By Monique Sassi & Michelle Pickett
It has been almost a year since the COVID-19 pandemic shuttered retail stores. With the vaccination program underway and the various government subsidy programs expected to come to an end in 2021, the fundamental questions at this time are: how are retailers thinking about and planning for the changes in the retail industry post COVID-19? How are they positioned operationally and financially to compete post COVID-19? How are retailers planning for the future?
In order to look ahead and understand what businesses should be considering at this time, it is worth noting how different retailers have reacted or responded to the pandemic. The almost 12 months of financial data and insolvency court filings are clear: COVID-19 has not had a generic effect on retailers.
Retailer Responses to the COVID-19 Pandemic
Most retailers have availed themselves of many forms of government aid and other support during the COVID-19 pandemic to provide liquidity and avoid substantial losses. These supports have included, among others, government-funded wage and rent subsidy programs, government and crown corporation loan programs such as the Business Credit Availability Program (BCAP) loan guarantees and co-lending programs, concessions from landlords, extended supplier terms, and concessions and/or covenant waivers from lenders. In addition, most retailers have benefited from the near elimination of travel and entertainment expenses and a significant reduction in general office expenses and marketing and advertising spend as they pivoted to social media and other online platforms to reach consumers.
However, certain retailers including “essential” grocery stores, home improvement, home furniture stores, and recreational equipment companies have gone one step further. They have taken advantage of curbside pickup opportunities and capitalized on ecommerce platforms to mimic or replace the in-store experience or leverage consumers’ renewed desire to “nest”, improve their homes and spend time outdoors.
In contrast, other retailers, such as work-related apparel retailers or stores which rely heavily on in-person sales and do not have access to curbside options (for example, mall-based retailers) have struggled to weather the pandemic. These retailers may have faced a severe decline in demand for their product and many have struggled to implement a successful digital retail experience. Others have adopted a “wait and see” approach — hunkering down, hoping to survive the economic downturn and planning to resume pre-pandemic operations. As discussed below, these retailers may be missing an important opportunity to reevaluate their business model going forward.
Strategic Court Filings During COVID-19
A number of retailers have used the COVID-19 pandemic as an opportunity to voluntarily file for creditor protection under the Companies’ Creditors Arrangement Act (CCAA) or file a proposal or notice of intention to file a proposal (NOI) under the Bankruptcy and Insolvency Act (BIA). Many of these retailers recognized the benefits of a formal restructuring and strategically filed in order to emerge as a going concern.
One such benefit of a filing is a “stay of proceedings” which prevents persons, including creditors and landlords from taking actions against the retailer during the insolvency filing and gives the retailer time to “breathe” and formulate a go-forward strategy. Filing a proposal or NOI under the BIA triggers an automatic stay of proceedings and the debtor is required to offer a proposal to its creditors for a vote by a statutory deadline failing which (or if there is insufficient support for the proposal) the debtor is deemed bankrupt. In contrast, the CCAA provides a debtor with more flexibility – there is no deadline to file a plan to creditors and while there is no automatic stay of proceedings, a court will likely grant a stay upon a successful application for protection for the debtor.
A proceeding under the CCAA or BIA can also facilitate a variety of creditor concessions such as partial payment of claims, conversion of claims to equity or deferral of debt. In the first 3-6 months of the pandemic, many retailers used the CCAA and BIA to renegotiate or terminate leases, one of retailers’ greatest expenses and liabilities. A court proceeding provides a ripe forum for re-negotiation of existing lease terms with landlords and the statutes also include provisions which allow a debtor to disclaim and exit a lease prior to the end of the lease term.
As an example, in July 2020, Montreal-based retailer, DavidsTea, which had faced declining sales and losses for multiple years before the COVID-19 pandemic, sought protection under the CCAA (which was recognized under Chapter 15 of the US Bankruptcy Code). To date, the retailer has disclaimed and exited more than 200 leases across Canada and the US and negotiated more favourable lease terms on the remaining leases. DavidsTea used the CCAA process to transition out of brick-and-mortar stores and focus nearly entirely on selling product online with wholesale distribution to third party grocery stores and pharmacies. The retailer is currently working on a three-year strategic plan.
This strategic use of court proceedings to address lease obligations was also used in June 2020 in the cross border restructuring of AllSaints USA Limited, by the UK-based contemporary fashion brand which initiated a “company voluntary arrangement” (CVA) proceeding in the UK which was recognized under the CCAA in Canada and Chapter 15 of the US Bankruptcy Code. Although the retailer had received rent deferrals from certain landlords, the COVID-19 pandemic, store closures and corresponding decline in sales made the substantial lease obligations in Canada, the US and UK unsustainable. Through the CVA and cross-border restructuring, AllSaints terminated or amended the terms of the majority of its leases to percentage or turnover-based rent. Creditors voted unanimously in favour of the CVA and amended lease terms and the recognition proceedings in Canada terminated in November 2020.
