March 25, 2009 / 12:55 AM / 10 years ago

As U.S. retailers fail, focus on bankruptcy law

NEW YORK (Reuters) - A 2005 law is being blamed for forcing more and more bankrupt retailers to liquidate, by depriving them of the time they need to slim down and reorganize as viable companies.

A sign advertising a store closing and sales is seen outside a hardware store in Islip, New York January 29, 2009. REUTERS/Shannon Stapleton

The revised bankruptcy code, passed four years ago and hailed as sweeping reform legislation, imposed a 210-day deadline on bankrupt retailers’ ability to break leases, a critical tool for a company with hundreds of unprofitable stores.

Landlords wanted the change to prevent ailing companies from lingering in sought-after storefronts and hurting their shopping centers.

However, the lawyers and consultants trying to rescue the bankrupt companies say the deadline deprives them of adequate time to overhaul these companies, and once that deadline passes the retailers are effectively saddled with leases for at least two years.

“Retailers that could have remained viable ... have not been able to do it because of need to deal with leases,” said Representative Steve Cohen, a Democrat from Tennessee. His commercial law subcommittee has held hearings on the failure of Circuit City, which closed more than 500 electronics stores after failing to survive bankruptcy.

Bankruptcy specialists say the 210-day period encourages lenders to limit bankruptcy financing to a couple months because they fear the retailer could find itself without stores on the 211th day after filing.

“I would say that there are some retailers that would have survived, even in this economy, but haven’t had the shot,” said Lawrence Gottlieb, who heads the bankruptcy practice of Cooley Godward Kronish LLP.

“Lenders insist (the business) better be sold or liquidated before the 210-limit expires. The result is it is legally and practically impossible for retailers to trying to reorganize,” Gottlieb said.

Cohen said there is support in Congress for revisiting the 2005 changes to the bankruptcy law and Representative Jerrold Nadler, a Democrat from New York, plans to introduce legislation to address the issue.

Landlords sought the 2005 changes to prevent bankrupt retailers from locking out a more desirable tenant.

“From our standpoint, prior to 2005, a retailer could operate indefinitely in bankruptcy,” said Malachy Kavanagh, a spokesman for the International Council of Shopping Centers.

Kavanagh said many landlords were willing to be flexible with the leases of Circuit City and Linens ‘n Things, and that landlords were not to blame for empty stores. “It’s very Darwinesque. Only the strong survive.”

An anecdotal survey in 2007 by the Commercial Law League of America found that among attorneys, the changes to the treatment of leases was the most unpopular change in the 2005 bankruptcy code.

Given the dramatic decline in consumer spending, it is difficult to prove that more retailers are being liquidated because of the change in the bankruptcy law.

However, specialists agree the speed at which companies are choosing to liquidate or sell their operations has taken many by surprise.

“Never would we have seen Circuit City or Linens ‘n Things go to liquidation. They could have reorganized,” said David Berliner of BDO Consulting. “Lenders are forcing quick sales. They’re not giving retailers time to see what works.”

Most retailers file for bankruptcy just after the year-end shopping season, when they have their strongest cash flow. The 210-day limit means a bankrupt chain doesn’t have time to test its revamped business through the entire business cycle.

“If a business files in January or February they won’t have a chance to test their strategy,” said Stephen Selbst, a partner who specializes on bankruptcy with Herrick, Feinstein LLP. “That’s really critical.”

Many specialists said that in the current difficult economy, many of the retailers filing for bankruptcy have been weak companies that would have struggled even if consumers went right on spending. The treatment of leases will become more of an issue next year, as stronger companies are forced to bankruptcy court.

“Midlevel players will start to be hit. They might be able to reorganize. Then, the 210 days does becomes an issue,” said Jerry Mozian of Tatum, a restructuring consultant.

Editing by Tim Dobbyn

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