A.B.C. Carpet Co., Inc – New York “Lifestyle” Furnishing Retailer Succumbs to COVID and Consumer Shift to Online Purchasing (and 50% Revenue Drop); “Opportunistic Debt” Specialist Sovereign Finance Appears Set to Serve as Credit Bidding Stalking Horse

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September 8, 2021 – A.B.C. Carpet Co., Inc and two affiliated debtors (dba as ABC Carpet & Home; “A.B.C. Carpet” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the Southern District of New York, lead case number 21-11591 (Judge David Jones). The Debtors, "a mission-driven home and lifestyle brand that is a favorite with designers, decorators and consumers," are represented by Oscar N. Pinkas of Greenberg Traurig, LLP. Further board-authorized engagements include (i) B. Riley Securities, Inc. (“B. Riley”) as investment banker and financial advisor (also wearing the hat of store/merchandise liquidator) and (ii) Stretto as claims agent. 

The Debtors’ lead petition notes between 1,000 and 5,000 creditors; estimated assets between $10.0mn and $50.0mn; and estimated liabilities between $50.0mn and $100.0mn. Documents filed with the Court list the Debtors’ three largest unsecured creditors as (i) Northern Trust ($15.5mn contingent, unliquidated, disputed bank debt claim, the Debtors provide no further detail as to this debt in their first day filings as at writing), (ii) Mccreary Modern,Inc. ($264k trade debt claim) and (iii) Ashoka Creations ($206k trade debt claim).

DIP Financing and Stalking Horse

The Debtors' have filed a motion requesting debtor-in-possession ("DIP") financing of up to $5.7mn ($2.25mn interim) to be provided by 888 Capital Partners, LLC (“888 Capital Partners”) with 888 Capital Partners to also serve as a stalking horse in a section 363 auction/sale process. The DIP financing comes with interest of 12% (default interest at 15%) and a commitment fee of $120k (ie roughly 2%). 888 Capital Partners [an entity created on August 3, 2021, with 888 being the Broadway address of the Debtors' flagship Manhattan store] has only recently purchased a majority holding of the Debtors' senior debt ($8.75mn outstanding as at Petition date, with $2.7mn of that held by Paulette Cole as described below) from Gerber Finance which had itself only recently made the funding available (December 2020).

Details as to the recent sale of that debt (price, etc.) have not been shared. Comments from the Debtors' investment banker (see Exhibit B of Docket No. 12) that negotiating positions held by 888 Capital Partners "eliminated the strategy of unsecured financing from a third party" would reinforce suspicions of a loan-to-own strategy; although at 14% (interest and fees) over what will be an accelerated sale/bankruptcy process (DIP milestones include an asset sale closing by October 31st) and with significant revenue generated by an inventory clearance process providing considerable comfort as to the Debtors' ability to repay the DIP financing with or without an asset sale, this may just represent aggressive, opportunistic lending. Either way, credit-bidding stalking horse 888 Capital Partners has the whip hand in these cases for now.

888 Capital Partners shares an address with Sovereign Partners which describes itself as "a real estate investment firm that specializes in the acquisition of quality assets and opportunistic debt throughout the United States….At Sovereign Partners, we have built a team with a comprehensive expertise in pursuing opportunities in undervalued properties, distressed debt and other unique scenarios throughout the capital stack."

A footnote in the Debtor's DIP motion notes that given her holding of a portion of the Debtors' prepetition senior debt, initially as majority-held by Gerber and now as held by 888 Capital Partners, LLC, the Debtors' CEO, Creative Director and largest shareholder Paulette Cole would hold an indirect minority interest in the purchaser (if the purchaser is ultimately the stalking horse). The footnote provides: "As discussed in greater detail in the bidding procedures motion, 888 Capital Partners, LLC is also the proposed 'stalking horse' bidder. 888 Capital Partners, LLC, or its assignee/designee, intends to credit bid the Prepetition Secured Obligations and DIP Obligations as part of its stalking horse bid. If the stalking horse bid is the successful bid and the sale is approved, the Participant will hold an indirect minority interest in the purchaser by way of her Participation Interest." The DIP motion adds: "As of the Petition Date, the outstanding balance due on the Prepetition Loan (including recent prepetition advances) was no less than $8,747,598.42, of which no less than $2.7 million constitutes the Participant’s [ie Ms. Cole's]  Participation Interest under the Participation Documents, including interest."

In comments provided to the New York Post, Aaron Rose, chief executive of the retailer, stated "ABC Carpet & Home is in advanced discussions with a strategic investor who has provided funding for the company’s operations and is developing a long-term financial plan that will continue the company’s iconic legacy. Business is operating as usual during this process.”

Other potentially interested parties reportedly include "a consortium of Iranian rug merchants and private equity firm Windsong Global in partnership with brand licensing firm Hilco Brands [although the engagement of B. Riley, would seemingly make that partnership less likely]…[and] Burch Creative Capital."

