Analysis

'Safe' Sectors Like Schools, Real Estate May Feel COVID Pain

Law360 (March 20, 2020, 8:08 PM EDT) -- As the world responds to the global spread of the novel coronavirus, bankruptcy practitioners say some cultural changes could become permanent and lead to trouble for private universities and commercial real estate owners previously thought to be insulated from the pandemic.

The COVID-19 pandemic has led to turmoil in the global economy in recent weeks, with major negative consequences for obvious business sectors like airlines, cruise ship operators and hotels that depend on consumers' willingness to travel, but the less obvious victims of the virus are those businesses whose model depends on the status quo. If the culture shifts too dramatically from a prolonged cessation of normal activity, sectors like private education, commercial real estate and financial services may not recover as readily.

Social distancing directives have led people across the globe to change how they shop, work and learn, and Schiff Hardin LLP partner Steven Wilamowsky said those changes could linger after the pandemic subsides.

Shortly after COVID-19 began spreading in the United States, colleges in the affected regions began clearing out their campuses and switching to online learning systems, he said, and schools that don't embrace that technology may see a drop in enrollment in the future.

"For smaller, less prestigious private schools, if people get too comfortable with distance learning and they're not ahead of the curve on that front, I see a lot of problems," Wilamowsky told Law360.

These types of schools — and not the Harvards and Yales of the world — may have a higher price tag for students than comparable public schools, Wilamowsky said, so if they don't have the same offerings that people want, students will flee for less expensive public schools.

He also said that commercial real estate operations might take a big hit if their tenants go belly up for lack of customers.

According to Amy A. Zuccarello, a partner at Sullivan & Worcester LLP, shopping malls specifically may not survive much longer in the aftermath of the new coronavirus. Amid years of struggling, mall operations have succeeded with a "destination" strategy, becoming entertainment hubs and not just storefront operations.

But with general struggles in retail even before the outbreak, a lot of shopping malls probably won't survive this new challenge, she said.

"The mall is probably on the list of the last places you'd want to be in this situation," Zuccarello said. "They don't sell a lot of essentials, and now there is nothing driving anyone out to a shopping mall."

Movie theaters are likely in the same boat, she said. Theater chains have carved out a niche for themselves over the last decade by rebranding to provide a more luxurious experience. But they face the same stress as malls in this environment, as most national chains have shut down completely for at least several weeks following the guidance of federal disease experts trying to stop the spread of COVID-19.

"This might just be the very last nail in the coffin for movie theaters, which had been struggling as it was," Zuccarello said. "They did some interesting things in the last couple of years to rebrand and revitalize themselves. ... They became these niche destinations. Now you don't have any patrons for the destination."

Some studios are making their movies that are in the middle of a theatrical run available for at-home streaming, which could become the new model if the theaters themselves don't make it through the next few months.

These troubles, coupled with the more obvious hurdles facing retail, travel and many other industries, will ripple out into the financial services industry, according to Ted Gavin, managing director of Gavin Solmonese LLC. The volatility of the stock market in response to the pandemic and anticipated layoffs and unemployment will damage people's willingness to spend or invest, he said.

"Anything that requires consumer confidence is going to take a big hit," he said. "People will be less likely to invest and less likely to use what income they do have. People are going to be a little bit squirrellier with money in general."

At the institutional level, these changes will force banks to adapt to the "new normal," and there will be some lag before they figure out how to operate in the altered landscape to minimize risk and exposure, Gavin said.

Damian Schaible, partner and co-head of the restructuring practice at Davis Polk & Wardwell LLP, said that some restructuring deals he is involved in will need to be renegotiated due to the recent upheaval in the markets, so lenders are even now trying to navigate the new world.

Schaible said the economy is only beginning to feel the effects of the crisis, and the worst conditions haven't yet arrived.

"We have not yet found a bottom, and we don't know when we will," he said. "Other than triaging and addressing liquidity emergencies, there isn't a lot we can do with distressed companies until we experience a bit of market stabilization."

Even in the affected industries, the survivors are going to be the companies with strong cash positions that allow them to ride out the volatility. Many began drawing down the availability under revolving credit facilities to bolster their liquidity as the market sank and the economy stagnated, he said.

"I don't want to sound like a Chicken Little or a doomsayer, but for companies with thin liquidity that don't have the ability to weather the coming storm, there are going to be challenging restructurings," Schaible said.

The challenges will come mainly from a reluctance to fund bankruptcy plans from existing creditors, and that might result in more Chapter 7 liquidations than Chapter 11 reorganizations, he said.

But this will all likely start a new recessionary cycle which bankruptcy professionals are familiar with, and there will be a recovery for many businesses able to survive the initial storm. Opportunistic investors will step in once they feel comfortable, and though some will put money into businesses too early in the cycle and might succumb to the high risk profiles, eventually the risk curve will flatten out, Schaible said.

"You're going to have people investing in distressed companies again and eventually we'll end up back in a new normal with stability," he said.

In the meantime, the obvious victims of the pandemic will be industries whose supply chain relies on vendors in Asia and parts of Europe that have been shut down by the disease outbreak and those who provide goods and services that aren't essential, like tourism and travel.

Christopher F. Graham, chair of the restructuring and bankruptcy practice at Eckert Seamans Cherin & Mellott LLC, said toy retailers may be specifically affected because they depend on Chinese vendors for their inventory, and airlines and hotels are seeing a dearth of customers.

The fashion industry, which relies on suppliers in China and has a large industrial presence in Milan, Italy, is likely to take a hit too, he said.

"You're going to see an economic hit to any industry that is dependent upon products supplied from China and products supplied in Italy," Graham said. "When talking about the fashion industry, I don't think it takes a rocket scientist to draw a line between Wuhan and Milan."

The effects of the outbreak are changing from day to day and sometimes hour to hour, and while there haven't yet been any bankruptcy filings directly linked to the coronavirus, it's a safe bet the highlighted industries won't make it through the ordeal unscathed.

"I'm sure they're coming," Graham said. "There is no question this will be a contributing factor, if not the main factor in some Chapter 11s. It's inevitable."

--Editing by Brian Baresch and Emily Kokoll.

For a reprint of this article, please contact reprints@law360.com.

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