Background
Forever 21 is well known as a “fast-fashion” mall retailer that grew quickly from its founding in 1984 through most of the past decade, appealing primarily to a young demographic whose preferences for cutting-edge fashion would otherwise exceed their budgets. In recent years, however, the retailer has been beset by a number of controversies and, more importantly, was a latecomer to the e-commerce revolution that changed the way the world shops and, in particular, the way Forever 21’s target demographic shops. Ultimately, the woes brought on by these challenges led Forever 21 to commence chapter 11 bankruptcy proceedings early in the fall of 2019 and to close over 100 locations quickly thereafter in an attempt to restructure its remaining operations.
A few months later, a buying group consisting of Simon Properties Group, a mall landlord at nearly 100 Forever 21 stores; Brookfield Property Partners, another major Forever 21 landlord; and Authentic Brands, a brand-management company whose portfolio includes such formidable names as Judith Lieber, Hickey Freeman, and Juicy Couture, successfully bid to purchase substantially all of Forever 21’s assets for $81 million in cash and the assumption of certain liabilities through a sale conducted under the auspices of the bankruptcy court under section 363 of the Bankruptcy Code. There were no other bidders for the assets, and vendors are expected collectively to write off hundreds of millions of dollars of claims against Forever 21 that will never be repaid. The buyers, meanwhile, will chance that they can successfully rehabilitate Forever 21 around a core that includes most of the retailer’s remaining U.S. stores and, in particular, one assumes, those located within the new owner groups’ mall properties.
Analysis
Forever 21’s bankruptcy came with the usual share of victims, including hundreds of vendors owed many millions of dollars, as well as Forever 21’s mall landlords. Unlike earlier retail restructuring cycles, mall landlords are no longer able to easily replace shuttered or struggling retail dodos with surviving, fitter competitors. This is because more recent retail bankruptcies have been precipitated less by problems with the pricing, value, demand, or other qualities associated with merchandise offered for sale, but rather by the platform upon which it is sold. Even prior to the devastating nationwide lockdowns caused by the coronavirus pandemic, consumers already were increasingly eschewing physical “bricks and mortar” stores for the internet, which has required traditional retailers to reconceptualize their businesses so that their stores become complements to their online presence that usually translates into smaller and/or fewer physical locations. That has a direct, material effect on retail landlords, and mall landlords in particular, who look to the marketing and name recognition provided by marquee national retail chains to drive foot traffic to their malls. In the increasingly frequent event that any of those national retailers are faced with bankruptcy or go out of business, there may no longer be eager competitors lined up to take their place because the competition is either primarily operating from a virtual, rather than actual, premises or is itself trying to right-size its physical retail footprint and is not looking for new space of that size or scale.
Without readily available replacements, therefore, mall owners are incentivized to try to keep struggling retail chains afloat, particularly where a particular retail chain has many locations within a small number of mall owners’ portfolios. Even where a distressed retailer’s prospects are questionable or too speculative for another third-party buyer, one or more major landlords may be willing to take a leap of faith on a retailer’s post-bankruptcy business plan to avoid the cost of portfolio-wide vacancies of a name-brand retailer and the potential domino effect on other stores within the same malls.
Indeed, that appears to be exactly what happened with Forever 21. The group that included Simon and Brookfield was the only group that bid—at a price too low to permit any recovery to Forever 21’s unsecured creditors. The fact that no third party came in with a competing bid under those circumstances strongly suggests that the Simon/Brookfield bid was more defensive rather than an inherent value proposition presented by a rehabilitated Forever 21. It should also be noted that this was not the first time these landlords have bought a distressed retail chain tenant out of bankruptcy—they did essentially the same thing in the chapter 11 cases of Aeropostale, a clothing chain that targets a demographic similar to that of Forever 21.
Is the purchase of troubled mall retailers by their landlords likely to become prevalent in retail chapter 11 cases? The circumstances under which such purchases are likely to make economic sense are narrowly circumscribed, which suggests that its potential to become a trend may be limited.
First, the retailer at issue must have a Goldilocks quality about it: If its rehabilitated future looks too good, then it will either attract exit financing in an amount sufficient to fund a stand-alone plan of reorganization or, if it chooses to reorganize through a sale of its business, it will attract an array of third-party financial and strategic buyers that will bid up the business to the point where it no longer is attractive to the landlords, both because the price is too high and because the very need for the landlord bid will have been eliminated or mitigated by the going-concern purchase of the business by a third party. On the other hand, if a seller’s prospects even after an operational restructuring appear weak, then the anticipated costs of preserving it, including the likelihood of ongoing losses, quickly outweigh any benefit associated with its presence within the bidding landlords’ portfolios.
Second, in order for the cost of the landlords’ investment to offer meaningful synergies, the particular tenant footprint must have the requisite level of concentration within the mall portfolios of a small number of large landlords, all or nearly all of whom must be interested in participating in the bid.
Third, the debtor-tenant itself must be a retailer that is an attractive tenant to its mall landlord in terms of its ability to drive mall foot traffic among a desirable demographic. It is probably not a coincidence that both Forever 21 and Aeropostale market to a young, highly desirable segment of the retail market that mall owners like to see frequenting their properties. One can surmise that a retailer specializing in adult incontinence products, for example, would not draw as much interest from mall owners, regardless of how rosy its post-bankruptcy EBITDA projections.
Finally, while the long-term ramifications of the COVID-19 crisis are not yet known, for the short-to-medium term it seems likely that the pandemic will independently create deepened levels of distress and liquidity constraints for mall landlords that may preclude their employment of the Brookfield/Simon strategy, irrespective of the advantages the strategy otherwise confers.
For these reasons, among others, it seems likely that the precedent set by Forever 21 and Aeropostale has created a useful, but specialized tool in the distressed retail toolbox for successfully dealing with a narrow band of chapter 11 cases from time to time, rather than a new paradigm for resolving retail bankruptcies in the new digital economy.
