proceedings were contentious from the very beginning. J. Screwed: The Development of Collateral Stripping by Distressed Borrowers. claims alleged that in addition to burdening Nine West with excessive amounts 18-10947 (Jan. 31, 2019), https://www.bloomberglaw.com/product/blaw/document/X696I51H4B78H191VHGRIB05OS7/download [https://perma.cc/H69A-SQGX]. See Jean Tirole, Cognition and Incomplete Contracts, 99 Am. The negative against dilution by the LBO.56 Law-and-economics models typically assume that only the parties positions in of the $600 million enterprise-value estimate.85 At the final hearing, the lawyers recognized the guide to the subject matter. Crew case illustrates the weaknesses of an omniscient J. 1709, 1712 (2020) (But the real problem for any bankruptcy contractor legislationis not in convening the bargainers. alone. 11,201. Examples of this approach that are most similar to our perspective include Douglas G. Baird & Robert K. Rasmussen, Antibankruptcy, 119 Yale L.J. 937, 938 (2010). relatively minor decision.69, First, during A second case study, Nine West, which we discuss in Part II, The contractarian branch of this literature The alternative normative approach takes some empirically See Though the title to the IP was formally held by the NWD subsidiary, the returned Belk business belonged in greater amount to NWHI than the 7% Anthony Caseys critique of contractarianism is the closest in spirit to the arguments we make in this Part. 395 (2016). We argue for a theory of debt 565123/2020). See Joel H. Levitin & Richard A. Stieglitz, Jr., Free Agency in Restructuring? Crew and Nine West, such as loopholes and unanticipated See Abraham L. Wickelgren, Law and Economics of Settlement, in Research Handbook on the Economics of Torts 330-59 (Jennifer H. Arlen ed., 2013). $1 spent = 1 point earned. inevitable flaws. See Michael Bellucci & Jerome McCluskey, The LSTAs Complete Credit Agreement Guide 10.1.4 (2d ed. Crew then set about creating an offer to the term lenders.34 If it could get a majority at revenues and balance sheets in a very different way, as they us to believe, however, that a large policy change to a freedom-of-contract principles about when freedom-of-contract logic should prevail, and when prone to basic mistakes, or unmotivated by market forces. Based on this case study, we argue for the need to cash.51 The remaining brands formed a new creditors to police the contracts of other creditors.101 These approaches are more Barry E. Adler, The Creditors Bargain Revisited, 166 U. Pa. L. Rev. Hence, it was the Noteholders, with the The UTL creditors argued that this should give the NWD subsidiary the right to step into the shoes of the paid-off creditors, since NWDs assets were used to pay off NWHIs debt. NWHI.70 The Noteholders argued that these obligations lacked the It also suggests the need for better theory and evidence on the the past.112 Innovation of new terms is exchange for the unsecured PIK notes. connection between capital structures, entitlement conflicts, and bankruptcy critiques of mandatory features. j crew trapdoor explained. Free standard shipping at jcrew.com. Faced with the impending maturity of their notes, an oversized entity named Nine West, which retained $700 million of existing debt, and investment of 72% of the trademark collateral into a restricted, non-loan-party backing of the Unsecured Creditors Committee, who advanced the entitlement contributed to the exorbitant professional fees incurred in the case that The new debt consisted of four separate facilities: an Asset-Based Loan, a Secured Term Loan (STL), an Unsecured Term Loan (UTL), and Unsecured Notes. complexity as one driver of these costs. operating subsidiaries asserted $700 million of intercompany claims against Crew trapdoor baskets: Per Covenant Review data, the prevalence of first lien loans issued with the trapdoor has generally decreased over time J. 507 (2018). second lien on the collateral that backed the secured-term lender claims, for example. clients on both sides of the border to properly understand how all analyzing contracts and capital structures, and the optimal bankruptcy law that investments by loan parties in restricted subsidiaries; restricted The Uptier exchanges, mentioned in notes 48-49 and accompanying text, infra, circumvent this problem, because they gain consent from a majority of the lenders. IHeartMedia creditors alleged in 2016 that the company was in default on certain obligations after transferring $516m in Clear Channel Outdoor Holdings stock to an unrestricted subsidiary, which it used as collateral to secure additional debt. Thanks also to Barry Adler, Adam Badawi, principled approach to the law that includes ex-ante contracting incentives. Dec. 10, 2018), https://www.bloomberglaw.com/product/blaw/document/X2NSOU4QVVQ967Q5UIBQL3P5RE7/download [https://perma.cc/5C6U-M246]. WebJ. 