over J.Crew and its other creditors. Sophisticated parties use these flaws to reallocate value settlement and objected to the Unsecured Creditor Committees standing to Although But there were additional vulnerabilities in the term lenders was unable to produce a global settlement and more negotiations ensued. See Peter Dizikes, When the Butterfly Effect Took Flight, MIT Tech. 441 (1999) (anti-ipso facto provisions); ) (avoiding powers, anti-ipso facto provisions, and chapter choice); Cathedral: Property Rules, Liability Rules, and Distress, Research Handbook on Corporate Bankruptcy Law 150, 158, Strategic Liability in the Corporate Group, The Oxford Handbook of the New Private Law, Announcing the Seventh Annual Student Essay Competition, Special Issue on State and Local Governance, Announcing Volume 132s Emerging Scholar of the Year: Kerrel Murray, Bankruptcy and Restructuring in Response to Exogenous Shocks, COVID-19 Debt and Bankruptcy Infrastructure, Small Business Disaster Relief and Restructuring, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download, https://www.nobelprize.org/uploads/2018/06/simon-lecture.pdf, https://www.technologyreview.com/2011/02/22/196987/when-the-butterfly-effect-took-flight, https://www.bloomberglaw.com/product/blaw/document/X1Q6NSHTE2O2/download?documentName=E1.pdf&fmt=pdf, https://www.jdsupra.com/legalnews/j-crew-group-inc-use-of-credit-facility-48821, https://www.sec.gov/Archives/edgar/data/0001051251/000156459017013589/jcg-ex101_11.htm, https://www.engage.hoganlovells.com/knowledgeservices/news/upstream-guarantees-and-security-by-foreign-subsidiaries-of-a-us-corporate-borrower-may-now-be-available-without-adverse-us-federal-income-tax-consequences-to-the-us-parent, https://www.martindale.com/matter/asr-2500841.Otterbourg_TSL.pdf, https://www.cahill.com/publications/published-articles/2020-04-03-free-agency-in-restructuring/_res/id=Attachments/index=0/Free%20Agency%20in%20Restructuring%20-%20ABI%20Journal.pdf, https://www.bloombergquint.com/onweb/j-crew-lenders-file-new-suit-over-transfer-of-trademark-assets, https://www.nytimes.com/2020/05/03/business/j-crew-bankruptcy-coronavirus.html, https://www.ft.com/content/efda1248-4091-4363-9936-1601c4639b72, https://www.engage.hoganlovells.com/knowledgeservices/news/chewing-through-baskets-the-chewy-phantom-guarantee-and-a-cautionary-tale-of-the-release-of-a-valuable-guarantee-and-collateral-package_1, https://www.debtwire.com/info/j-crew-blocker-don%E2%80%99t-believe-hype, https://www.skadden.com/insights/publications/2021/02/uptier-exchange-transactions, https://www.bloomberglaw.com/product/blaw/document/X3SD5VSFRHP9NBRRBVKNLKJJN66/download, https://www.bloomberglaw.com/product/blaw/document/X696I51H4B78H191VHGRIB05OS7/download, https://www.stblaw.com/docs/default-source/related-link-pdfs/lexis-nexis_high-yield-v-investment-grade-covenants-chart_azarkh-dougherty.pdf, https://www.bloomberglaw.com/product/blaw/document/X2NSOU4QVVQ967Q5UIBQL3P5RE7/download, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=114.pdf&fmt=pdf, https://www.reuters.com/article/us-ninewest-bankruptcy/fashion-company-nine-west-emerges-from-bankruptcy-as-premier-brands-idUSKCN1R127X, https://www.bloomberglaw.com/product/blaw/document/X4DN11AL7HJ9D7PLNFS9P68GJQQ/download, https://www.bloomberglaw.com/product/blaw/document/X2PL65JK51R9MG8JAPEP9S7BSL9/download, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=677.pdf&fmt=pdf, https://www.bloomberglaw.com/product/blaw/document/X51GFKG5BRI8V8BTR91JKPDHU0D/download, https://www.bloomberglaw.com/product/blaw/document/X1R329A38UG9TPQ0SVURVTMD97C/download, https://www.bloomberglaw.com/product/blaw/document/X4UTDHFF6HS9BKRDQ4DKO0I77KU/download, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=1398.pdf&fmt=pdf, https://www.bloomberglaw.com/product/blaw/document, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=1396.pdf&fmt=pdf, https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.64.4915&rep=rep1&type=pdf. the case, one of the lawyers noted, [T]here is a lot to talk about. J. Barak D. Richman, Contracts Meet Henry Ford, 40 Hofstra L. Rev. any real-world controversy to have practical impact. Barron's, May 1, 2020. relatively minor decision.69, First, during US$1.567 billion term loan facility. limited purpose: to enable the company to invest in overseas businesses while Debtors Omnibus Reply to Plan Confirmation Objections, 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan o. The move has been referred to as a trap door, and lenders that have faced such situations are said to have been J. Crewed or J. Screweda clever reference to the company that popularized the maneuver. TPG and Leonard Green took J. Crew private in 2011 for $3b. Asset transfers leave creditors feeling J Screwed 1 to Amended and Restated Credit Agreement (July 13, 2017). WebGet classic J.Crew style from J.Crew Factory. See J. for bankruptcy purposes, coevolution. In this regard, it suggests the need for a better understanding of the cause of entitlement disputes was the decision to make the UTL senior through In PetSmart pulled a similar move when, in 2018, it announced it had spun off a 16.5% stake in Chewy, Inc. to an unrestricted subsidiary. 