Chapter 11, Liquidation & Individuals’ Cases: A Fashion/Retail Bankruptcy Primer

From J. Crew and Neiman Marcus to Brooks Brothers and True Religion, the onset of COVID-19 has brought with it an ongoing stream of bankruptcy filings, with many of the filing parties making note of the global health pandemic and its impact on their businesses. In nearly all of these instances, the companies seeking bankruptcy protection are doing so on a Chapter 11 basis, thereby, enabling them to continue operating (in whatever capacity they current can in light of varying phases of re-opening and re-closing across the U.S. and beyond), while they execute their reorganization plans.

While Chapter 11 is one of the most commonly-utilized forms of bankruptcy, it is not the only type of proceeding, and it is not necessarily clear to most brands and retailers what the process actually entails. With that in mind, here is a brief look at the most common forms of bankruptcy and how they apply in fashion …

Chapter 11 Bankruptcy

As previously noted, Chapter 11 is one of the most commonly utilized types of bankruptcy. While it can take a number of forms, a Chapter 11 case is frequently referred to as a “reorganization” bankruptcy, as it involves a debtor (i.e., the entity that owes the debt – aka retailers like Neiman Marcus or J.C. Penney or brands, such as True Religion, J. Crew, and Brooks Brothers) seeking an adjustment of debts, either by reducing the debt or by extending the time for repayment, or seeking a more comprehensive reorganization of its business.

The formal Chapter 11 process begins with the filing of a petition with the relevant bankruptcy court by the debtor, followed by the debtor proposing and executing a formal reorganization plan with the court – including a classification of claims reflecting the money it owes to creditors and specifying how each class of claims will be treated under the plan – which will be voted on by its creditors.

“Once the plan is approved by the bankruptcy court, [it] constitutes a binding contract regarding the debtors’ debts and obligations,” according to Elizabeth R. Brusa, an associate in Bradley Arant Boult Cummings LLP’s Banking and Financial Services Practice Group, and “creates new contractual rights, replacing or superseding pre-bankruptcy contracts.”

After a company has filed its Chapter 11 petition, it may continue to operate its business. For a company like Neiman Marcus, this could mean operating its e-commerce sites, and re-opening its brick-and-mortar outposts, depending, of course, on the city/state and its stage in the COVID-19 non-essential business re-opening process. In furtherance of conducting business as usual, companies may resume buying and paying for post-petition goods and services. Given that it is in the business of stocking and selling third-party goods, for Neiman Marcus, for example, this may mean entering into contracts with the designers/brands that it regularly stocks in order to fill its shelves and continue to generate revenue.

When the debtor has met the obligations of the reorganization plan, which includes repaying creditors in accordance with the terms of the plan, the company is able to emerge from Chapter 11 bankruptcy protection. The matter will be deemed complete once the debtor files a final report showing how the business assets have been administered, records of payments and any other information relevant to the closing of the case.

Brusa notes that “typically, much more negotiation between debtors and their creditors occurs in a Chapter 11 bankruptcy, and these cases tend to last longer and involve more litigation than cases filed under other chapters.” However, a core benefit of Chapter 11 (and other forms of bankruptcy protection) is the “automatic stay” that applies once a debtor files it petition, which serves to halt all creditor actions, including lawsuits, foreclosures, repossessions, bank levies, wage garnishments, and other collection activities (subject to certain exceptions).

Chapter 7 Bankruptcy

Put simply, Chapter 7 bankruptcy is a liquidation. Most commonly relied upon by companies that are no longer operating or that are looking to cease operations (potentially in certain regions, as was the case for Roberto Cavalli, whose American subsidiary filed a Chapter 7 petition in April 2019, while the company’s main entity continued to operate in Europe), and that plan to liquidate their assets in order to repay creditors.

As such, a Chapter 7 bankruptcy case does not center on the filing – and carrying out – of a plan for reorganization, and instead, involves the appointment of a trustee, who takes control of the company’s assets, sells the non-exempt assets, and uses the proceeds to repay the company’s creditors. The proceedings, themselves, generally last for about 90 days from when the debtor’s files its bankruptcy petition. Although, instances that involve significant liquidation and sales of assets may last for longer and involve litigation before a debtor emerges from the case.

While businesses that file for Chapter 11 bankruptcy usually continue operating, it is not uncommon for a Chapter 11 bankruptcy proceeding to turn into a Chapter 7 liquidation.

Chapter 13 Bankruptcy

Unlike Chapter 11 and Chapter 7 cases, Chapter 13 bankruptcies are exclusively available only to individuals and potentially, sole proprietorships, and thus, not multi-member corporations. Called a wage earner’s plan, Chapter 13 filings provide for an adjustment of debts of an individual with “regular income,” thereby, enabling the filing party to keep his/her property (such as their home) and pay debts over time, usually over the course of three to five years, in accordance with his/her proposed repayment plan.

Not completely dissimilar from Chapter 11 cases, and subject to certain limitations/exceptions (such as a $419,275 cap on unsecured debt and $1,257,850 for secured debt), Chapter 13 enables a debtor to modify his/her payment terms on secured debts, and to eliminate obligations that he/she cannot pay over the plan’s term.

As for the key benefit of Chapter 13 proceedings, as Investopedia aptly notes, such a bankruptcy case “prevents the liquidation of all [of the debtor’s] assets. In particular, it is frequently used to avoid the forced sale of an individual’s home, which Chapter 7 cannot do.” While Chapter 11 may also prevent a forced home sale,it is “usually too expensive and complicated a procedure for most debtors.”