Clearance and Consignment Sales

The Debtors will ask for Court authority to engage B. Riley Retail Solutions, LLC Clearance "to represent and assist the Corporation in operating and managing the clearance and consignment sales…"

Goals of the Chapter 11 Cases

Aaron Rose, the Debtors' chief executive officer, stated in a declaration filed in support of the Debtors' first-day motions (the "Rose Declaration"), "The Debtors have two immediate goals in these chapter 11 cases: (i) secure the use of cash collateral and DIP financing and (ii) consummate a sale of their assets that will maximize recoveries for the Debtors’ estates and maintain a viable business. Immediate use of cash collateral and DIP financing on an interim basis will stabilize the business, avoid a wind-down of the business, and allow the Debtors to pay employees for any accrued and unpaid wages. In the event the Debtors are unsuccessful in obtaining immediate use of cash collateral and DIP financing, the Debtors would be forced to liquidate.

Unlike many other retail cases, the Debtors have not commenced this case to liquidate and shutter operations. As set forth in their sale motion, based on the pre-petition marketing process, interest received from potential purchasers and the Stalking Horse APA from 888 Capital, the Debtors are seeking to pursue a sale of their assets on an expedited timeframe in order to limit administrative expenses and maximize value for the benefit of their stakeholders."

Events Leading to the Chapter 11 Filing

The Debtors provide: "The Debtors’ business operations have been severely impacted by the pandemic, including government-mandated store closures, fulfillment issues due to supply chain shortages, production delays, and delays in return to work for nearby commercial office spaces. The impact of the pandemic on Debtor ABC Carpet & Home was more pronounced than many other retailers given that the Debtors’ flagship store is in New York City, which was the subject of not only more restrictive regulations than many other municipalities, but also experienced a mass exodus of current and prospective customers leaving the city. In addition, the Debtors’ business has been negatively impacted for the past few years by other adverse market trends, including the shifting of sales from traditional brick-and-mortar retailers to online retailers, changing consumer preferences and construction delay related impact to operating performance at the Debtors’ 888 Broadway store location. The Debtors’ liquidity position has now reached the point that further deterioration, without near-term funding, would likely require that the Debtors cease operating. Accordingly, the Debtors have determined in their business judgment, after exploring various strategic options, that a sale of substantially all of their assets as a going-concern is in the best interests of their creditors and estates. 

While the Debtors have a significant customer base, the impact of the COVID-19 pandemic caused the Debtors’ revenue to decline year-over-year.

Year through date to July 31, 2021, the Debtors’ gross sales were approximately $25.46 million, an approximate 50% drop from the same period in 2018."

The Rose Declaration further explains, "Despite the Company’s unique position in the marketplace, the last few years have been increasingly challenging. The Company’s operating performance has been in a steady decline and has relied in several instances on Ms. Cole to advance loans to the Company to avoid liquidity shortfalls and operational challenges. The diminishing operating performance is the result of a confluence of events that have been exacerbated by the COVID-19 pandemic. Those events have included a slow transition to digital marketing and e-commerce, liquidity shortfalls created by increasing costs and declining revenues, and construction issues that impacted operations, all of which were then magnified by the brick and mortar shock caused by the pandemic.

The pandemic not only resulted in significantly reduced foot-traffic in the landmark store — a location designed to be an experiential marketplace — it also caused supply chain shortages and production delays, which in turn caused inventory levels to shrink, order lead times to extend, and also resulted in cancelled customer orders and lost revenue.

Even so, Ms. Cole [Paulette Cole, guarantor and great-granddaughter of the man who established the rug business that grew into abc carpet & home] remained committed to the business and the Company’s staff, and advanced yet further funds to help the Company meet its short-term obligations. By April 2020, however, with year-over-year revenues continuing to decline, that arrangement became unsustainable, and the Debtors retained B. Riley to help source capital or identify a potential strategic transaction (including a sale of the Company or its assets). B. Riley prepared extensive marketing materials and went to market to source opportunities, but it quickly became clear that the uncertainty of the pandemic at that time was creating a significant obstacle to attracting capital or an acceptable transaction partner. Instead, B. Riley was able to successfully source the Gerber Facility in October 2020, which provided the Debtors with needed liquidity.

With the effects of the pandemic lingering, even after the stores re-opened, the Debtors’ business continued to suffer. Sales continued to be slow, government mandated restrictions limited capacity, much of the Company’s target demographic had temporarily relocated outside of New York City, and the Debtors’ had insufficient liquidity to pay vendors and acquire additional inventory. In addition, given the Company’s financial troubles, many of the Company’s vendors forced advanced credit requirements on the Company, which further strained liquidity.

Despite these challenges, the Debtors worked diligently to maintain their operations in the face of declining liquidity and increasing financial uncertainty. While seeking a stable and long-term solution for the business, the Debtors engaged with, and extended exclusivity to, a potential strategic partner for a sale of the Company or its assets. Ultimately, after almost eight months of negotiation and devoting considerable resources to the process, no transaction materialized.

