Last year the Wayne New Jersey-based toy retailer announced it would be filing for Chapter 11 bankruptcy protection in an attempt to relieve itself of the debt left over from its 2005 $6.6 billion Chapter 11 filing and acquisition by Kohlberg Kravis Roberts, Bain Capital Partners, and real estate investment trust Vornado Realty Trust. That deal was valued at $6.6 billion.
When the retailer filed for bankruptcy protection it had $4.9 billion in debt. Of that debt, $400 million was interest payments due in 2018 and $1.7 billion due in 2019.
“Today marks the dawn of a new era at Toys R Us where we expect that the financial constraints that have held us back will be addressed in a lasting and effective way,” announced Dave Brandon, the company’s chairman and CEO at the time of the company’s Chapter 11 filing. “We are confident that these are the right steps to ensure that the iconic Toys R Us and Babies R Us brands live on for many generations,” he added.
The company had plans to operate as usual throughout its approximately 1,600 Toy R Us and Babies R Us stores around the world but now appears to be closing some of those stores, shrinking its fleet about 20% by closing 182 stores. Some of those closings may be avoided if the company is able to negotiate more favorable lease terms.
This is all in an effort to reinvent the company as a leaner, smarter retailer.
“The reinvention of our brands requires that we make tough decisions about our priorities and focus,” Toys R Us Chief Executive Dave Brandon said.
The company also has plans to convert some of their locations into combined Toys R Us and Babies R Us stores.
Going-out-of-business sales are scheduled to begin in February and be completed in April.
Chapter 11 Bankruptcy
Toys R Us is the most recent brick and mortar store to fall victim to the recent shift in shopping trends. Most consumers now look to online retailers such as Amazon to purchase clothing and consumer goods.
Chapter 11 Bankruptcy Protection
Under a Chapter 11 bankruptcy protection plan, a debtor is able to reorganize and restructure its financial affairs. The plan is a contract between the debtor and the debtor’s creditors that outlines how a debtor will operate and pay for future obligations.
Often this plan means a debtor will need to downsize operations in order to reduce expenses and free up assets. Often times, as is currently being seen with Chevron and similar oil companies, a move to cut spending and lower costs is a way to recoup some money in order to avoid bankruptcy.
Liquidation and Chapter 11
In some cases, where restructuring will not yield enough income to pay debts, a “liquidation plan” is necessary. Under liquidation, a debtor’s operations are shut down and its remaining property is sold to recoup money to pay off creditors.
Typically, a debtor receives four months to propose a reorganization plan following its initial filing of Chapter 11. This “exclusivity period” can be extended to up to 18 months following the petition date if the debtor is able to show good cause. While it can be extended, it can also be shortened, depending on the circumstances of the filing.
After the “exclusivity period” ends, the creditors’ committee and/ or other parties are able to propose competing reorganization plans. This is a fairly rare practice though. In these cases, it’s typical that a creditor committee or other party will move to either dismiss the bankruptcy filing or convert the case to Chapter 7. During Chapter 7 a bankruptcy trustee cancels many (or all) of the company’s debts. This can also mean the trustee will sell, or “liquidate” some of the property to pay back creditors.
Though rare, occasionally, a Chapter 11 reorganization plan will allow for every creditor to be paid back immediately, and in full. If this is not the case, as per usual, creditors are allowed to vote on whether or not they will accept the proposed Chapter 11 plan.
During this vote, at least one class of “impaired” claims must approve the Chapter plan in order for the plan to be approved by the bankruptcy court. Upon the plan being confirmed, an “impaired” claim is an obligation that will not be paid in full or when originally due.
Bankruptcy Court Approvals
The bankruptcy court must also approve:
- any sale of assets (property or real property). This excludes items such as inventory that is sold by a retail debtor during the ordinary course of business. For example; if a t-shirt company files for bankruptcy, they would still be allowed to sell their t-shirts.
- entering into or breaking a lease on real or personal property.
- mortgages or other secured financing arrangements that will allow the debtor to borrow money after the bankruptcy case is filed.
- the shut down or expansion of business operations.
- entering into or modifying union, vendor, licensing, and other agreements and contracts, and
- the retention of, and payment of fees and expenses to, attorneys and other professionals.
Role of Creditors
Creditors, shareholders, and other parties that have a vested interest in the company are able to support or oppose actions that will require bankruptcy court approval. These interests and opinions will be considered in bankruptcy court and determinations on how to proceed will be made. It’s only under Chapter 11 plans that formal votes are given by creditors and equity holders.
Unsecured creditors typically participate in Chapter 11 cases via a bankruptcy committee that is appointed to represent their interests. This committee is allowed to retain attorneys at the debtor’s expense. In some bankruptcy cases, shareholder committees are also able to take an active role in the bankruptcy decisions.
Confirmation of the Chapter 11 Plan
“Confirmation” is when a proposed bankruptcy plan is approved by a bankruptcy court. In order to confirm a Chapter 11 bankruptcy plan, the court needs to rule that the plan meets numerous requirements, including:
Feasibility. Feasibility means the proposed plan is likely to succeed. A debtor will need to prove that it will be able to raise sufficient revenues during the course of the plan’s term in order to cover its expenses and payments to creditors.
Good Faith. The plan needs to be proposed in good faith and not by means forbidden under applicable law.
Best Interests of Creditors. The plan must be in best interests of its creditors, meaning that a creditor will receive at least as much under a proposed Chapter 11 plan as they would had the case been converted to a Chapter 7 liquidation. This “best interest” often means that the debtor will need to pay a creditor in pull. Typically, Chapter 11 debtors are not able to meet this “best interest” and thus only pay a fraction of what they owe.
Fair and Equitable. The plan also must be “fair and equitable,” meaning the following:
- Secured creditors (meaning it has a mortgage against a real property or lien against personal property like inventory and equipment) must be paid, over time, at least the value of their collateral.
- The debtor is not able to retain anything on account of their equity interests until all obligations are paid in full. This is either immediately upon plan confirmation or over time (which includes interest). A bankruptcy court is able to allow equity holders to retain ownership interests in the debtor in exchange for “new money” that is put towards paying reorganization expenses. Otherwise, equity holders lose all ownership rights once the plan is confirmed.
Some of the confirmation requirements (like the fair and equitable test) are only applicable if the affected creditors vote against the proposed bankruptcy plan.
Does Chapter 11 Work?
Studies show that about 10 to 15% of Chapter 11 cases are successful, meaning the company is able to reorganize. Often cases are dismissed or converted to Chapter 7 liquidations. For a case to be dismissed the bankruptcy court must approve its dismissal. Conversion or dismissal can be done if a debtor fails to show it will be successful in reorganizing.
Working with a Bankruptcy Attorney
Bankruptcy law can be intricate and confusing. Because of this, if you believe you are a candidate for bankruptcy, you should immediately contact a bankruptcy attorney. They will be able to look at your case and your financial situation to determine if you are a good candidate, and what type of bankruptcy you should file.