Part III: Supplier considerations: Assessing and leveraging your leverage

As most global markets attempt a return to normal (or a new form of normal) business, it is hard to imagine a sector or an industry that isn’t already reeling from the effects of the past three months. Getting back on your feet is hard enough in the current environment, without having to worry about further setbacks impacting your business. But how would you react if your key supplier called tomorrow to let you know that they were insolvent and unable to provide you with goods or services? Worse, what if you had already placed (and paid for) a large order with them that was critical to your ability to continue business?

In addition to the customer risk mitigation measures we looked at in Part II of this series, management needs to have in place systems and options to avoid the impact of supply-chain risk. Continuously monitoring your supply chain is essential during this period, to avoid the risk of your suppliers’ misfortunes infecting your own business (particularly for your critical suppliers and those for which there doesn’t appear to be a possible replacement).

But what is the legal position? What can (and can’t) you do if you catch wind that your key supplier is about to pull down the shutters? In the US, a termination provision in your supply agreement allowing you to terminate for insolvency or bankruptcy events (so-called ipso facto clauses) is completely unenforceable. In fact, any

Part II: Customer Considerations: Risk Mitigation = Smarter Sales

In the coming months, very few companies, whether public or private, will be able to avoid including statements in their quarterly reports or financials that attribute single or double digit percentage declines in revenue to doubtful accounts and insolvencies of major customers caused by the pandemic. For many, if not most, that disclosure will continue beyond Q4 of 2020 and through 2021.

In prior periods, lenders and other key stakeholders may have been tolerant to these one-off, non-systematic declines due to unanticipated insolvencies of customers (and the ability to replace the revenue/income either through liquidation of collateral or replacement of customers). After all, none of us have a crystal ball, and many of the insolvencies were unforeseen (or unexpected). To the extent they had it, lenders and other creditors didn’t have to worry about being able to liquidate collateral – a market was almost always available to sell collateral (or sell their products elsewhere), and there was plenty of money in the market to facilitate transactions (and curb the downside risk).

Post-pandemic, while companies may still not have crystal balls, they at least have tarot cards and Ouija boards – and the signs are strong that market participants will be impacted across industries on a global basis. Lenders and other key stakeholders will want to know what measures were taken to mitigate those reported declines, particularly if the secondary markets to mitigate risks of nonpayment will be stretched (or perhaps non-existent)

Part I: Getting on the Same Page

Globally, boards and management teams are taking stock of current operations and finances to identity vulnerabilities to the unprecedented distress that markets are anticipating from the pandemic for the next 12-18 months.  As part of those discussions, many retail businesses (and those with operations related to retail, like landlords, logistic companies, shipping interests, etc.) are focusing on receivables and risk weighting as to the collectability and the follow-on impact of doubtful accounts.

These conversations will inevitably lead to the age-old conflict that pins finance and legal functions – that are largely focused on risk – against business/sales functions, which are generally focused on sales and keeping customers happy.  Pre-pandemic, sales teams historically had a leg up as revenue generation inevitably trumped risk mitigation in the context of strategic decisions.  However, the same behavior and cultures that have been allowed to prevail when there was only a handful of distressed counter-parties cannot persist where companies are now dealing with entire portfolios of customers and vendors in varying degrees of stress and distress.

To be effective with mitigation, it means that Finance, Legal and Sales need to quickly get on the same page in terms of identifying the level of risk each counterparty poses to the business (and how that counterparty’s inability to pay or deliver goods/services will impact the overall business).  In doing so, companies will be better able to allocate scarce resources to counterparties that pose the greatest degree of near-term risk while

Humanity has largely embraced the “we are in this together” mentality from a health crisis perspective. Yet, even as world leaders scramble to contain the COVID-19 pandemic, we have yet to fully grasp the follow-on impact from the pandemic and particularly, how it will affect world economies. For this “second phase” of the world’s response to the pandemic, the ultimate question is whether business and financial counter-parties will equally share the risk of loss. Bankruptcy judges have jurisdiction to fashion remedies for parties in their courtroom, but Congress and COVID-19 have left them no choice but to rule on issues immediately in front of them without the ability to limit the impact of their decisions on other market players. With a goal of tempering the COVID-19 related damage, recent difficult decisions in U.S. Bankruptcy Courts have invoked unprecedented results, but employing U.S. Bankruptcy Courts as our method of policing the economic impact of the pandemic may disproportionately impact risk-shifting.

Our economy relies on numerous players, all of whom are impacted (and impact one another): (a) unemployed people can neither pay their rent nor inject discretionary spending to restart retail and other industries; (b) retail tenants that do not generate income cannot pay their rent, resulting in commercial landlords/property owners potentially defaulting on their mortgages; (c) lenders with overdrawn revolvers cannot (or will not) further extend credit to defaulting borrowers; (d) companies that are cash-strapped cannot pay employees, landlords or lenders. Stated simply, there will be an echoing breakage if a disproportionate amount of the

With the holiday season now upon us, analysts are closely watching the restaurant industry, particularly the casual dining segment. Reminiscent of the conditions in 2008-2009, many are speculating whether the increase in online consumer shopping that served as a catalyst for the current “Retail Apocalypse” will reduce crucial holiday shopper foot traffic and push some teetering dining chains over the edge.

In the first half of Q4 2017 alone, there were at least three Chapter 11 filings by national and regional casual dining chains, including Romano’s Macaroni Grill and Vasari LLC, the second largest franchisee of Dairy Queen franchises. In Q2 2017, Ignite Restaurant Group commenced its Chapter 11 cases to conduct a 363 sale process for Joe’s Crab Shack and Brick House. Meanwhile, industry commentators are keeping a close watch on some household name chains and other mid-market brands such as Bravo Brio and Bertucci’s.

Following in the footsteps of apparel retailers, over the last eighteen months, a number of national and retail restaurant chains have announced significant store closures in an effort to right size operations. By now, many restaurants are likely evaluating these same strategies to weather the expected storm. However, executive teams should be cautious and not assume that the out-of-court recipe for restructuring an apparel footprint will be effective for a restaurant chain.

Larger Landlord Pool = Greater Holdout Risk

In many cases, a restaurant chain and apparel chain with similarly sized footprints will have disparate negotiating leverage due to the make-up of their landlord

Despite the downturn in many retail sectors, retailers should not automatically adopt a “glass half empty approach” but instead view the impending cycle as creating opportunities for companies in both the U.S. and globally.

In recent months, a steady stream of analyst coverage has painted a bleak outlook for the retail industry. Between February and March 2017, BCBG Max Azria, Eastern Outfitters, hhgregg, Gander Mountain, and Gordmans were among the companies added to the long list of retailers to seek bankruptcy protection. In February 2017, Moody’s Investors Service reported that the number of distressed U.S. retailers has tripled since the 2008-2009 recession. With 19 companies currently in Moody’s Caa/Ca retail portfolio, industry analysts are forecasting this current distressed cycle will surpass the conditions that existed for the industry in 2008-2009. The continued growth of online retailers is expected to hasten that result.

For companies with healthier balance sheets, the current level of distress in the industry could present prospects for strategic acquisitions, to diversify, or expand domestically or globally. Likewise, retailers feeling the financial strains of the downturn may still have viable options to outlive competitors and capture market share of those less successful. In either case, to unlock these opportunities retailers would benefit from divorcing themselves of any apprehension associated with the notion of restructurings, distressed assets, or the U.S. Chapter 11 bankruptcy process.

Buyer’s Market

Flexible retailers with an understanding of the Chapter 11 sales process can compete for the same lucrative opportunities private equity funds have historically