Pursuit of Strategic Alternatives

With the Company’s financial distress deepening and the Debtors falling into default under the Gerber Facility, in July 2021 the Company once again retained B. Riley to help facilitate a capital solution. Shortly thereafter, the Company also retained GT to help develop and execute on a strategic alternative with B. Riley. Accessing its considerable retail industry contacts, B. Riley targeted over 80 potential transaction parties likely to have an interest in pursuing a strategic transaction with the Company.

More than 20 prospective transaction parties entered into non-disclosure agreements and more than 10 parties conducted due diligence in the data room setup by B. Riley and the Company. Several of those parties conducted substantial onsite diligence with Company representatives at 888 Broadway and engaged in advanced negotiations with the Company and its professionals. Several parties also submitted either terms sheets or letters of intent to B. Riley and the Company.

As discussions with several parties advanced, 888 Capital emerged as the frontrunner. To solidify their intentions, 888 Capital purchased and took assignment of the Gerber Facility and agreed to make protective advances under the facility to fund the Company’s operations to get to a sale transaction. As negotiations progressed, 888 Capital expressed a desire to pursue a transaction under section 363 of the Bankruptcy Code and a willingness to provide DIP financing to help facilitate a chapter 11 filing.

On September 8, 2021, following weeks of arm’s-length negotiations between the Company and 888 Capital, the parties entered into both a Stalking Horse APA and DIP Credit Agreement. 51. Under the DIP Credit Agreement, 888 Capital has agreed to loan the Debtors over $6 million, subject to the DIP bid budget, various milestones and certain other conditions."

Prepetition Indebtedness

As of the Petition Date, the Debtors are subject to asserted outstanding funded debt obligations consisting of (i) approximately $8 million in senior lien secured debt outstanding under the Gerber Facility; (ii) approximately $15 million in unsecured loans from Northern Trust; and (iii) approximately $40 million in unsecured insider loans.

The Debtors' secured debt includes a Promissory Note and Loan and Security Agreement executed on October 1, 2020 in favor of Gerber, predecessor in interest to 888 Capital, as lender (in such capacity, the “Prepetition Lender”) to provide Debtors with one or more loans (the “Prepetition Loan”) in the principal amount of $5,000,000.00. In connection with the Prepetition Loan, Ms. Cole executed a Guaranty dated as of October 1, 2020 pursuant to which she guaranteed the payment of certain of the Obligations of Debtors to Prepetition Lender and, in March 2021, pledged as collateral her right, title and interest in and to a deposit account in her name.

On July 21, 2021, the Prepetition Lender and Ms. Cole executed a Participation Agreement, pursuant to which Ms. Cole acquired a $2,000,000 undivided junior participation interest under the Prepetition Loan Documents (the “Participation Agreement”). On August 4, 2021, the Prepetition Lender and Ms. Cole executed a Partial Release of Collateral, also lent to the Company under the Prepetition Loan, pursuant to which Ms. Cole acquired an additional $700,000 undivided junior participation interest under the Prepetition Loan Documents (the “Release Agreement” and together with the Participation Agreement, the “Participation Documents” and Ms. Cole’s interest under the Prepetition Loan Documents, the “Participation Interest”).

The Prepetition Loan matures on September 30, 2022 and bears interest at the rate of three percent (3%) per annum in excess of the prime rate plus five percent (5%) in the case of a default. As of the Petition Date, the outstanding balance due on the Prepetition Loan (including recent prepetition advances) was no less than $8 million (the “Prepetition Secured Obligations”), of which no less than $2.7 million constitutes Ms. Cole’s Participation Interest under the Participation Documents, including interest.

About the Debtors

According to the Debtors: “abc is a lifestyle brand with a rich legacy in home, hospitality, and wellness known for instilling a sense of wonder and action in our guests. Food, comfort, rest, and ritual are transformed through the lens of personal and planetary well-being into choices that are good for people and even better for the world. What started in the late nineteenth century as a pushcart business selling carpets became one of the largest and most diverse rug and home collections in the world. Since 2003, our demand for consciously made artisanal goods has helped transform the retail landscape."

Corporate Structure

According to the Rose Declaration, "The Company is a family-owned business that was operated by Ms. Cole from 2003 until I joined in 2019. Ms. Cole, along with various trusts maintained for the benefit of Ms. Cole and/or her daughter, own directly or indirectly each of the Debtors.

The governing board of each of the Debtors (collectively, the “Boards”) is currently comprised of Ms. Cole, Deirdre O’Connor — an independent director whom I selected and who was appointed to the Boards in July 2021 — and me. Each of the Debtors’ Boards has delegated to Ms. O’Connor and me authority with respect to matters related to the Debtors’ bankruptcy filing, any sale process and restructuring."

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