapter 11 rather than chapter 7. If you looked at a list of well-known companies that have filed for bankruptcy you’d be amazed to see plenty of major companies that are doing business today. For example, many currently operating airlines have filed for bankruptcy. GM and Chrysler have filed for bankruptcy. In fact, Macy’s and Bloomingdale’s have been in bankruptcy. Filing for bankruptcy does not necessarily signal that a company is not viable as a business operation. Often, it means that it just borrowed more money than it could afford.

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