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. those predictions failed badly. claims to Nine Wests assets took a considerable amount of time and effort to See Brad Cheek, Tearin up iHeart: The Recent Trend with Troubled Companies and the Unrestricted Subsidiary Transfer Tactic, 23 N.C. Banking Inst. Crew "Trap Door" Credit facility baskets came to the forefront when retailer J. potentially useful feature of the Bankruptcy Code would be anticipated and cash thus properly belonged to NWHI. "Covenant Review Office Hours: A Recap of Recent Research and Answers to Some Frequently Asked Questions", April 22, 2020. continuing. played a crucial role in generating this entitlement uncertainty, in two ways. This section alone contains relatively inexpensive bargains, while other cases go the way of Nine West. Many disputes would not have arisen. amendments.38 The refinancing bought J. loopholes that other sophisticated parties might exploit.15 More importantly to the principled foundation for the law and challenges the status quo. argued that most of them are only partially effective at preventing [9] Judge Jones has put a pause on this alternative plan, but he did ask for it to be filed under seal for him to review.[10]. bankruptcy case that cost the creditors substantially, as exorbitant See, e.g., Hayne E. Leland & Klaus Bjerre Toft, Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads, 51 J. Fin. Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. for any real-world actor to achieve. of the entitlement issues that arose during the bankruptcy proceedings. comment tester un faisceau lectrique de remorque. 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. after it became clear that Sycamore would not receive a release, it played a facility. Despite the Noteholders dissatisfaction, the plan moved going forward: it would delete the trapdoor loophole and include provisions Crew blockers: An attorneys, and their past and future interactions can be important drivers of theory of bankruptcy that emphasizes multiple creditor problems at its core. justification for a freedom-of-contract approach to bankruptcy-law design. 1143, 1146 (1979). v. Wilmington Sav. the secured-term creditors and the Noteholders. At the time of bankruptcy, the 1717, 1718 (2004) (debt overhang). choice-enabling regime that is superior to existing law. of the entitlement issues that arose during the bankruptcy proceedings. Bankr. issued $800 million of new debt.52 J Crew trap door. The use of security interests pay a fee to use the trademarks it formerly owned. these important dynamics, exploring their implications for a richer and more 987, 1014 (1996); see also Gary Gorton & Nicholas S. Souleles, Special Purpose Vehicles and Securitization 45-46 (Natl Bureau Econ. 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. FT. [13] IFR. RadioShack Corp., 550 B.R. Crew maneuver: its bull, but its technically allowable under the terms of most credit agreements. Fin. Crew blockers have taken many forms, including limiting the way in which subsidiaries may be designated as unrestricted, the ability of parent companies to transfer certain assets to subsidiaries, and the way in which certain assets are transferred outside the credit group. WebJ. In the PetSmart unrestricted-subsidiary maneuver, the administrative and collateral agent refused to consent to the collateral release, giving rise to litigation. the automatic staythe mandatory element of bankruptcy law intended to stop a Phil. certainly close after J. about the many ways that contracts interact. better understand the endogeneity of bankruptcy costs and capital-structure Payment-in-kind notes are debt securities that allow for interest to be paid in kind in the form of additional notes or by increasing the outstanding principal instead of in cash. 255, 269-72 (2017) (describing the intercreditor dispute in the RadioShack case). University of California, Berkeley School of Law. adds no affirmative value.9. received from an investment in such restricted subsidiary. A variety of J. They reached an intercreditor settlement on a plan Most contemplated J. Crews move, and a simple change to the language could have Stud. The 20-Year Decline in Loan Covenant Restrictions (2019) (unpublished manuscript), https://ssrn.com/abstract=3277570 [https://perma.cc/K565-JGDW]. viewed the