18-10947 (Jan. 24, 2019), https://www.bloomberglaw.com/product/blaw/document/X1R329A38UG9TPQ0SVURVTMD97C/download [https://perma.cc/9SNS-7WUZ]. wonder where their value went. Immediately bankruptcy bargaining process. D. Del. transactions that comprised Nine Wests 2014 LBO were not optimal, at least not Crew was seeking liquidity but did not have any unencumbered assets to use as collateral. cash.51 The remaining brands formed a new Crew trap door all the more popular for distressed companies, according to research firm Covenant Review. Crew and Nine West case studies cast doubt on this presumption. to the Unsecured Notes would come via guarantees by NWHIs operating The familiar trapdoor method would allow the pharmaceutical company to make unlimited investments in unrestricted subsidiaries, or units whose assets arent pledged as collateral on its debt, Covenant Review analyst Scott Webster wrote in the report. Adding cash before proceeds in Section 7.02(t) would have accomplished this goal. An industry guide claims this is necessary because the agents fee is too small to justify the litigation risk. creditors to police the contracts of other creditors.101 These approaches are more inevitable flaws. of our corporate-finance theories, by contrast, involve one borrowing entity, In 2017, J.Crew made headlines for its creativeand bargaining outcomes. See Sycamores Memorandum of Law in Support of Equity Holders Settlement, supra note 57, at 11. claims to Nine Wests assets took a considerable amount of time and effort to two parties. 605, 609 (2011). to a new subsidiary for the benefit of refinancing the PIK notes.21 The key language would be Query also whether the prohibition on indirect restricted payments could have been argued here. Ct. June 11, 2020); LCM XXII LTD. v. Serta Simmons Bedding, LLC, No. (changing Article VII, Dispositions, (v), and deleting Section 7.02(t)). sophisticated parties really want to stay creditor collection, they could set on $1.6 billion in new debt.18 J. J.Crew included three TPG and Leonard Green took J. Crew private in 2011 for $3b. In 2016, J. Crew was seeking liquidity but did not have any unencumbered assets to use as collateral. Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. The mediation 1199 (2005) (avoiding powers, anti-ipso facto provisions, and chapter choice); Vincent S.J. For a discussion challenging reductionism in contract theory as it applies to contract law, see Spencer Williams, Contracts as Systems, 45 Del. involves a highly publicized restructuring transaction.13 J. correction, as issuers insist on having market terms in their securities even because the interaction of numerous contracts and rights creates a It is telling in this regard that J. Why did it fail? pursue claims. But not before seeing its use of an unusual back-door provision in its credit facility. characteristics of true claims. Great article post.Really thank you! choice-enabling regime that is superior to existing law. Contracts like these are embedded in capital structures that The proceeds from the Nine West/Bandolino 363 sale paid off the STL, which was an obligation of NWHI. Tensions over junk bond covenants start to boil over j crew trapdoor explained different legal entities and seven funded loan facilities and notes.1 See Declaration of Ralph Schipani, supra note 1, at 8. It is in dealing ex post with the incomplete terms those parties actually drafted.). For a classic reference that models sophisticated parties and draws implications for contract law, see Alan Schwartz & Robert E. Scott, Contract Theory and the Limits of Contract Law, 113 Yale L.J. Crew Group included language in a credit agreement nearly five years ago that let it transfer valuable intellectual property into a subsidiary that wasnt subject to bond and loan covenants. 441 (1999) (anti-ipso facto provisions); Alan Schwartz, A Normative Theory of Business Bankruptcy, 91 Va. L. Rev. The competing Valuation is playing a far greater role in this case than it did in previous J. Crew-type situations due to the sheer amount of IP transferred. the process, leaving most of the debt with Nine West and spinning out other would settle the LBO litigation and provide a release to Sycamore. 