Big Law Firm’s New Strategy in Retail Bankruptcies? Avoid Delaware

Kirkland & Ellis has filed three extraordinarily similar retail cases in as many months outside of the U.S. Bankruptcy Court for the District of Delaware.

By Stephanie Gleason

Kirkland & Ellis LLP, the giant law firm that’s been the busiest in handling public company bankruptcies since 2008, is evolving a new strategy for handling the wave of retail insolvencies that’s sweeping the nation’s malls and shopping centers with a twist: Don’t file in Delaware.

Three recent retail filings follow nearly identical – and unusual for retail – legal strategies. Children’s retailer Gymboree Corp., teen retailer rue21 Inc. and discount shoe-seller Payless Holdings LLC have all filed for chapter 11 bankruptcy in recent months outside of Delaware with plans to close stores but not place assets on the auction block. In each case, lenders have agreed to invest more. The structure of the filings stand in contrast to those of Wet Seal, American Apparel, Sports Authority, The Limited and practically every other recent retail chapter 11 bankruptcy, which have been marked by auctions, often failed, and liquidations.

The similarities between the three filings are no accident, and stem from what they have in common: Each is represented by Kirkland, which has handled 15% of all publicly held bankruptcy filers since 2008, according to the UCLA-LoPucki Bankruptcy Database, more than any of its rivals. The firm’s restructuring team, many of whom worked on some of the most prominent oil and gas debt-for-equity swap cases last year, includes James H.M. Sprayregen, Matthew Fagen, Jonathan S. Henes, Anup Sathy and Joshua A. Sussberg. Weil Gotshal & Manges LLP ranked second during the period, with about 9.5% of public company filings, according to the UCLA database.

Kirkland is “obviously working with a model now,” said Jay Indyke of Cooley LLP, who represents the committee of unsecured creditors in rue21 and has worked with the creditors of RadioShack, Wet Seal and others. “They keep tweaking it,” he said, but “they’re trying to come up with a formula.”

The hallmarks of the new Kirkland formula are this: Enter bankruptcy with the support of at least two-thirds of a lender group that agrees to refinance a portion of their debt into equity, often through a refinancing into a super-priority bankruptcy loan. The same group also agrees to recapitalize the company, usually by backing an equity rights offering. If necessary, promise holdouts or unsecured creditors some recovery contingent on a “yes” vote for the bankruptcy-exit plan. Get in and out of bankruptcy quickly. Promise management incentives. Avoid Delaware.

In fact, a search of Pacer filings, the UCLA-LoPucki database and Kirkland’s own press releases failed to turn up a single case in the last 12 months where Kirkland has represented the debtor and the case has been filed in Delaware. The most recently located was that of yellow-pages company Dex Media Inc.’s on May 16, 2016.

A spokeswoman for Kirkland, Kate Slaasted, didn’t respond to multiple requests for comment on this story, including a list of questions that asked whether the firm was avoiding filing in Delaware.

Last year many of the hallmarks appeared in Kirkland oil and gas cases such as Southcross Holdings LP, Linn Energy LLC, Sabine Oil and Gas Corp., Ultra Petroleum Corp., C&J Energy Services Ltd. and Midstates Petroleum Partners LP. It fit well in an industry downturn that was driven by a deeply depressed commodity price where lenders didn’t want to accept low recoveries on assets they believed would bounce back.

But applying it to retail isn’t a natural fit because few believe that the market will return.

Perry Mandarino, ‏head of restructuring at B. Riley Financial who recently worked on Bebe Stores Inc.’s out-of-court restructuring and store liquidation, likened what’s going on in retail to the homebuilder crash in 2009 and 2010. “There’s just too much of them, there are too many doors open.”

And yet, three separate lenders to three separate ailing retail chains have recently decided to reinvest more money into brick-and-mortar. If the companies are successful they’ll all leave bankruptcy with upwards of 700 stores remaining.

The cases are not a slam dunk, despite the pre-negotiations. However, issues that arise won’t be up to the well-known judges in Delaware, who’ve presided over scores of retail cases, to decide.

Gymboree, rue21 and Payless are before bankruptcy judges in Richmond, Va., Pittsburgh and St. Louis, none of whom have never had a large retail chapter 11 case. Payless’s judge in St. Louis, Judge Kathy A. Surratt-States, handled mega coal case Peabody Energy Inc. and Judge Keith L. Phillips of Richmond oversaw the filings of another massive coal company, Patriot Coal Corp., and of oil and gas company Penn Virginia Corp. (also both Kirkland cases). Circuit City Stores Inc. filed for bankruptcy in Richmond in 2008, but was assigned to a different judge than Gymboree.

The lack of Kirkland filings in Delaware, however, follows a fairly notable one, that incorporated Kirkland’s formula: KKR & Co. LP-backed oil and gas company Samson Resources Corp.’s filing in Delaware on Sept. 17, 2015.

The deal it brokered prior to filing for bankruptcy would have wiped $3.25 billion in debt off its books. Junior bondholders had agreed to exchange $1 billion in bond debt for ownership of the company. The group had also agreed to purchase $485 million in new loans and to support a rights offering.

Samson hoped to exit bankruptcy in months, by Dec. 1, 2015, but said it expected opposition to the plan from unsecured bondholders. The deal offered that group, owed $2.25 billion, just a 1% equity payout to be shared with all other general unsecured creditors. That number was to drop to 0.5% if the group opposed it.

But the company didn’t make its exit quickly from bankruptcy. The deal fell apart as oil prices fell and Samson remained in bankruptcy until February 2017, when after selling some assets it successfully confirmed a new bankruptcy-exit plan.

Through the case, Kirkland and the judge didn’t always see eye-to-eye. At the first-day hearing, Judge Christopher Sontchi said he was “furious” at the company’s lenders over the terms of their consent to cash collateral. On Feb. 8, 2016, Judge Sontchi refused to approve a Kirkland fee application for hours it billed defending its own services. Judge Sontchi’s chambers didn’t respond to a request for comment.

Delaware is the busiest bankruptcy court in the country, having handled 44% of all publicly-traded bankruptcy filers since 2008. That’s compared to 20% in the Southern District of New York, the only other bankruptcy court that’s near as busy. The venue became popular in the 1990s following a ruling that if a company incorporated in Delaware it could also file for bankruptcy there. The bankruptcy court in the state known for friendly business laws thus became regarded as friendly to bankrupt debtors as well. Retailers and others not headquartered in the tiny state have often sought out Delaware, much to the frustration of counselors based elsewhere and advocates for employees and small vendors that might be affected and don’t have the funds to travel.

But now, that perception seems to be changing.

“It’s a real home court there,” Mandarino said of Delaware, which could cause some firms to “look elsewhere.”