Body Shop, Red Lobster creditor protection cases show pitfalls in corporate dynamics

Companies like the Body Shop and Red Lobster are recent examples of how dynamics between foreign companies and their subsidiaries can spell trouble for businesses in Canada.

No matter how well the local arm of a global retailer or franchise restaurant performs, it might not matter if its parent company is struggling.

And when a subsidiary is forced to funnel its cash to the top echelons of the business, cover losses in other segments of the company or otherwise not have full control over its balance sheet, it can be dragged down along with the parent.

The Body Shop Canada Ltd. said in court filings it had to seek creditor protection earlier this year because its parent company, a European private equity firm, stripped it of cash and pushed it into debt, forcing it to close some stores.

Meanwhile, assets belonging to Red Lobster Canada, which a court was told two weeks ago is cash-flow positive, are similarly on the chopping block after the chain’s U.S. parent company filed for Chapter 11 bankruptcy protection. It was a move that exacerbated the Canadian arm’s already strained ability to cope with evolving consumer tastes and increased competition.

The difficulties such corporate arrangements surface are not new, but these recent cases are a reminder of the pitfalls they can produce.

“I don’t know that it’s all that surprising to me (that these scenarios happen) because that’s a business relationship,” said Daniel Waeger, Canada Research Chair in corporate governance, who teaches at Wilfrid Laurier University in Waterloo, Ont.

“When you have a conglomerate structure in a business, if the parent is not doing well then that’s going to affect the subsidiaries potentially.”

Sometimes subsidiaries – Canadian or otherwise – can be negatively impacted by an owner or corporate sibling who runs into financial trouble or sees sales decline.

“If on one side of the business things go wrong, then there is just less money to go around that you can distribute or, potentially, you have to take money out of your subsidiary that is actually doing well in order to support other parts of the business,” he said.

Another example of a challenge for subsidiaries is when a business changes hands or gets new leadership.

“Every change of power or change of control of the company is going to raise the spectre of how are we positioned against other parts of the business?” Waeger said.

In cases where private equity or hedge funds take control, he said there can be both a positive and a negative outcome.

The positive result comes if the fund is able to make a company’s operations more efficient, but often there is a negative story if the fund is only buying the firm because “they are after a profit.”

“Change in control – it’s a roll of the dice,” Waeger said.

“Where you’re going to fall is sort of a bit unpredictable at the outset, and as a subsidiary, you’re sort of, to a certain extent, at the mercy of those changes.”

Some companies that face troubles wind up filing for bankruptcy and closing.

Bed Bath & Beyond Canada Ltd., for example, filed for creditor protection last year, saying it was unable to repay its loans and its parent company had determined it was no longer able to provide financial and operational support to its Canadian arm. It closed all of its stores.

However, many others survive rough patches by selling assets or the entire business, or seeking creditor protection, so they can restructure and try to salvage the company.

“In a lot of cases, the companies are bought out, usually at a reduced size, with some of the stores already having been closed,” said Dina Kovacevic, editor of Insolvency Insider, a Canadian newsletter detailing bankruptcy and creditor protection news.

“Then it continues under new ownership, and truly the public is often none the wiser unless they’re reading the news.”

Toys “R” Us Canada managed to stay in business after it sought creditor protection in 2017 to cope with financial repercussions stemming from troubles in its U.S. business because it was sold to Fairfax Financial Holdings Ltd.

The Canadian segment of Toys “R” Us had long been the company’s “jewel in the crown” and was far stronger than its American counterpart – even though the separately-run entity always had less money, the toy retailer’s then-president Melanie Teed-Murch said in 2018. HMV-owner Putman Investments ultimately bought the business.

The U.S. business, however, closed all of its stores and has only recently begun rebuilding.

But repairing a brand is no easy feat. It takes time, money and a lot of customers willing to open their wallets, which are in short supply these days as high inflation and interest rates push many to rethink purchases.

“It seems like people haven’t really gone back to shopping as much as they used to or going out to eat at restaurants as much as they used to,” Kovacevic said.

“It just seems like the world is a different place and people don’t have as much money to spend.”