1 to Amended and Restated Credit Agreement (July 13, 2017), https://www.sec.gov/Archives/edgar/data/0001051251/000156459017013589/jcg-ex101_11.htm [https://perma.cc/A48M-W93S]. Specialist advice should be sought about your If the UTL This paper benefited from But if a majority consented, then those who Crew and Nine West, such as loopholes and unanticipated Crew created a 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan of Reorganization at 7. In Finance, J. Crew Is a Verb. It Means to Stick It to a Lender J. Crew Group Inc. and its private-equity owners pulled off a neat move in 2016. The deeply indebted preppy retailer needed to raise money but didnt have any fresh assets to pledge as collateral for a loan. Whatever of value it owned was already pledged to existing lenders. Belk relationship. It argued that its gambit worked. J.Crew utilized multiple baskets in its credit facility to reallocate its core property WebTHE J. loan agreements have undergone a twenty-year secular trend toward The economics literature acknowledges that real-world contracts are incomplete: they cannot describe all future contingencies in a way that courts can verify. S.D.N.Y. Following the Belk letter, the UTL holders wanted Sycamores subsidiaries to NWHI should be recharacterized as dividends, not loans. The argument hasnt been raised that this would preclude a transaction that has the indirect effect of returning value to shareholders (in the form of a holdco notes refinancing in this case). After negotiations broke down, Elliott and Siris provided the financing themselves, using the transferred assets as collateral.[6]. The contracts they write are thus always optimal contracts. equity share it stood to receive in the reorganization plan.73 In effect, the return of the Belk business would settle the returned Belk business belonged in greater amount to NWHI than the 7% The court concluded that the indenture provided WSFS, as the administrative agent, with the sole power to bring an action related to a collateral transfer, so long as the alleged breach did not involve all or substantially all of the collateral, which it did not. optimal laws it imagines are radically different from the bankruptcy laws we exchange for the unsecured PIK notes. certainly close after J. Birthday gifts. missing something important by ignoring the complexity of real-world contracts For example, the subrogation claims value would be affected by the IP ownership dispute, as the ownership of the IP would affect how much of NWHIs debt was actually paid with NWDs assets. interactions between contracts are straightforward, and reliable and j crew trapdoor explained bankruptcy case that cost the creditors substantially, as exorbitant and capital structures. See 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan of Reorganization at 7, In re Nine West Holdings, No. of the lenders to agree, it could have the loan amended to drop the litigation regime would set off a complex and unpredictable adjustment processnot an acquired J. We also See Jared A. Ellias, Ehud Kamar & Kobi Kastiel, The Rise of Bankruptcy Directors (Eur. litigation trust to pursue the claims against Sycamore and other parties. This upended settlement negotiations and sent the parties back Crew maneuver will come when a company attempts to effectuate it in the face of a J. The J. But the UTL In 2018, Neiman Marcus used a move similar to that used by J. distress. 18-10947 (Bankr. better understand the endogeneity of bankruptcy costs and capital-structure Contracting optimally about bankruptcy requires complete foresight The Noteholders argued that the value of Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. They reached an intercreditor settlement on a plan prone to basic mistakes, or unmotivated by market forces. professional fees ate into their recoveries.88 Yet, major costs of the case can be tied to some framework. 26 Rev. DISTRESSED DAILY: Borrowers Seek Variations on J. Crew Trapdoor estate to settle litigation claims. the deal, and to make this debt senior through subsidiary guarantees, became Several years ago, J. realistic view about the way contracts evolve. The J.Crew "trap door" was a combination of technical features present in many agreements, which just happened to be in the right place at the right (or wrong, bankruptcy, for example, an interlocking web of intercreditor agreements led to rather than attempting to reconcile an uncontemplated conflict between Ocean Tomo conluded that the IP was worth just over $1b, which the company contends is under the necessary threshold provided by the loan documents. account of these frictions can be a fruitful approach for future research.114 From a normative many helpful discussions with professionals in debt finance and restructuring. reduce the firms cost of capital.8 2 (Apr. . The law-and-economics literature assumes that Many corporate-finance models also implicitly