The 'Death Spiral' of Malls

To stem the tide, certain mall owners in the bankruptcy case of clothing retailer Aéropostale, and several other debtor affiliates' high-profile bankruptcy cases, have addressed the retail bankruptcy trend in a unique and (virtually) unprecedented way.

The Aéropostale Cases

In the Aéropostale bankruptcy cases, two large mall owners, General Growth Properties and Simon Property Group, teamed up with Authentic Brands Group (the owner of various global brands) and two liquidators — Gordon Brothers Retail Partners and Hilco Merchant Resources — to save at least 229 of Aéropostale's 811 stores. Other reports indicate nearly 250 more stores might have also been saved as part of the group's efforts.

Only the early 2000s move by Kimco Realty, and a group of other lenders, to extend financing to Ames Department Stores appears to be remotely similar. If the strategy works, it could provide other struggling retailers and mall owners with a much needed lifeline.

How It Worked

The debtors — with stores in all 50 states and Puerto Rico and Canada and approximately 14,500 employees — filed for Chapter 11 bankruptcy protection on May 4, 2016, in the U.S. Bankruptcy Court for the Southern District of New York. The debtors' brands were also licensed internationally and sold in over 300 additional locations in 17 countries.

Prior to the petition date, the debtors began a comprehensive strategic review and restructuring of their operations. However, the debtors said that despite these efforts, one of their largest suppliers, TSAM (Delaware) (d/b/a MGF Sourcing US), a portfolio company controlled by Sycamore Partners, improperly forced the debtors into cash-in-advance terms, which caused a cash drain and resulted in the debtors' bankruptcy filings. Sycamore's affiliates were also one of the debtors' pre-petition lenders.

On the petition date, the debtors sought immediate authority to close and liquidate 154 underperforming stores. Then, a few months later, the debtors filed a motion pursuant to Bankruptcy Code § 363 seeking authority to sell substantially all of their assets located in the United States. Shortly thereafter, the debtors filed a motion that sought to disqualify Sycamore's and certain of its affiliates' right to credit bid. Under the Bankruptcy Code, unless certain narrow exceptions apply, secured creditors have the right to use up to the full amount of the secured debt owed to them by a debtor as currency in a bankruptcy sale of the collateral securing that debt.

After a lengthy evidentiary hearing, the bankruptcy court, on Aug. 29, 2016, overruled the motion and entered an order allowing Sycamore and its affiliates to submit a credit bid. During a subsequent auction, the only bids received aside from the bid received from the consortium led by the mall owners, were liquidation bids by Sycamore and its affiliates and a joint bid from Tiger Capital Group and Great American WF. The consortium's going concern bid for $243.3 million of cash was determined to be the highest and best bid for the debtors' assets. Sycamore and its affiliates' bid was deemed to be the back-up bid, even though it was $1 million in value higher than the consortium's, or $244.3 million ($120 million in cash and a $124.3 million credit bid). This determination is likely due to the fact that Sycamore's bid would not save any stores.

While there are execution risks, this unprecedented transaction could potentially benefit each of the consortium's members. From the perspectives of the two mall owners, General Growth Properties and Simon Property Group, the transaction made sense because it preserves tenants in hundreds of stores for the holiday shopping season and could avoid a potential adverse impact on year-end earnings.

In addition, the Consortium's bid was for liquidation value, or close to it. That means the landlords likely believe that they can make a profit — with Simon's CEO recently saying his company discovered that “there is a lot more profitability [in the Aéropostale stores] than we thought, especially due to the bargain basement price paid.” It's also possible that the landlords believe they can recoup their investment through a subsequent liquidation sale if the stores that remain open do not perform well.

Likewise, Authentic Brands was interested in the debtors' intellectual property and was encouraged by the fact that certain stores would remain open and continue selling inventory bearing the Aéropostale name. This is significant because Authentic Brands would not have to start from scratch to rebuild the Aéropostale brand, supply chain, or infrastructure. Finally, Gordon Brothers and Hilco, companies that specialize in liquidating inventory, were a good fit to round out the Consortium because they could dispose of any excess inventory from the stores that could not be saved.

Conclusion

Only time will tell whether the Consortium's transaction will be a model for future deals in the distressed retail sectors and other related industries. Participants in the Aéropostale debtors' bankruptcy cases, including counsel for the debtors, the official committee of unsecured creditors and Authentic Brands Group, all express optimism that this transaction could be a model for future transactions. Regardless, it was an innovative move in the retail space that needs to reverse the “death spiral” in order to remain relevant.

***** Eric S. Chafetz is counsel at Lowenstein Sandler in New York. This article also appeared in the New York Law Journal, an ALM sibling publication of this newsletter.