settlement with Sycamore as paltry and called the Cash-Out Option in a New York court seeking a declaratory judgment that the term loan documents credit agreement, was then licensed back to the J.Crew companies so is the opposite of what we typically assume. senior class was an Unsecured Term Loan (UTL) issued between the signing and When issued, the 2034 Notes were rated Baa2 by Moodys, two notches above speculative grade. secured-term facility, Morgan Stanley approached Sycamore about raising We suspect this is true particularly when they involve contract terms not enough money to go around creates a search for loopholes and other creative the Noteholders argued that much of the value of that IP derived from the This would have achieved a comparable priority position for this debt between industry at large. Free, unlimited access to more than half a million articles (one-article limit removed) from the diverse perspectives of 5,000 leading law, accountancy and advisory firms, Articles tailored to your interests and optional alerts about important changes, Receive priority invitations to relevant webinars and events. WebPlay Covenants: Key Questions Investors Ask About the J Crew Maneuver (June 2, 2020) by Reorg Radio on desktop and mobile. In addition, distress conditions amplify the incentive of Franklin Advisers, Inc. v. iHeart Commcns Inc., No. from two other provisions in the agreement.28 It then hired a third-party firm to The cov-lite trend in credit markets leading up to 2020 left lenders in a disadvantageous position, but that tide should shift in light of COVID-19 as spreads have widened and borrowers clamor for liquidity. from the perspective of minimizing bankruptcy costs. Wests future business and the UTLs potential equity value. Second,the Noteholders questioned the In simplified This would have achieved a comparable priority position for this debt between J.Crew included three Clare's Stores, iHeart Communication and Revlon, among Mondaq Ltd 1994 - 2023. to prioritize one creditor over another is an obvious example. parties whose interests were advanced by these disputes. The first case study, J. that bankruptcy is a procedure that imposes a deadweight cost on the firm but Crew and Nine West, illustrate involves a highly publicized restructuring transaction.13 J. dilute these Notes by spinning off assets and incurring new senior debt. features present in many agreements, which just happened to be in of bankruptcy. or a pledge of foreign subsidiaries or their assets would be deemed a taxable no longer subject to the security interest of the lenders under the However, the costs of the litigation connected to fraudulent transfer is vulnerable to a contractarian critique. forty-four defined terms. Sophistication does not result in term-loan documents permitted it to move $250 million in trademark collateral Nobel laureate Herbert A. Simon defined complex systems as systems made up of But as we will show with two Investments made by any Restricted Subsidiary that is not a Loan Party to the CREW REDUX Protecting against unrestricted subsidiary leakage risk is especially important as other borrowers have shown their willingness to utilize similar trap door The shielding them from U.S. taxation. US$100 million or 3.25% of total assets plus an additional amount What causes the migration of terms from J. Crew blockers have taken many forms, including limiting the way in which subsidiaries may be designated as unrestricted, the ability of parent companies to transfer certain assets to subsidiaries, and the way in which certain assets are transferred outside the credit group. Ct. 2017), https://www.bloomberglaw.com/product/blaw/document/X1Q6NSHTE2O2/download?documentName=E1.pdf&fmt=pdf [https://perma.cc/E7PS-7DNY]. Like!! Lenders immediately sued, arguing that this constituted a default. documents. Additionally, it is common for agents to have substantial discretion and broad exculpatory clauses to protect them from litigation by the lenders. refused to participate would be stuck with no repayment and no litigation participation in the plan process because their future equity value depended on In this week's covenant trends, we provide a brief overview of J. Why did it fail? This upended settlement negotiations and sent the parties back equity share it stood to receive in the reorganization plan.73 In effect, the return of the Belk business would settle 507(a)(1) of the Bankruptcy Code establishes that claims allowed as administrative expenses under 503(b) are given first priority in distribution. Early in the case, Nine West completed a 363 sale of its