(Bloomberg) -- Sports Authority Inc. limped into bankruptcy in March with a straightforward plan to survive as a smaller, more nimble purveyor of bats, balls, sneakers and sweatpants.
Job One? Close unprofitable stores and sell off their inventory.
But almost immediately a fight broke out over who owned some of that inventory: The retailer or the vendors who supplied it on consignment? Employees had to pull more than $25 million in stock from liquidation sales while the company and the suppliers bickered about how deeply to slash prices and who got the money.
The slimming-down process was abandoned. Now Sports Authority, which once boasted almost 500 stores and 14,500 employees, is shutting down entirely. The meltdown had many causes, but the consignment conflict was a crucial blow and raised an issue many hadn’t thought existed. That’s making vendors and lenders more cautious as the crucial holiday ordering season dawns, with some suppliers looking into the best ways to secure their interests before a retailer goes bankrupt.
“That’s the uncertainty that is bothering people in the industry,” said Charles Tatelbaum, a creditors’ rights and bankruptcy lawyer at Tripp Scott in Fort Lauderdale, Florida. “We will see a tightening of credit and more scrutiny. The more retail failures there are, the more the vendors are getting skittish.”
Changing consumer habits and the rash of retail bankruptcies this year may make those in the industry rethink past practices, said Mike Murray, senior managing director at Wells Fargo & Co.
“You could make the argument that given the state of retail, everyone’s going to be analyzing -- whether or not it’s retailers or lenders -- what makes the most sense and, in particular, vendors,” he said.
For most of its stock, a retailer typically pays for goods up front and assumes the risk that products won’t sell. But retailers also get some items without paying in advance under consignment deals. Suppliers retain the risk in hopes of getting more when the item is bought by a consumer.
Sports Authority took the consignment model further than most.
“A substantial portion” of sales were based on consigned goods from 170 vendors, the company said in court documents. At the start of the bankruptcy, shelves were stocked with 8.5 million consignment items worth $85 million.
Sports Authority asked U.S. Bankruptcy Judge Mary Walrath in Delaware for permission to liquidate consigned goods like any other items. Vendors led by running-shoe maker Asics America Corp. fought back, claiming they still owned the goods.
Walrath delayed ruling on the ownership question, but handed the vendors a temporary victory, ordering that consignment goods be either sold at normal prices or removed from liquidation sales.
That decision is confusing and needs to be clarified, said Gary Wassner, chief executive officer at Hilldun Corp., a New York firm that provides financing to suppliers.
“I don’t think most people realize the ramifications,” he said.
Consignment vendors usually lose control over their goods if they haven’t protected themselves properly before a retailer goes bankrupt. Chains conducting going-out-of-business sales offer steep discounts to clear out doomed locations, with most proceeds going not to the suppliers but to lenders who claim the inventory as collateral.
Such goods take up a small share of shelf space at most chains and are typically favored by luxury retailers and jewelers. But there’s heightened interest in these deals, Wassner said.
“There is an uptick, for multiple reasons, in consignment requests,” he said. Even upscale department stores are looking to buy more goods on consignment. Vendors, though, are not enthusiastic about sharing that risk, he said. “We’re seeing more requests for it, and brands are very reluctant to do it.”
In the meantime, “people are going to have to do a lot more diligence,” said Kenneth Rosen, who heads the bankruptcy practice at Lowenstein Sandler LLP. Lenders will want opinion letters detailing what their claims are for all the goods in a store, an added cost. “I have to logically assume that every lender that watched Sports Authority is going to say to their borrower, ‘I want to know that everything that I see in your store is subject to my claims,’” Rosen said. Had the situation in Sports Authority been known, lenders would have likely provided less financing, he said.
Sports Authority asked Walrath to rule that 160 such suppliers had to take a back seat to the lenders, arguing that bankruptcy law overrode the consignment contracts, including the vendors’ rights to set prices. Asics and the other consignment vendors responded that they still owned the goods.
The vendors could have avoided that fight by filing paperwork under the Uniform Commercial Code giving them first call on the proceeds from a consignment sale, said C. Jordan Myers and Mike Parisi, restructuring and financing lawyers at Alston & Bird LLP. The paperwork requires the vendors to also notify a retailer’s lenders that the goods can’t be claimed as collateral, they said.
Many suppliers find the process tedious and costly, so they don’t bother, Parisi said. Only one in four of Sports Authority’s consignment suppliers tried to take those steps, the company said in a court filing.
Walrath’s interim decision favored vendors, but it also wrecked the chain’s plans to run going-out-of business sales at 140 stores while trying to keep the rest open. By the time Sports Authority and the Asics-led vendor group settled their fight in July, it was too late to save the chain.
And the ownership question remains open because several suppliers refused to settle. If they don’t cut a deal, Walrath may decide once and for all what rights, if any, vendors retain in bankruptcy when they fail to file the UCC paperwork.
The question could also haunt struggling retailers and their lenders. Store owners need to go into bankruptcy with a clear understanding of who has dibs on the inventory, Myers said. Sports Authority didn’t, and it’s paying the price.
“For a retailer to survive and emerge from bankruptcy, almost everything has to go as expected,” Myers said. “There can’t be any hiccups along the way because the time is so short.”
Walrath’s decision accelerated the liquidation, he said. “This was kind of the nail in the coffin.”
The case is In re Sports Authority Holdings Inc., 16-10527, U.S. Bankruptcy Court, District of Delaware.
--With assistance from Dawn McCarty To contact the reporters on this story: Steven Church in Wilmington, Delaware at firstname.lastname@example.org, Lauren Coleman-Lochner in New York at email@example.com. To contact the editors responsible for this story: Andrew Dunn at firstname.lastname@example.org, Nick Turner at email@example.com, Kevin Orland
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