While the pandemic has caused catastrophic shake-ups in all sectors of the economy, one of the hardest-hit has been the retail industry.

For many retailers, COVID has led to financial hardship from which recovery is all but impossible. Nationally, 27 major retail companies have filed for bankruptcy so far in 2020. In Hawaii, when tourism ground to a halt this spring, visitor-dependent retailers suffered both lower levels of traffic into their stores and shutdowns instituted by the government to protect public health.

While the state has begun to welcome back tourists, the numbers are not expected to reach pre-pandemic levels in the coming months, leaving many retailers to face difficult choices in the near term, as debts continue to mount.

Bankruptcy ins and outs

While no business wants to contemplate closing up shop, if a business is forced to make that decision, it has a variety of options for doing so. In situations where significant funds are owed, liquidation of assets might make sense.

Bankruptcy, which means seeking relief of debts from the court, is a last-resort option because it entails handing over control to the bankruptcy judge and creditors. Also, ironically, the legal and filing fees can be expensive. Filing for bankruptcy can represent a fresh start, but it is not a decision that should ever be taken lightly.

When major retail chains like Neiman Marcus talk about bankruptcy, they are most likely referring to a Chapter 11 filing. A Chapter 11 bankruptcy lays the groundwork for a path forward, by establishing a plan for reorganization. Generally speaking, this is a situation where the business will continue to exist, in some form, and the debt owed will be paid off over time in the future. If a retail establishment has intangible assets of value such as a beloved brand, reputation or robust social media following, then Chapter 11 may be a viable option. Strong consumer brands have been known to rise from the ashes and live on through reinvention.

Smaller businesses can use the Small Business Case provisions of Chapter 11 as long as their aggregate debt is not more than $7.5 million, temporarily increased from $2,725,625 in response to effects of the pandemic. Under these provisions the Chapter 11 process is fast-tracked and some of the expenses reduced.

A Chapter 7 filing

Companies and individuals also can weigh a Chapter 7 filing. Unlike Chapter 11, the Chapter 7 scenario does not involve a drawn-out repayment plan. Assets are liquidated and used to pay creditors. Chapter 7 makes sense when there is no reasonable path forward and no foreseeable financial means to keep the business running. An individual who completes a Chapter 7 bankruptcy will receive a discharge from debts owed at the time bankruptcy was filed, but a corporation or other entity that files Chapter 7 will cease to exist when the case is completed. It is important to understand that the record of the bankruptcy will stay on a credit report for 10 years, potentially affecting one’s ability to secure good credit terms or secure credit at all in the future.

Eligibility to file for Chapter 7 bankruptcy may be limited if discretionary income is available to pay down the debt. Eligibility is also affected based on the amount of secured and unsecured debt when filing for Chapter 13, which allows individuals with regular sources of income to pay creditors over three to five years. These limitations could leave a Chapter 11 filing as the only possibility in certain cases.

Depending on the amount of debt owed by a business, it might make more sense to negotiate with creditors individually to establish repayment plans, rather than filing for bankruptcy.

Final thoughts

There is no one-size-fits-all solution for retailers looking to move to the next chapter. For those with insurmountable outstanding bills, bankruptcy might represent a fresh start. Be sure to vet all options with a professional to understand the potential impact of a bankruptcy on your ability to pursue future ventures.

Tom Roesser is a partner in the transactional practice group at Carlsmith Ball LLP. He can be reached at troesser@carlsmith.com.