Alternative Strategies for Maximizing Results During Retailer Liquidation Projects

<p>At some point in every
restructuring of a consumer products retailer, the company and its advisors
will be called upon to analyze the importance of the company's key
asset groups to its future success. Assets will be evaluated based on
anticipated returns on future investments, anticipated carrying costs and
an assessment of the opportunities that could be created from the
redeployment of invested capital into other assets or asset classes.
Inevitably, this analysis will lead to the identification of
underperforming or excess assets, followed closely by the development of a
strategy designed to maximize the recovery value from the disposition of
such assets.

</p><p>Experience suggests that every retailer, even well-run
healthy retailers, carry under-performing and excess assets on their
balance sheets. For instance, it is an axiom of retailing that, when taken
as a whole, every inventory can be segmented into quintiles from the best,
fast-turning, high-recovery and high-margin items to the worst, slow-moving
items that require significant markdowns to move, if at all. Moreover, all
stores are not created equally. The characteristics that define whether a
store is a good, positive contributor or a drain on precious cash flow may
not be readily apparent at the time the retailer commits to an expensive
build-out and 10 years of rental obligations. Just like its inventory, the
real estate portfolio of a mature retailer will contain winners and losers
and many levels in between.

</p><p>For retailers restructuring under the protection of
chapter 11, there is a well-defined strategy available to address the drag
of underperforming inventory and real estate assets. This strategy calls
for the liquidation of the inventory by selling it directly to the consumer
through the medium of a "going-out-of-business" or
"store-closing" sale (GOB sale) coupled with a real estate
disposition program designed to utilize the leverage created by the
trustee's power to assume, assume and assign, or reject a lease under
§365 of the Bankruptcy Code. Properly orchestrated, these strategies
will allow the retailer to maximize the recovery value of its inventory
while minimizing the liabilities associated with its real estate, the
key phrase here being "properly orchestrated." The premise of
this article is that the traditional paradigm for the orchestration of the
inventory and real estate disposition strategy may not always lead to the
best result for the estate, the debtor's managers, vendors and other
parties in interest.

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<big><center><i>The choice of which service provider will conduct a liquidation event can have a material impact on the results achieved during that project.
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<h4>The Liquidation Paradigm</h4>

<p>Over the past 10 years, the model for driving the
liquidation process has essentially become institutionalized. The stores to
be closed are identified, the excess inventory is earmarked for sale and
segregated on the company's books, and an information package
describing the characteristics of the store leases and the inventory is
created and disseminated. Typically, the company and its legal and
financial advisors drive this process. If there is a lender with a
collateral interest in the assets, it will also be injected into the
process together with other institutional constituents such as the
creditors' committee. Recently, a new entrant into this process is
the consultant who on behalf of the lender or the company is retained
specifically for the purpose of assisting and in some cases managing the
process of developing the disposition strategy and dealing with the service
providers that provide the expertise necessary to effectively execute a
disposition project.

</p><p>Once the process is underway, the company will
identify a service provider and enter into an agreement with that service
provider setting forth the terms and conditions for the disposition
project. That agreement is circulated among interested parties, and an
auction typically ensues. Bankruptcy lawyers and judges like the fact of
the auction, because bankruptcy jurisprudence suggests that a sale
following a properly noticed auction is entitled to a finding of
"good faith" and the protections of §363(m) of the Code.
The financial advisors to the respective constituencies also seem to like
the auction dynamic. To the extent the auction results in an increase from
the stalking-horse price, they can take comfort in the view that the
process has resulted in added value. Finally, the secured lenders like the
auction since they perceive that it provides a certain, market-tested
result. The one key constituent remaining is the merchant/debtor. Is it
satisfied with the results of the auction? More often, it seems that the
answer is no, especially in those instances where the liquidation project
involves a subset of non-core assets with a debtor focused on
reorganization and looking to maximize the recovery on its non-core assets
in as painless (<i>i.e.,</i> non-disruptive) a fashion as possible.

</p><p>To understand why this happens, one must examine the
dynamics of the sale procedures. Following the identification of the
"stalking horse," that service provider and the debtor will
have many days, if not weeks, to work through the underlying contract, iron
out issues and generally get onto the same page in terms of how things
should work. Then, the day before the §363 hearing, the auction takes
place and additional bids are received. Very often, the stalking horse goes
home, and a new service provider (the "winner") steps in. This
new party has not had days of conversations with the company. Moreover,
having just paid a higher price for the liquidation opportunity, this party
will be unwilling to make concessions or reach interpretations with respect
to contractual provisions that might have a negative impact on its ability
to recoup its investment. Reconciliation may become a problem, and
ultimately the bargain the company thought it had struck disappears.

</p><h4>Alternative Strategies</h4>

<p>There are alternative strategies that can be utilized
to address this problem. The first is to structure the arrangement with the
service provider as a consulting arrangement. Under this type of structure,
the service provider's compensation can be structured around a
"soft" guaranty. Most often this is done by putting the service
provider's fees at risk unless certain recovery thresholds are
satisfied. Once the recovery threshold is met, the service provider can
earn a base fee with an incentive fee designed to align interests as the
parties seek to maximize every dollar.

</p><p>A second type of arrangement is a "hard"
guaranty at a leveraged-down threshold with upside sharing to the company
after the threshold is met and the service provider's base fee is
paid. Sharing can be weighted in favor of the company so that it obtains
the lion's share of any upside produced. For example, if 80 percent
of the upside generated in a project automatically flows to the company,
there would seem to be little or no benefit derived from an auction where
the guaranty is likely to move only a few percentage points.

</p><p>In either circumstance, the company gets its pick of
service provider without the risk of a subsequent upset. Indeed, if there
is to be an auction at all, it would seem to make more sense to conduct it
with sufficient time to allow the company to get comfortable with its
service provider and to make sure they are on the same page before the
court is asked to approve the service provider's contract. Indeed, in
a few recent cases, prospective debtors have run their selection processes
and conducted an auction prior to commencing the bankruptcy case.
Thereafter, the case and the sale motion are filed with the selection of
the service provider a <i>fait accompli.</i>

</p><h4>Consideration of Alternative Structures May Avoid Unintended Results</h4>

<p>The choice of which service provider will conduct a
liquidation event can have a material impact on the results achieved during
that project. Different service providers have different strengths and
weaknesses, as well as different outlooks on the way problems should be
solved and opportunities realized. It seems strange that a decision so
vital to the success or failure of a reorganization should be left to
chance at an auction on the eve of the approval hearing. There are several
strategies that can be used to avoid unexpected results while permitting
the company to achieve results it and other constituencies will be happy
with. In all cases, a careful consideration of these options should ensue
before the liquidation process gets underway. At the end of the day, your
clients will thank you.

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