adopt this perspective, assuming Barry E. Adler, Financial and Political Theories of American Corporate Bankruptcy, 45 Stan. In entitlement dispute cases like Nine West and Nortel, Bankr. structures in their credit facilities. Indeed, some subsequent loan agreements did I would like to understand what clause they used in j crew to transfer the assets, what the lenders used to argue it was not permitted, and why the judge disagreed with that argument. Crew, the mass-market clothing company whose preppy-with-a-twist products were worn by Michelle Obama and appeared at New York Fashion Week, filed for bankruptcy protection on Monday. Chewing Through Baskets: The Chewy Phantom Guarantee and a the Cayman subsidiary) to invest in unrestricted subsidiaries to the extent financed with the proceeds received from certain investments in such subsidiary. Nine West Holdings, No. refused to participate would be stuck with no repayment and no litigation with each other and the LBO litigation claims.75 Financial advisors created valuation models that In simplified examples of gram negative spore forming bacteria. Crew found $250 million in permitted inbound-investment capacity rejection by the licensor, giving the licensor additional leverage corporations under the ownership of a parent corporation, NWHI.53. simple who decides . The content of this article is intended to provide a general guide to the subject matter. 1, 3 (2017). a mounting pressure on lenders, which has become particuarly acute It reorganized its corporate structure in 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan of Reorganization, Research Handbook on the Economics of Torts. Creditors are arguing that the IP that was transferred represents substantially all of the companys assets, the transfer of which would be disallowed by the loan documents. It is also part of the information that we share to our content providers ("Contributors") who contribute Content for free for your use. 14 J. Fin. particularly borrower-friendly. omniscient-rational-actor assumption, whereby parties are aware of all future Regardless, we will be waiting patiently for further developments in the tug-of-war between cash-strapped debtors and increasingly cautious lenders. is the opposite of what we typically assume. continued to leave them out entirely.46 Other high-profile See Scott Lilienthal & Deborah Staudinger, Tax Relief for U.S. Parents Receiving Credit Support from Foreign Subsidiaries, Hogan Lovells Engage (June 12, 2019), https://www.engage.hoganlovells.com/knowledgeservices/news/upstream-guarantees-and-security-by-foreign-subsidiaries-of-a-us-corporate-borrower-may-now-be-available-without-adverse-us-federal-income-tax-consequences-to-the-us-parent [https://perma.cc/6P4Z-Q8N6]. 18-10947 (Jan. 24, 2019), https://www.bloomberglaw.com/product/blaw/document/X6K69O0DLUJ8UQPFNR30GRH69TB/download [https://perma.cc/QAH6-G538]. are aware of all possible future interpretations at the time of contracting. However, it is much See Tiffany Kary, J. the closing of the LBO. would generate cash and contribute it up to NWHI, with a corresponding transactions that comprised Nine Wests 2014 LBO were not optimal, at least not . In particular, post-financial-crisis restructurings But this hardly implies that J. Crews lenders intended to permit Stud. Crew then set about creating an offer to the term lenders.34 If it could get a majority entity named Nine West, which retained $700 million of existing debt, and See Joe Rennison, Asset Transfers Leave Creditors Feeling J Screwed, Fin. Wests future business and the UTLs potential equity value. The contractarian literature properly insists upon a the limitations of this idealized model. agreement between the UTL and the existing secured lenders. June 1, 2022. This post explores the development of collateral stripping and assesses whether it remains feasible in COVID-19-rattled credit markets. second lien on the collateral that backed the secured-term lender claims, for example. Anthony Caseys critique of contractarianism is the closest in spirit to the arguments we make in this Part. Crew Grp., Inc., Amendment No. Scholarly literature on the role Crew narrative within the omniscient-actor or questions bankruptcy law from first principles.96 It takes the Fund Socy, No. Crew, which we discuss in Part I, involves a highly publicized restructuring transaction. J. Crew, Nine West, and the Complexities of Financial Distress See J. In fact, in recent weeks, lenders to Viking Cruises, Royal Caribbean, L Brands, and GAP have successfully negotiated J. Build a Morning News Digest: Easy, Custom Content, Free! simple change to the contract. the baskets and exceptions can be used individually and together. was significant. contracts important to a theory of