Bankrupt Retailers: Pushed to the Brink

On Feb. 19 the electronic gizmo retailer Sharper Image filed for Chapter 11 bankruptcy protection. As part of its court filing, Sharper Image management committed to its lenders to close 90 of its 184 stores. But within weeks, newly appointed Chief Executive Robert Conway decided to liquidate the rest of the stores. Conway, who is a principal at turnaround specialist Conway, Del Genio, Greiss & Co., reached the conclusion that it would be nearly impossible to secure adequate financing to restock the remaining 94 stores. "We didn't want to delay the process to a point where there would be no value left, and we decided liquidation was the best option. The last few stores closed at the end of July," says Conway.

But the final nail in the coffin for Sharper Image came three years earlier, when U.S. bankruptcy law was revised to add cash payments to utilities and other suppliers, and place a 210-day cap on the amount of time bankrupt companies have to decide whether to keep a lease.

No Time to Reorganize

The rapid dissolution of Sharper Image took many in the bankruptcy industry by surprise. But that chain isn't alone. Several retailers that have filed for Chapter 11 protection (BusinessWeek.com, 7/21/08) since the economy started swooning have unraveled just as quickly: Wickes Furniture closed down its 36 stores. Friedman's is in the process of selling off jewelry and is closing its 377 stores, while Whitehall Jewelers is liquidating its 300 stores. All these companies filed for bankruptcy reorganization in 2008. And in December 2007, Bombay Co. and Levitz closed all their stores.

The new provisions in the bankruptcy law—pushed primarily by mall owners, suppliers, and utility companies, and signed by President George W. Bush in 2005—were intended to shorten the time that a company stays under court supervision. The point was to protect creditors, who sometimes had to wait years for payments while lawyers racked up hefty fees and managers collected big pay packages. "There was a pattern in some bankruptcy courts of granting extensions for as long as the debtor wanted, and that had to be stopped," says Lynn LoPucki, a professor at the University of California at Los Angeles School of Law and author of Courting Failure: How Competition for Big Cases Is Corrupting the Bankruptcy Courts.

Not everyone thinks sick companies should be given a second, or sometimes third, lease on life. Already many retail experts believe that chains overexpanded during the flush consumer spending of the past decade, and that parts of America now have more stores than people to shop at them. Given the track record of some big retailers, even if the latest bunch of troubled companies were to emerge from bankruptcy, they might wind up right back in court a few years later. Bradlees, Tower Records, and FAO Schwarz are among those that have filed multiple bankruptcies in recent years.

Strong Headwinds

All filers are covered by the new bankruptcy law, but the changes were particularly harsh on retailers. For companies that already are short of cash—and, in the current environment, unlikely to find new financing—these new provisions in the law can amount to a death sentence. "Liquidity is sucked out of the debtor in a way that it becomes hard to survive," says Lawrence Gottlieb, chair of the bankruptcy and restructuring practice at New York law firm Cooley Godward Kronish, who has represented creditors' committees in the bankruptcies of Sharper Image and Linens 'n Things.

Retailers already face strong headwinds. Consumers' appetite for discretionary purchases has dwindled sharply, and credit conditions are tight. That has led to shrinking sales month after month at most retailers and a string of store closings. Foot Locker (FL) is closing 140 stores; Wilson's Leather is closing 160; Ann Taylor (ANN), 117; and jeweler Zales (ZLC) has closed 105.

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