On November 10, 2008, Circuit City Stores, Inc. (“Circuit City”) filed for reorganization relief under Chapter 11 of the United States Bankruptcy Code.  Slightly more than two months later Circuit City announced abandonment of its plan to reorganize.  Instead, Circuit City will liquidate all of its assets.

What does this liquidation of Circuit City mean in terms of the potential for bankruptcy preference claims?

We have looked at the financial and other public information available.  Our preliminary assessment is that the Circuit City liquidation has the potential create a massive number of bankruptcy preference claims.

We stress that our assessment is based on incomplete and outdate financial information.  Circuit City has provided no financial information since early November.

Also, due to the way that Circuit City filed is list of creditors paid within 90 days of bankruptcy (the “Preference Period”), we are not able to make any determination if Circuit City was paying its suppliers in the ordinary course prior to its filing bankruptcy.  However, this would be a matter of defense to preference claims.

The Number and Amount of Payments in the Preference Period are Staggering

The following table is based on the Circuit City bankruptcy filings:

Number of Creditors Receiving Payments in the Preference Period 2,682
Number of Payments Made in Preference Period 15,083
Amount Paid During the Preference Period $      2,032,936,381

These are the gross numbers.  If payments that, by their very nature, are unlikely to be preference payments are removed, then the numbers change:

Number of Creditors Receiving Payments in the Preference Period 2,560
Number of Payments Made in Preference Period 15,400
Amount Paid During the Preference Period $    1,830,348,067

The Likelihood of Preference Claims is Disproportionately Higher with Smaller Vendors

Circuit City was the second largest consumer electronics retailer in the United States.  Its leverage in purchasing was substantial.  In many instances, Circuit City was negotiating purchase terms with suppliers who were as large as or even larger than Circuit City.  Its top 10 vendors by payments during the Preference Period are:

Sony electronics inc
Samsung Electronics Amer inc.
Toshiba computer systems div
Canon USA
LG electronics
Toshiba America Consumer Products
Panasonic North America
Panasonic Company National Acct

Payments to these vendors ranged from $25,000,000 to more than $200,000,000 during the Preference Period.

Large suppliers are by no means immune from bankruptcy preference claims.  Our belief that it is less likely that these major suppliers will face preference claims is based on their leverage dealing with a large customer, that they have credit management departments who closely monitor receivables and that they have in-house counsel to move quickly when a potential preference situation arises.

It is frequently the mid market to smaller suppliers who face the brunt of the preference claim process.  These suppliers are not only niche suppliers of goods to a retailer on a national level.  In the case of a bankruptcy involving a company that has multiple locations (Circuit City had more than 567 retail outlets when it announced its liquidation), every location has suppliers of goods and services.

To further get a picture of the preference situation, it is helpful to look at a distribution of the numbers.  The following table shows the number of creditors by grouping based on the amount of payments received in the Preference Period.

Payments Greater Than
or Equal to
But less than Creditors
$500,000   237
$400,000 $500,000 40
$300,000 $400,000 72
$200,000 $300,000 128
$100,000 $200,000 412
$5,475 $100,000 1,675

As you can see, the suppliers who were paid less than $200,000 during the Preference Period are going to represent the vast bulk of the pool of potential preference claims.

For these suppliers, Circuit City would have represented a major customer.  Leverage for these suppliers in dealing with Circuit City would have been minimal to non-existent.  Any aggressive response to an erratic payment situation would have been difficult.  Also these suppliers, due only to their size, would have been less likely to have had access to credit management and in-house legal resources.

When Will We Know If and When Circuit City Bankruptcy Preference Claims are Coming

The liquidation of the US Circuit City stores is to be completed my March 31, 2008.  However, this does not mean that the process of preferential transfer recovery will start immediately.  The Circuit City retail stores in Canada have not been scheduled for liquidation.  Circuit City continues to look for a buyer.  We believe it is unlikely that preference claims will be brought before that sale or liquidation occurs.

We have reviewed the limited financial information available.  Looking at the schedules filed by Circuit City in the bankruptcy, we think that preference claims are likely.  A schedule summary provided by Circuit City in its bankruptcy filings in November showed assets of $3,090,256,780 and liabilities of $3,249,333,444.

The actual situation likely will be much worse than is shown in the November schedules. In these schedules inventory was valued at $1,344,921,972; office equipment, furnishings, supplies at $68,178,945; machinery, fixtures, equipment and supplies used in business at $68,076,540; fixed assets – various at $250,723,869; and building and improvements net of depreciation  339,497,766.  The notes to the schedules stated that the numbers had not been adjusted for any impairment.  A substantial impairment of assets typically arises in any liquidation.  We think that a substantial shortfall in recovery of these amounts is likely.

Our best guess at this point is that the preference recovery process will start in the summer of 2010.  We will update this assessment as more information is obtained.