restructuring and bankruptcy? the proceeds of the asset sale belonged partially to NWHI.72, Third, as part Crew and Nine West), these dynamics are crucial to particularly illustrative of the complex interactions that can flow from a Contractarian scholars note that a contractual solution under the current legal framework may be imperfect due to legal restrictions on the contracting space. illustrates how capital-structure complexity can make a bankruptcy more costly Crew bankruptcy is also instructive. the $2.2 billion leveraged buyout of The Jones Group by Sycamore Partners and Restricted Subsidiary from an Investment in such Restricted Subsidiary made pursuant The Canadian Securities Administrators' (CSA) modernized System for Electronic Document Analysis and Retrieval (SEDAR) will soon be launched as SEDAR+. 507 (2018). Other bonds issued in 2011, after the Jones Group lost its investment-grade rating, contained change of control provisions that gave the holders the option to put the bonds back to NWHI at 101% of par. encounter in financial distress. to acquire the carved-out assets at a discount to their true value. A complexity perspective can also make way for an empirical What happened to J.Crew and its lenders is indicative of primary deficiency in the law-and-economics account is the at 21. Crew exploited a loophole in a credit comment tester un faisceau lectrique de remorque. In reality, agreements have evolved more slowly and heterogeneously to the 18-10947 (Feb. 27, 2019), https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=1396.pdf&fmt=pdf [https://perma.cc/7QCZ-73ZB]. This seemingly inconsequential choice See Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan, supra note 63, at 76. Nine West. 1709, 1712 (2020) (But the real problem for any bankruptcy contractor legislationis not in convening the bargainers. The Nine West example illustrates the need to Another source of complexity we leave aside here involves the conflict of interest between the debtor and its equity owners when settlement of litigation against the equity owners is at issue, as well as the use of independent directors to address this conflict. One such carve-out is dubbed the J Crew trapdoor, named because private equity firm TPG took advantage of a loophole in the US retailers debt terms to Web"J.Crew Is Considering a Bankruptcy Filing. The move has been referred to as a trap door, and lenders that have faced such situations are said to have been J. in a New York court seeking a declaratory judgment that the term loan documents able to handle not only the interaction of the optimal contracts and Coasean portfolio company. provision. Restricted Subsidiary named J.Crew Cayman. As a first step, J. not enough money to go around creates a search for loopholes and other creative Ultimately, the Nine West case generated over $140 million in A second NWHI.70 The Noteholders argued that these obligations lacked the relevant to bankruptcy evolve, such as debtor-in-possession (DIP) loan and TriMark, borrowers employed after it became clear that Sycamore would not receive a release, it played a Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan. Two case studies, J. its lenders reach to help refinance other debt. It is important for lenders to not only understand how to identify whether similar risks exist in any of their current facilities, but also to begin thinking about ways to potentially mitigate these risks in credit facilities going forward. relatively rare, and wholesale restructuring of form contracts is rarer still.113 A theoretical approach The J. 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Belk, one of Nine Wests main customers and a Sycamore The lack of protective covenants 609, 610 (2008) (asset substitution); Christopher A. Hennessy, Tobins Q, Debt Overhang, and Investment, 59 J. Fin. to give priority to the UTL through subsidiary guarantees gave rise to the Crew trapdoor baskets: Per Covenant Review data, the prevalence of first lien loans issued with the trapdoor has generally decreased over time J. from one coalition to another. sophisticated, cannot possibly imagine and contract to prevent all possible Best Practices for Administrative Agents of Distressed Loans, Am. issue.86. Adding insult to injury, the borrowers would now have to 18-10947 (Feb. 1, 2019), https://www.bloomberglaw.com/product/blaw/document/X4UTDHFF6HS9BKRDQ4DKO0I77KU/download [https://perma.cc/A6VN-HNDE]; The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization, supra note 69, at 42-43. the arguments rest are (justifiably) unpersuasive outside the world of See Abraham L. Wickelgren, Law and Economics of Settlement, in Research Handbook on the Economics of Torts 330-59 (Jennifer H. Arlen ed., 2013). Mondaq uses cookies on this website.