The news of the iconic toy retailer, Toys R Us, filing for bankruptcy has really dominated the business headlines, particularly as we enter the Christmas season. On September 18, 2017, Toys R Us filed for protection against its creditors under Chapter 11 of the US Bankruptcy Code. Toys R Us has approximately five billion dollars of long-term debt on the books, and simply cannot continue operations unless the company’s finances are restructured.
Not Going Away
For anyone who has played the board game Monopoly (available for purchase at Toys R Us), the idea of bankruptcy means that it is game over for one or more participants. Monopoly has made the term “bankruptcy” synonymous with “out of business forever”. But that is not necessarily the case in reality.
In the United States, there are various types of bankruptcies that can be utilized. One of them allows a company to restructure its operations rather than shut everything down, which is the option that Toys R Us utilized. So in 2017, customers can still get their Christmas presents from Toys R Us, even though they filed for bankruptcy.
The real sad part about Toys R Us is that the iconic company would be quite profitable if not for the unnecessary debt it took on in the mid-2000s. Toys R Us used to be a publicly traded company. In other words, any individual could buy and sell shares of Toys R Us on the stock market. Then one day, a group of private equity firms decided that they wanted to buy everything, and remove Toys R Us from the stock exchange. In business terms, this is referred to as “going private”. The private equity firms took out a bunch of debt in order to purchase all the outstanding stock of Toys R Us from individual shareholders. This debt was then loaded onto the financial books of Toys R Us.
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In 2017, the debt became too much for Toys R Us to handle. Their recourse was to file for bankruptcy protection in order to have some of that debt written off. This is similar to when people file for personal bankruptcy in order to have their credit card debt discharged. In both cases, the end result is a fresh start for the debtor.
Unfair For Creditors?
When a corporation or an individual files for bankruptcy, someone who is owed money (i.e. the creditor) will be left holding the bag. After the bankruptcy process is complete, the creditor will not be able to collect all the money that is owed to it. In one sense, bankruptcy forces the creditor to subsidize the poor choices of the debtor. This appears to be quite unfair, and there are places in the world where the option to file for bankruptcy does not exist.
But in the United States, the idea behind a restructuring-style bankruptcy is that the creditor will at least be able to recover some money. Whereas, if there was no bankruptcy option, the debtor would simply close up shop and disappear, with the creditor being able to recover nothing.
For Toys R Us, Chapter 11 of the US Bankruptcy Code is key. This is the provision of the law that allows Toys R Us, as the debtor, to keep possession of the company and its assets, instead of handing it all over to the creditors. The legal term for this arrangement is “Debtor in Possession”. Then Toys R Us is free to search for financing from other lenders to keep operations going. Toys R Us did just that when it received a three billion dollar commitment from a group of lenders. Had Toys R Us filed for Chapter 7 bankruptcy, it would mean that Toys R Us would cease operations altogether, and eventually disappear as a company. Under Chapter 11, Toys R Us can instead work to restructure its operations and debt, in the hopes of eventually emerging from bankruptcy as a leaner, more efficient company.