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Law360 (March 23, 2020, 3:04 PM EDT) --
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| Eric Horn |
The question now is how it will liquidate its goods when malls are beginning to shutter and foot traffic is decimated by fears and restrictions due to COVID-19, with no end in sight. Modell's is one of the first large retail Chapter 11 liquidations to be initiated during the COVID-19 pandemic and will likely serve as a test case for liquidations in this new reality facing the marketplace.
According to the "first-day" declaration of its chief restructuring officer, Modell's currently has 134 brick-and-mortar locations in various strip centers and regional malls throughout the Northeastern and mid-Atlantic United States, with 33 of those stores located in New Jersey. According to the same declaration, Modell's currently owes its prepetition secured lenders approximately $29.56 million in revolving debt, and $9.23 million in term debt.
Additionally, Modell's owes in excess of $100 million in general unsecured debt, comprised of, among other things, amounts owing to vendors and amounts of outstanding obligations owing to landlords. Considering that Modell's will likely reject nearly all store leases, other than the ones that it will be able to assume and assign to a purchaser of any such lease, it is estimated that the amount of general unsecured debt will increase significantly.
As part of its first-day request for relief, Modell's filed a motion to use its prepetition secured lenders' cash collateral to fund its liquidation. According to the proposed budget attached to its request, Modell's anticipates liquidation receipts to be in the range of $11.6 million to $16.98 million per week for the next 45 days. It anticipates fully paying off the senior secured debt by mid-April.
By May 2, Modell's anticipates that it will have approximately $20 million left over after paying off its senior secured debt to fund the remainder of the wind-down, which will be used to pay, among other things, stub rent and 503(b)(9) claims — those claims arising from goods sold and delivered to Modell's within the 20 days preceding its Chapter 11 filing.
By interim order of the bankruptcy court dated March 13, Tiger Capital Group LLC's consulting agreement with Modell's was approved on an interim basis. Tiger is being engaged to assist Modell's in its liquidation efforts and store closings. From the consulting agreement between Tiger and Modell's, it appears that the liquidation term is from March 10 through May 31, which may be extended upon agreement of the parties.
The next major event in this case is the formation of an official committee of unsecured creditors, which is scheduled to take place at the end of this month. The committee will certainly have its own opinion and thoughts regarding the trajectory of this case, as well as the likelihood of the liquidation timeline and cash collateral budget.
With fears and restrictions of COVID-19 devastating the nation, one of the hardest hit industries is retail. Malls across the country have either shuttered or substantially restricted access. In New Jersey, where Modell's has 33 locations, indoor malls have been required to close, although stores with an individual entrance outside of the indoor part of the mall may remain open with certain restrictions for now.
Regardless of whether retail locations remain open during this time or not, foot traffic has certainly been substantially reduced and retail spending has been rapidly declining during these unprecedented times. Without foot traffic and shoppers, Chapter 11 retail liquidations simply will not succeed. While retailers may attempt to push a portion of its inventory to online sales, retailers with a large brick-and-mortar presence will not be able to make up for the lack of in-store sales.
Is it likely that Modell's is going to meet its liquidation projections? The answer is a likely no — not in the current environment. So, what's next for Modell's and its liquidation efforts?
As stores are able to remain open, Modell's will continue its liquidation efforts in an effort to bring in as much cash as possible before the deadline. It will have to work with its prepetition secured lenders and its other constituents to push back on the agreed-upon deadlines for the liquidation process. At this point, it's unlikely that the lenders will have any choice but to go along with an extended process.
The biggest issue with extending the liquidation, however, is going to be the added-on administrative expenses incurred as a result of an elongated process. For instance, and most importantly, post-petition rent will continue to accrue — which will be the landlords' main issue. The additional lease expense was not calculated in its budget and those additional costs, among others, will likely leave the debtor's estate administratively insolvent.
Modell's will be hard-pressed to accurately model out a liquidation term and the extent of proceeds received therein in light of the uncertainty as to how long the COVID-19 pandemic will last. All major constituent groups will have some tough decisions to make in the days ahead. Absent a party coming in to purchase substantially all of Modell's assets, which seems unlikely in this new coronavirus reality, creditors, particularly unsecured creditors, should be prepared to take a major loss.
Over the next several months, the marketplace will likely see a substantial uptick in retail failures. The likely mandatory closing of nonessential stores and businesses, as well as growing unease in the economy, will continue to substantially erode retail sales. While lenders of asset-based loans may hold off on calling defaults for the time being, and landlords and other vendors may provide certain concessions, the lack of sales and cash accruing will eventually take its toll and ultimately cause many retailers to fail.
While the Modell's Chapter 11 was filed a little more than a week ago, one lesson that retailers can already glean from the filing is that until malls and stores are operational and consumer confidence increases, any attempt to run a fulsome liquidation process will likely not achieve its desired result.
Eric H. Horn is a partner at A.Y. Strauss.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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