The recent giant retail bankruptcy filings by Toys ‘R’ Us and Sears Canada are not standalone cases in the retail sector. According to the recent Quarterly Report Of Business Bankruptcy Filings, in 2016, the United States experienced a year-on-year increase of 26% in the number of retail company bankruptcy filings. The sector generated 15.77% of all bankruptcies in 2017 year-to-date south of the border while the Sears Canada liquidation is making headlines in Canada.

The reasons for the bust of the traditional retail industry are plentiful. For one, the pressure from online retail platforms like Amazon, which is growing at more than 20% per year, is immense, but a sudden switch from the brick-and-mortar store model is not easy. Companies often underestimate the time and R&D expense necessary for the launch of a competitive online retail platform. While in-store sales are dropping, retail chains have a hard time responding quickly, given the often large capital investments in long-term leases and real estate. As retail is typically a low-margin business, companies can find themselves in the position of not being able to pay the bills, and are forced to file for bankruptcy protection.

The Amazon success story is not the only reason for the vast number of retail reorganizations in the past year. Driven by its growing affluence and increasing population, Canada is attracting copious numbers of luxury brands such as Sandro and Maje, Warby Parker, and others which are rendering the top quartile of the market ultra-competitive and further squeezing margins. At the same time, the ‘extreme-value’ sector is growing, spearheaded by Dollarama and Dollar Tree, which are adding locations and higher value products. In addition, traditional mid-tier retailers, such as Winners, Marshalls and HomeSense are entering the value sector. This deadly combination of rapid expansion of luxury retailers into Canada on one end, and the bolstering of the value sector on the other can make it difficult for companies that are stuck in the middle to give people reason for visiting their stores. In particular, retailers that lack an identifiable customer base, have poor customer service and/or lack of investment in consumer experience or carry an excessive product overlap with either larger or lower cost competitors are struggling.

Some other retailers such as Payless Inc., Gymboree Corp., and Toys ‘R’ Us are left overleveraged from prior private equity buyouts, either from before the 2008 financial crisis or during the recently ended period of cheap money. The struggle to pay down debt over many years and the inability to refinance due to the changing interest rate landscape and sluggish performance, leaves little money for investments to adopt to the changing marketplace.

Whether an LBO gone wrong or the inability to successfully enter the online retail space, as well as pressure due to increased competition or lack of adaptation to the changing demands of shoppers, many retailers have found themselves in Chapter 11 in the United States or a CCAA restructuring in Canada. Despite an often dire situation, many retailers have a very strong asset base and a working business that may merely need a balance sheet restructuring or help rescaling its physical store presence. Despite more retail stores opening than closing so far in 2017, we expect the retail sector adaptation to be ongoing and present ample opportunities for distressed debt funds and strategic buyers to get involved in future Canadian retail reorganizations.

The author would like to thank Shreya Tekriwal, Articling Student, for her assistance in preparing this legal update.

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