Brick Mortar & Beyond: The Age of Bankruptcy

As NYU Law’s Class of 2023 prepares for life after graduation, we find ourselves entering a brave new world. Many of us were barely high school graduates when the 2008 crisis happened, but entered adulthood experiencing its lingering effects. When we entered law school, Bed Bath & Beyond was a favorite for new dorm furnishings, but we’ve since witnessed the company file for bankruptcy, unable to keep up with competition from online retail giants. Bed Bath & Beyond was not alone: our Class attended law school amidst a widespread downfall for retail companies. What went wrong with the American retail store industry? The rising cost of capital, high interest rates (coupled with reduced consumer spending), and obnoxious real estate prices are some reasons. But a deep dive shows that other factors may have accelerated, if not caused, the great retail downfall.

The 2008 crisis led to the demise of many home decor stores, giving Bed Bath & Beyond an advantage in the sector. For several years after, they showed significant growth. However, in 2019, as the share price dropped and store sales declined, the company declared its first annual loss. The same year, activist shareholders launched a proxy challenge to change the board of directors. Bed Bath & Beyond settled, agreeing to nominate new directors to the board and hire Mark Tritton of Target as the CEO.

Bed Bath & Beyond then embarked on a strategy to sell its private-label goods while phasing out existing brands from its shelves, a strategy that would be the first nail in the coffin. This was a complete overhaul of the business model – lower prices for comparable products – that had worked so well for the company. Only finding private-label brands on shelves did not resonate with customers and the company’s share price continued to tank, hitting $4 per share in 2020. While the company saw some brief respite in the meme-stock craze of 2021, when its prices shot up above $50, the rise had no foundation and stocks tanked as rapidly as they had risen. The activist investors' shakeup possibly caused more damage than keeping the original management would have, an interesting proposition to consider as the SEC’s new universal proxy rules make it easier for such challenges to be mounted.

As Tritton stepped away in 2022, the company was failing to find a buyer in bankruptcy and it seemed that liquidation was inevitable. However, the company orchestrated an interesting last-minute commercial move by selling $225 million worth of equity stock and another $800 million worth of warrants to a consortium of institutional investors. While Bed Bath & Beyond would receive the $225 million upfront for the stock, it would receive the $800 million in tranches if and when the investors converted the warrants into stock. The investors could choose to convert the warrants if the weighted average share price stayed above a certain price. While it seemed like Bed Bath & Beyond had been saved, Matt Levine pointed out the obvious: that the investors were buying the shares to sell. Any sale would likely only reduce the share value, particularly since most of the money received went towards repaying creditors, rather than improving business fundamentals. In April 2023, as Levine had predicted, the share price entered a death spiral and the company filed for Chapter 11 bankruptcy after all. The goal was to liquidate its assets and repay its creditors to the extent possible. Retail investors, as well as college students everywhere who relied on the store’s famous 20% off deal, were left empty-handed.

Incidentally, the past year saw the potential re-emergence of another beloved American retail institution. Sears came out of four years of Chapter 11 bankruptcy proceedings with 22 stores across the country, a far cry from its glory days. ESL invested heavily in the company in 2003, but their plan to revive the giant was hindered by the 2008 financial crisis and by Sears’s inability to pivot successfully to online retail. ESL’s Eddie Lampert provided much-needed liquidity through other means, including purchasing stores from them in a leaseback transaction and providing loans worth nearly $500 million. Despite these efforts, the company filed for bankruptcy in 2018.

The bankruptcy was messy. Lampert’s entities were the company’s largest secured creditors and therefore first in line to receive any remaining value from the liquidation. Sears and unsecured creditors sued Lampert, accusing him of improperly transferring the company’s assets to enrich himself. Lampert, in turn, claimed that he had wrongfully been denied priority by the court overseeing the bankruptcy proceedings. In 2022, the parties reached a settlement of $175 million with Lampert not admitting to liability for wrongfully enriching his entities. Thus, the most expensive retail bankruptcy since 2016 came to an end, with almost everyone – shareholders, employees, customers and most creditors – emerging a loser. Only Lampert walked away less of a loser, holding onto the better parts of what remains of Sears.

As the Class of 2023 started their final year of law school, the last vestiges of the bankruptcy proceedings of another nostalgia-heavy retail institution came to an end. Creditors of Toys R Us entered into a confidential settlement with former executives, ending a lawsuit that alleged that the company spent nearly $600 million on ordering inventory during Chapter 11 bankruptcy proceedings without disclosing that it was unlikely to avoid going into liquidation. Toys R Us was hard hit by online retail, but it had also saddled itself with debt in 2005 when Bain, KKR, and Vornado bought it in a leveraged buyout. The PE funds were never able to turn the company around enough to repay the debt or recoup their investment. Even after the company filed for bankruptcy in 2017, executives continued to assure suppliers and creditors that they could successfully come out of the bankruptcy without having to enter into liquidation, by taking on a debtor-in-possession (DIP) loan. On this assurance, suppliers continued to sell the company inventory on unsecured credit. But they failed to mention the stringent and nearly impossible terms of the loan, and when the company could not meet its targets under the terms of the loan, the lenders stopped extending credit. Toys R US filed for liquidation in 2018, and the DIP loan, which was secured with inventory, would be paid back through the liquidation proceedings. But that would leave nothing to the suppliers and other unsecured creditors of the company and, once again, leave retail investors with worthless shares.

Bed Bath & Beyond, Sears, and Toys R Us are only a few of the many retail stores that have gone bankrupt in the past two decades, and the number only seems likely to increase. Many blame private equity and hedge funds for the industry’s demise: private equity brings expensive executives who are comfortable with taking on high amounts of debt, and are reluctant (or unable?) to restructure these companies with a long-term perspective. Or maybe it is simply that in a world of Amazons, there is no real way to save brick-and-mortar stores when they seem to offer little more than nostalgic value without the convenience to go with it. In the coming years, as consumers forget what it was like to not shop online, will any retail stores survive in the physical world? It remains to be seen, because all happy companies may be alike, but every unhappy company is unhappy in its own way. Either way, the next few decades will be an interesting time for young lawyers – and consumers – everywhere.

Soumya is an LL.M. candidate at NYU Law. Prior to this, she was a capital markets lawyer in India for five years and worked with two of India’s leading law firms. At NYU, she is a Graduate Editor of the Journal of Law & Business and serves on the board of the Law & Business Association.