One retail company after another backed by private equity has entered Chapter 11 bankruptcy proceedings in recent months—Wet Seal and rue21 are two of the latest examples. Yet in many cases, as debt has piled up to unsustainable levels, the investors in these businesses are still making profits (or limiting their losses) by extracting hefty dividends.

Is such an arrangement fair? Payless, the operator of a chain of discount shoe sales, is trying to find out.

Payless
By Rickywood (Own work) [CC BY-SA 3.0], via Wikimedia Commons
The company, which went belly-up in early April, is investigating whether dividend payments that were made after its acquisition in a 2012 LBO by Golden Gate Capital and Blum Capital are responsible for driving the company into bankruptcy. Payless’ creditors are alleging irresponsibility by the two firms in ginning up more than $350 million in dividends since the takeover—cash that surely could have been used to pay off the company’s reported $838 million in outstanding debt at the time it filed for bankruptcy.

The investigation serves as something of a rebuke to the PE model. While firms are of course within their rights to pay themselves dividends, it’s a practice that’s long been pointed to as an example of private equity extracting existing value from companies for itself rather than contributing to long-term financial health.

Payless’ past few years are representative of retail’s recent struggles. The business was part of the publicly traded Collective Brands before being spun out in 2012 by Golden Gate and Blum. In the years since, the ongoing rise of Amazon and other forms of online shopping have driven customers away from Payless stores. Golden Gate and Blum, though, still had bottom lines to meet. In a span of roughly 12 months in 2013 and 2014, backers of Payless received $351 million in dividend payments.

Upon filing for bankruptcy last month, Payless also announced plans to close 400 stores. Last year, 31 PE-backed retail companies went bankrupt, according to the PitchBook Platform, a decade high; so far this year, 12 more business have completed proceedings.

Who are some of those companies? PitchBook subscribers can find out.

Article by Kevin Dowd, PitchBook