A similar process was undertaken in June 2020 by apparel retailer Comark Holding Inc., which owns brands Ricki’s, Cleo, and Bootlegger, whereby a quick CCAA proceeding (approximately 3 months from start to finish) was used to exit or renegotiate over 280 leases which facilitated the ultimate sale of the business to the previous owner and principal shareholder.
BIA and CCAA proceedings also provide a forum to conduct a court-approved sale process for all or part of the debtor’s business resulting in the granting of an approval and vesting order whereby a court approves a sale of assets free and clear of any creditor claims. Recently, Mountain Equipment Co-operative (MEC), Canada’s largest supplier of outdoor equipment, utilized the CCAA and a “pre-pack” sale in British Columbia to save its strong but over-leveraged business. MEC, which had debt and liquidity constraints prior to COVID-19 was unable to source adequate replacement financing on acceptable terms. A company will usually enter into CCAA protection first to utilize the benefits of the stay and then run a sale process. However, in early 2020 MEC ran a sale process and in September 2020 it entered into an asset purchase agreement to sell substantially all of its assets to a Canadian subsidiary of a US private investment firm. Three days later MEC filed for CCAA protection and sought court approval of the sale. The transaction provided stability during the CCAA proceeding and allowed the brand to survive (albeit in a different corporate form) and continue employing a substantial number of employees while shedding underperforming stores and excessive debt.
An abridged sale process was used in the context of an NOI in May 2020 by Coalision Inc., the parent company of the brand Lole., in order to source a buyer and avoid a liquidation. The retailer undertook a very limited sale process and completed a sale of the debtor’s assets in July 2020 to a syndicate of entities (some related to the debtor) that will focus on the profitable online and distribution business without the unsustainable debt.
The CCAA and BIA also allow a retailer to secure first priority interim or debtor-in- possession (DIP) financing to fund the restructuring which is important for a debtor that is liquidity-constrained and foresees a somewhat lengthy restructuring process. For example Reitmans (which owns the brands Reitman’s, Thyme Maternity, RW&Co, and Penningtons) and Aldo each filed for CCAA protection in May 2020. Both retailers experienced financial difficulties and attempted out-of-court restructurings prior to the COVID-19 pandemic to no avail. The debtors were able to secure substantial DIP financing to fund their continuing operations while they exit or renegotiate leases and wind down unprofitable business segments.
Financial Review Now Is Key
What is clear is that COVID-19 has changed the operating environment for many businesses, including retailers which has impacted many aspects of their financial model.
In some instances, returning to the pre-COVID status quo is not an option for success. Certain fundamentals in the industry have changed. After a year of largely online shopping, delivery or curbside pickup, consumers have discovered more convenient ways to interact with retailers. While a return to instore shopping is certain, online sales are expected to comprise a larger percentage of retailers’ sales in the future and consumer’s baseline expectations around the online experience including delivery times have changed. How are retailers positioned to adapt to these new demands? Retailers will need to consider how they engage with their customers online, how to compete effectively to increase traffic to their website and sale conversion rates. They also need to consider the efficiency of their supply chains and/or fulfillment models. If they need to make capital investments to meet customer demand and expectations, are they planning those now? Do they have access to funding?
With operational and financial models set to change, retailers will need to proactively assess their future financial position and liquidity, particularly in the transition period as they wean off government subsidies, address rent deferrals and extended payment terms with suppliers, face the end of covenant waivers or relief provided by lenders all while rebuilding working capital. In addition, many of the percentage rent agreements negotiated in 2020 were limited to a two-year period and will expire in 2022, and payments under BCAP loans secured early in 2020 may also be due in 2022.
Retailers have options, but they need to consider now what their business will and can look like post COVID-19. Developing a business plan and financial model will provide retailers with insights into the challenges the business may face post COVID-19 in terms of profitability and liquidity. Used proactively, these tools can also provide the retailers with adequate runway to address these issues, whether it is cost reductions, changes in its operating model, or sourcing additional funding for capital investments or working capital to avoid a crisis and potential financing restructuring in the future.
If a retailer’s financial model and business plan suggest that its current operating model would not align with the post-COVID environment, a retailer should consider whether an operating restructuring or financial restructuring is a strategic option for the business.
Authors:
Michelle Pickett is a partner at PwC Canada’s Deals practice in Toronto 
Monique Sassi is a restructuring partner at Cassels Brock & Blackwell LLP’s Toronto Office
