A few weeks ago, top U.S. mall owners Simon Property Group (NYSE:SPG) and Brookfield Property Partners (NASDAQ:BPY) seemed to be closing in on a deal to buy J.C. Penney (OTC:JCPN.Q) out of bankruptcy. While retail-focused private equity firm Sycamore Partners had offered a slightly higher cash bid than the consortium led by Simon and Brookfield, the mall owners' willingness to offer lease concessions appeared to be a trump card.

Unfortunately, negotiations hit a snag last weekend. As a result, J.C. Penney is turning its attention to hammering out a credit bid, under which its lenders would use their debt claims to buy the company. However, the risk of liquidation is rising with every day that the retailer remains in limbo.

The most sensible deal hasn't come to fruition

JCPenney stores anchor dozens of malls for both Simon and Brookfield, giving both real estate titans a big stake in the company's survival. That made them the most likely buyers -- and up until last weekend, they were on track to rescue the ailing department store chain.

Yet in a bankruptcy court hearing on Monday, Joshua Sussberg -- a lawyer representing J.C. Penney -- said that talks with bidders had reached a "stalemate." He indicated that Simon and Brookfield were still the top bidders as of last weekend. However, redevelopment rights and other lease terms emerged as a key sticking point, according to Bloomberg.

Sussberg said that J.C. Penney is still open to reviving a deal with Simon and Brookfield or with any of its other suitors. However, the holiday season is approaching, and the company doesn't have infinite time to engage in negotiations. As a result, J.C. Penney is now trying to quickly arrange a credit bid that would hand full control of the retailer to a consortium of its lenders in exchange for forgiving its debt. The lenders are also exploring a co-ownership scenario where they would partner with Simon and Brookfield or other bidders.

The exterior of a JCPenney store

Image source: J.C. Penney.

The business is on shaky ground

At the time of its bankruptcy filing, J.C. Penney hoped to exit Chapter 11 by November, ahead of the holiday season. The company saw a quick resolution as vital, as it needs to instill confidence in its vendors. If vendors become unwilling to provide inventory because they fear the retailer won't be around to take delivery and pay for the merchandise, J.C. Penney's fate would be sealed quickly. Customers also need reassurance. J.C. Penney's sales plunged 45% year over year last quarter -- a bigger drop than peers have reported.

Additionally, the longer the bankruptcy proceeding drags on, the lower the potential recovery for J.C. Penney's lenders in the event of a liquidation. While J.C. Penney reported a surprise operating profit for the month of June, sales slowed in July and the company swung back to a $122 million operating loss ($70 million excluding restructuring costs). Between the pandemic and the upheaval associated with the bankruptcy process, these operating losses are likely to continue in the months ahead.

Lawyers for J.C. Penney and its creditors recognize that time is of the essence and are trying to draw up a credit bid within 10 days. That said, a lawyer representing the lenders cautioned that there were real obstacles to negotiating a credit bid in that period of time. If J.C. Penney's business performance deteriorates further or the two sides struggle to reach an agreement, the lenders may decide to salvage what they can from a liquidation.

Down to the wire

If J.C. Penney is staying in business, it needs to start building up inventory for the holiday season immediately. Conversely, if it is going out of business, it needs to liquidate its current inventory sooner rather than later. That raises the stakes for the current negotiations.

There's still potentially a place for a slimmed-down J.C. Penney in the U.S. retail landscape, particularly as the COVID-19 pandemic is likely to thin out the competition. Despite the recent negotiating snag, mall owners like Simon Property Group and Brookfield Property Partners certainly have a stake in the retailer's long-term health. Nevertheless, time is running out to save this iconic retailer and the tens of thousands of jobs it supports.