Sears faces tough foe: an unforgiving bankruptcy code

When Sears Holdings Corp filed for Chapter 11 bankruptcy on Monday, it said it would close another 142 unprofitable Sears and Kmart locations and seek to reorganize around financially healthier stores.

It also triggered a "time bomb" that retailers have had a tough time surviving.

Over the last dozen or so years, bankrupt retailers have had less time to make major strategic decisions for their survival and landlords and lenders have had more leverage in the process.

The change stems from a 2005 legislative overhaul of the bankruptcy code that forced companies to find an agreement within seven months on its real-estate leases, or allow landlords to walk away from the agreement. Previously, companies would spend a year or two working out a viable survival plan.

Restructuring specialists blame the shorter timeframe for the rapid liquidations of chains such as Circuit City, Linens 'n Things, the Borders book store chain and Toys 'R' Us.

The law intensifies the pressure on Sears and Chairman Eddie Lampert to restructure the company and turn it into a relevant, viable business.
"They have less money and a shorter period of time to make decisions," said Ted Gavin of the Gavin/Solmonese restructuring advisory firm. "There's more transactional risk."

Sears did not respond to requests seeking comment. A spokesman for Lampert declined to comment.

To be sure, jeans company True Religion Apparel Inc, Perfumania Holdings Inc, Payless ShoeSource, Gymboree Corp and Harry & David in recent years have all successfully navigated Chapter 11.They did so within the tighter timeframe that Sears now confronts.

Many of the chains that successfully reorganized in recent years were able to negotiate lower rent payments from landlords, who were willing to work with a troubled company rather than risk finding another tenant amid a surge of store closings.

On Monday, Reuters reported that many large U.S. malls and shopping centers that are controlled by real estate investment trusts have waited years for Sears' demise. They will now be able to raise rents on contracts, some of which were signed more than 20 years ago.

Earlier in the day, a bankruptcy judge approved $300 million in financing to keep Sears open through the holiday season. Sears is also considering the sale of "a large portion" of its stores and said they could be bought by Lampert's hedge fund in a bankruptcy auction.

Prior to 2005, retailers approached bankruptcy differently. Chains, such as R.H. Macy & Co, would typically pile up cash at the year-end, seek protection from creditors in January and then spend at least a year or two working out a viable business plan.

After landlords complained to Congress about bankrupt "ghost tenants" that tied up key locations in a mall or strip center, lawmakers responded by adding the time limit on leases in the Bankruptcy Abuse Prevention and Consumer Act of 2005.

This seemingly simple change has been blamed for plenty of failed retail turnarounds and had an immediate impact on the length of cases.
Half of bankrupt retailers reorganized successfully prior to the 2005 law, but just 12 percent did so afterwards, based on a 2014 study by Lawrence Gottlieb, a bankruptcy lawyer with Cooley.

Gottlieb also found the average case was cut to three months from 12 months prior to 2005 law. More and more retailers began liquidating, or quickly closing weak stores and finding a buyer for the much smaller chain that emerged from bankruptcy, something Sears is considering.

Lenders that provide money to carry a retailer through its restructuring have been the drivers of the compressed timeframe for bankruptcies. Lenders generally use a company's inventory as collateral, so they demand short cases to ensure the inventory can be sold before the retailer is kicked out of its store locations.

For example, Sears' lenders are providing $300 million for its restructuring and demanded the company has a plan of reorganization approved by the bankruptcy court in less than seven months.

One question is how well Sears and Kmart will manage to scrape by in the forthcoming holiday season.

When Toys R Us went out of business earlier this year, its liquidation left a large gap in the toy retail marketplace, which competitors like Walmart, Target Corp and others rushed to fill.

Sears share of the overall retail industry has shrunk to about 0.4 percent from 5.4 percent a generation ago, said Craig Johnson, president of consultancy Customer Growth Partners.

Appliances, electronics and home improvement products make up the bulk of Sears' revenue and generated about $7.2 billion in annual sales last year.

According to a study led by UBS analyst Michael Lasser in February, some appliance sales could leak to Amazon.com Inc as it now carries the Sears Kenmore appliance range, he said.

Eighty percent of Sears stores are within a 15 minute drive of Home Depot , Lowe's and Best Buy , and 71 percent of Kmart stores are located within 15 minutes of a Walmart Inc supercenter, he estimates. The retailer has shut down several stores since then.

Todd Zywicki, a law professor at George Mason University Antonin Scalia Law School, said getting ailing stores out of anchor locations and replacing them with an exciting new concept benefits an entire shopping center.

"There was a built-in time bomb," he said of the 2005 law. He said a chain does not need years to decide to keep a store location. "A lot of times you're delaying the inevitable."