Chapter 22 Is Not Necessarily a Bad Thing

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Originally written for and published by ABL Advisor, September 2019

The feasibility requirement in the U.S. Bankruptcy Code requires a finding from the Bankruptcy Court that “confirmation of a plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.”

The recent deluge of Chapter 22s, particularly in the retail sector, seems to suggest a check on feasibility is missing. In 2019 alone, Charming Charlie, Gymboree, and Payless all refiled for bankruptcy within 24 months of exiting from a prior bankruptcy with a plan of reorganization confirmed and supported by their constituents. In hindsight, it appears the restructurings did not go far enough to adapt their business models to be competitive in the Amazon-disrupted retail environment. But does that mean these companies should have been liquidated rather than emerge with a plan of reorganization doomed to fail? Let’s examine.

Charming Charlie

Founded in 2004, Charming Charlie sells a wide assortment of jewelry, handbags, apparel, gifts and beauty products, with the merchandise organized by color. The company initially filed for bankruptcy in December 2017 and emerged from Chapter 11 in April 2018 with a court-confirmed plan of reorganization supported by all major constituents and funded by a multi-billion-dollar alternative credit investment manager. The plan ultimately failed and the business filed for Chapter 22 in July 2019.

In the approximately 16 months in which the business operated post-initial filing, it employed 3,000 full-time and part-time employees, occupied and paid rent on 390 retail locations, contributed to the local economy of the locations in which it operated, allowed its vendors to continue to supply goods and services, while creditors from the initial bankruptcy received what they agreed to.

Had the bankruptcy court determined feasibility was missing from the plan and steered the company to liquidation at the time, then all of these benefits would have been lost. The sophisticated multi-billion-dollar alternative credit investment manager did its own risk analysis and decided to proceed, so why should the court be responsible to second guess the investor to save it from itself?

Gymboree

Gymboree was a private-equity-owned children’s clothing retailer that operated three distinct brands. At the time it initially filed for bankruptcy in June 2017, it was operating about 1,300 retail locations. The business emerged from Chapter 11 in September 2017 with a confirmed plan that called for the closure of 390 stores. The plan was financed by a group of the company’s lenders-turned-owners. Gymboree filed Chapter 22 in January 2019 and was ultimately liquidated.

In the period between bankruptcies in which the business operated, it employed approximately 10,000 full-time and part-time employees, occupied and paid rent on 900 retail locations, contributed to the local economy of the locations in which it operated, and allowed its vendors to continue to supply goods and services.

Again, had the bankruptcy court determined that feasibility was missing from the plan and steered the company to liquidation at the time, then all of these benefits would have been lost. The owners were savvy lenders turned owners and assessed that supporting the plan was a risk they could accept.

Payless

Payless was a private-equity-owned shoe company that engaged in worldwide sales of low-priced footwear. It initially filed for bankruptcy in April 2017 and emerged from Chapter 11 in July 2017 with a confirmed plan financed by a group of hedge fund creditors. No credible contest to feasibility was launched at confirmation. Payless filed Chapter 22 in February 2019 seeking to liquidate its North American assets.

In the ensuing period, the business employed approximately 16,000 full-time and part-time employees, occupied and paid rent on 3,500 retail locations, contributed to the local economy of the locations in which it operated and allowed its vendors to continue to supply goods and services.

Again, had the bankruptcy court determined that feasibility was missing from the plan and steered the company to liquidation at the time, then all of these benefits would have been lost. The owners were savvy hedge fund creditors who ought to have known the risks associated with financing the plan of reorganization.

The other beneficiary in all of the above are the bankruptcy professionals involved in each filing.

Is Enforcing the Feasibility Requirement Feasible?

There is a lot of similarity in the above cases. In the absence of a contested plan, should the court or the United States Trustee have independently required more evidence of feasibility before the plans were approved?

Strict interpreters of the Bankruptcy Code would argue that an affirmative finding of feasibility and that retail debtors are incapable of meeting that burden unless their business models have been altered. The agreement of the constituencies to a plan is not enough. This view assumes that a Chapter 22 filing is indicative of failure. However, as outlined above many stakeholders benefited from the businesses attempting to execute their plans of reorganization. One could argue that there is an opportunity cost to employees, landlords, and creditors when business have no justifiable reason to exist other than as purely an “option.”

However, many of these stakeholders would likely agree that “a bird in hand is better than two in the bush.”

Is it better to try again and fail again rather than to have never tried again? I think so.