THE REORGANIZATION OF KMART - By: Jon Fisher Justin Wolbert

THE REORGANIZATION
     OF KMART

           By:
       Jon Fisher
     Justin Wolbert

Goals of Presentation
•Tell the story of Kmart
•Lessons for Debtor’s
 counsel
•Lessons for Creditor’s
 counsel

Sebastian S. Kresge
Date                         Event

1897   Worked with J. G. McCrory’s in Memphis, Tennessee

1899        Founded his own five-and-ten-cent store

1912       Incorporated the S. S. Kresge Corporation

1924        Kresge is worth $5 billion in 2009 dollars

1962         Kmart, Wal-Mart, and Target founded

1966                     Dies at age 99

The Rise and Fall of Kmart

• In 1988, Kmart was larger than Wal-Mart
  • Kmart had sales of 26 billion, with 692 million of
    profit
  • Wal-Mart had sales of 16 billion, with 627 million
    in profit

• By 2002, Wal-Mart was larger than Kmart
  • Kmart had sales of 32 billion, with 95 million in
    losses
  • Wal-Mart had sales of 220 billion, with 7 billion in
    profit

1988 Company Profile

 Sales              Profits

                              Wal-Mart
         Wal-Mart
         Kmart
                              Kmart

2002 Company Profile

 Sales
                             Profits
                     7,000
                     6,000
                     5,000
                     4,000
         Wal-Mart    3,000
                     2,000
         Kmart       1,000
                         0
                    -1,000

What Happened?

• Inability to successfully compete against
  Wal-Mart

• Lack of a coherent corporate philosophy

• Corporate Compensation
  • Ex. Chairman and CEO at the time of
    bankruptcy, Charles Conaway, received $23
    million in compensation for 11 months of work
    ($2,900 per hour, 24/7)

Continued
• Conaway negotiated a $6.5-million lump-
  sum payout if he was "terminated" within
  18 months. The following day, Kmart filed
  for Chapter 11 bankruptcy.
• Mark Schwartz, president and COO,
  walked away with his $3-million retention
  “loan.”

Continued

Charles Conaway         Mark Schwartz

Beginning of the end

• ESL, a “vulture” hedge fund, buys large
  amounts of Kmart debt.

• Kmart secures promises for $2 billion in
  post-petition financing.

ESL Investments

 Is a hedge fund that buys distress assets

 Bought approximately $1.2 Billion in
  debt

 Headed by Eddie Lambert, Called the
  “next Warren Buffet”

 Promised to invest at least $700 million

Eddie Lambert

Beginning of Bankruptcy

On January 21, 2002, Fleming Companies halts all
   shipments of groceries.
-   Fleming is Kmart’s sole grocery provider
-   Fleming accounts for 11% of all Kmart’s sales

On January 22, 2002, Kmart files bankruptcy.
-   Kmart files 23 first day motions
-   One month in, docket = 900+ documents
-   One year in, docket = 8,000+ documents

Issues

 Critical Vendor

 JDA

Paying Critical Vendors
• Kmart received authorization to pay pre-
   petition claims of $183.8 million to “critical”
   vendors.
• Section 105(a): “The court may issue any
   order, process or judgment that is necessary
   or appropriate to carry out the provisions of
   this title.”
• Days before confirmation, Critical Vendor
   Order is overturned by the District Court
  • Section 105 should be used to enforce the
      code, not change it.

Seventh Circuit Affirms
• Dicta: Section 363(b)(1) might provide
  authorization.
• “The trustee…may use, sell, or lease,
  other than in the ordinary course of
  business, property of the estate…
• Must show
 • The “critical” vendors would cease
    providing goods to the debtor without
    payment
 • Best interests of the estate

JDA Software
• JDA provided computer support for the
  Caribbean.

• The International CFO of Kmart said that
  Kmart would pay for all post-bankruptcy
  services even if he had to write the check
  himself.

• Kmart did not pay and deleted the software.

Outcome

• Section 503(b) provides that the “the
  actual, necessary costs and expenses of
  preserving the estate” are to be treated as
  an administrative expense.
• The Court did not require payment
  because there was no benefit to the
  estate.

Kmart Proposes a Plan

 Negotiations for payment

 Splitting the money

 Effects on the parties

Issues to be Resolved

 Who is Kmart?

 Did Kmart know that it was
 approaching bankruptcy?

Substantive Consolidation

  Kmart’s Story   Creditor’s Story

Fraud

Kmart’s Story           Creditors' Story

Coming to a Resolution

 Treated as Consolidated

 Establish a trust

 Pre-petition lenders get 40% of claims

 Claims will be paid in Cash

Distributing the Wealth

Class                         Claims           % of     Amount Paid
                                               Recovery

Class 1: Secured claims          $61,000,000        100        $61,000,000

                                                                        0
Class 2: priority claims                  0           0

Class 3:Pre-petition claims   $1,076,156,647         40       $430,462,659

Class 4: Note claims          $2,277,384,986       14.4       $327,943,438

Continued

Class                            Claims                % of Recovery    Amount Paid

Class 5: Trade Vendor Lease         $4,300,000,000                9.7     $417,100,000

rejection claims

Class 6: Other unsecured              $200,000,000                9.7      $19,400,000

claims

Class 7: General unsecured                $5,000,000             6.25        $312,500

convenience claims
                                                                                      0
Class 8: Preferred obligations        $648,043,500                N/A

Sharing the Wealth

              Class 1 : Secured claims

              Class 3: Prepetition claims

              Class 4: Prepetion note
              claims

              Class 5: Trade Vendor/
              Lease rejection claims

              Class 6: Other unsecured
              claims

              Class 7: General
              unsecured convenience
              claims

Effects

 Kmart Company

 DIP Financers

 Employees

 Senior Management

 Plan Investors

Kmart Company

DIP Financers

Employees

Senior Management

Plan Investors

Continued

 Bought Kmart for slightly under a Billion

 In 2003, sold less than 5% of leases for $850
  million

 Bought Sears and merged the companies in
  2004 for $10 billion

 Kmart has yet to show a profitable year, aside
  for selling of real estate

Sears Holdings

Takeaways from Presentation

        Debtor’s Counsel

        Creditor’s Counsel

Debtor’s Counsel
• Imitate
   • Hit the ground running with DIP
     financing lined up
   • Positive perception to court and vendors
• Learn
   • Critical Vendor Order – don’t reach too
     far
   • JDA – strategic assurances

Creditor’s Counsel
• Imitate
   • ESL spotted a great opportunity and
     transformed it into a way to get money
   • Know when to strike a deal
• Learn
   • Fleming – be careful what you ask for
   • JDA – assurances are not enough
      • Request payment in advance?
         • Avoidable preference
      • Force assumption of pre-petition
        contract?

Questions or Comments?