By Cindy Liu
The COVID-19 pandemic has caused a wave of bankruptcies, forcing companies large and small to close their doors. According to the American Bankruptcy Institute, 4247 businesses have filed for Chapter 11 bankruptcy nationwide as of July 2020. Industries such as retail, travel, and restaurants have been hit particularly hard by the coronavirus; however, all businesses have felt the pressure of the severe recession.
In the United States alone, the list of COVID-19 bankruptcies grows each day, including many iconic household names such as Hertz, Lord & Taylor, and J. Crew. According to Edward I. Altman, creator of the widely used Z-score formula for predicting corporate insolvency, there will be a record breaking number of “mega” bankruptcies, or filings by companies with liabilities exceeding $1 billion. Altman cites the buildup in corporate debt and debt issuance, particularly in the U.S. where bond issuers account for nearly half of the $2.1 trillion bonds that have been sold by companies globally this year, as key factors behind increased corporate insolvency.
However, the term “bankruptcy” is not necessarily synonymous with liquidation. Rather than marking a company’s death, bankruptcy can be used to kickstart a company’s revival. Particularly among so-called mega companies, declaring bankruptcy is often used as an opportunity for restructuring and financial reshuffling, rather than outright liquidation. Chapter 11 of the U.S. Bankruptcy Code is designed to give financially distressed companies a second chance—the opportunity to reorganize, reduce debts, and re-emerge stronger into the market. Companies that file for Chapter 11 bankruptcy will often cut expenses, sell non-core assets, make capital improvements, and negotiate with creditors to restructure debt terms. Chapter 11 can also be viewed as a “breathing spell” from pressures such as competitive market forces and creditor demands. This gives companies some room to focus on formulating their plan for a strong re-emergence into the market.
The path to re-emergence often involves collaboration between management, creditors, consumers, and even the government. During the financial crisis in 2009, General Motors (GM) filed for Chapter 11 bankruptcy, marking one of the largest Chapter 11 bankruptcies in U.S. history. Within 40 days of its bankruptcy filing, GM shed layers of management, adjusted its capital structure, received a $50 billion federal bailout, and refocused its allocation of resources. GM’s comeback story has been widely publicized by both the media and the U.S. administration, celebrating and investigating how the company was able to regain its profitability as America’s largest automaker. Other well-known companies who have experienced successful bankruptcy re-emergences in the past few decades include Delta, Marvel, and Converse. A common thread among all these comebacks is a tremendous amount of resilience, adaptability, and confidence.
So what does this mean for COVID-19 bankruptcies? Is there potential for re-emergence?
When Lord & Taylor, the oldest U.S. department store chain, filed for Chapter 11 bankruptcy protection in early August, the company had about $127.9 million of debt obligations. The company’s owner, Le Tote Inc., took aggressive action to close all 38 locations, furlough store associates, and dismiss much of Lord & Taylor’s executive leadership. While the company is currently working with a skeletal staff to maintain an active e-commerce presence, Le Tote holds an optimistic vision for the future of the department store, hoping that the post-pandemic world will be more receptive to its new business model—part retail, part rental.
COVID-19 has also forced major retailer J. Crew to file for Chapter 11 protection. Most notably, J. Crew’s plan for bankruptcy includes restructuring $1.65 million of debt by converting it into equity. In addition, the company has been freed from $150 million in annual interest payments, allowing it to invest more heavily in areas such as e-commerce and digital marketing, which will likely shape the post-pandemic retail landscape. Like in many other industries, the future of retail post-COVID-19 will demand change and accelerate innovation.
However, Chapter 11 bankruptcy also has its limitations. According to Stuart Gilson, Professor of Business Administration at Harvard Business School, Chapter 11 bankruptcy is associated with heavy legal and investment banking fees as well as strenuous administrative demands. Additionally, bankruptcy corrodes consumer confidence and adversely affects stock values regardless of company size or former reputation. After a company files for Chapter 11 protection, its stock will generally reach near-zero values and will be delisted from major exchanges. However, it is important to remember that these limitations are temporary, whereas choosing to forgo Chapter 11 protection can lead to permanent closure.
Overall, Chapter 11 bankruptcy gives companies the chance to get back on their feet and avoid liquidation. Particularly for mega companies such as Lord & Taylor and J. Crew, a period of organizational and financial restructuring can lead to a successful re-emergence in the market. Furthermore, bankruptcy can be beneficial for debt-saddled companies because it forces large-scale change to occur in a highly efficient and focused manner. Rather than dealing with a company’s death, Chapter 11 bankruptcy provides the necessary pathway to a company’s revival.