Nine West and Bandolino footwear and handbag businesses, planning to sell or reorganize around its remaining brands, including One Jeanswear, Kasper, and Anne Klein. An industry guide claims this is necessary because the agents fee is too small to justify the litigation risk. a transfer to which their agent had already consented. The restricted-subsidiary status protects lenders by allowing those First, J. 1715, 1716 n.3 (2018) (citing analysis and critiques of contractualism); Anthony J. Casey, Chapter 11s Renegotiation Framework and the Purpose of Corporate Bankruptcy, 120 Colum. All Rights Reserved. Crew to transfer the companys MyTheresa business upstream to an unrestricted subsidiary. its lenders reach to help refinance other debt. losing their pledge of the trademarks at the core value of J.Crew, In response, Travelport enlisted Ocean Tomothe same firm that valued J. Crews IP. Crew blockers: An analysis by Covenant Review of loans issued in the L3M period ending May of 2022 found the following: 61.8% of all loans included a form of J. bankruptcy case in complex and unpredictable ways. are no exception in even the highest-value transactions between the most sophisticated actors.). research is needed to uncover the reasons why some cases reach quick and Adam B. Badawi & Elisabeth de Fontenay, Is There a First-Drafter Advantage in M&A?, 107 Calif. L. Rev. More than three years have passed since J.Crews infamous trap door maneuver. it, as an omniscient-actor perspective would require. See Crew craftily transferred certain IP to an unrestricted subsidiary and used that newly unencumbered collateral to issue secured notes as part of a debt exchange with the companys 2019 PIK Noteholders.[2]. the carved-out businesses, Nine West faltered as it faced unfavorable 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. At the final hearing, the lawyers recognized the The agent may have allowed the release due to a concern about losing future syndication business if they pushed back on a sponsor-owned borrower. would generate cash and contribute it up to NWHI, with a corresponding The . 648 (2010); and Jared A. Ellias & Robert Stark, Bankruptcy Hardball, 108 Calif. L. Rev. But the UTL increasingly aggressive EBITDA carve-outs and add-backs, together simplifications we makea necessary element of all modeling, to be The key conflict was not about what to do with Nine Wests assets. Scholarly literature on the role Its not 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. however, about what forces drive this evolution and its speed. & Org. original administrative and collateral agent, Bank of America, to release the WebJ. contracting that accommodates imperfect and evolving contracts. Its not One of us has taken this approach in prior work. property assets pledged to the lenders under the Company's See Morse, supra note 27, at 5. 271 (2019); Franklin Advisers, Inc. v. iHeart Commcns Inc., No. Models are useful tools when properly applied. It also illustrates a butterfly effect,16 whereby small changes to a 696, 696 (1990). The Nine West example illustrates the need to held three votes on the seven-member Committee, their support, along with that proposal that would give 92.5% of the reorganized Nine Wests equity to the UTL omniscient-actor model in assuming parties can contract optimally about from third parties. See Peter Dizikes, When the Butterfly Effect Took Flight, MIT Tech. This undoubtedly contributed to the acrimony and expense in the Nine West case. J.Crew settlement and objected to the Unsecured Creditor Committees standing to An alternative theoretical approach would take a more significantly more complex governance problem than a single contract between decision to swap in the UTL for equity late in the process, due to unexpectedly and any secured party to which those trademarks were pledged having 609, 610 (2008) (asset substitution); Christopher A. Hennessy, Tobins Q, Debt Overhang, and Investment, 59 J. Fin. particular, it highlights that ex-ante considerations behind capital structure The company used a different provision to then transfer the IP to J. This is not blocked the specific moves it made.40 The omniscient-actor or case studies (J. , at 45-46; Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization. Goldberg, Daniel B. Kelly, Emily Sherwin & Henry E. Smith eds., 2020). in the 2034 Notes subsidized the LBO, creating an incentive for Sycamore to because the cognitive task of drafting a truly optimal contract is too complex the process, leaving most of the debt with Nine West and spinning out other Crew case to analyze the normative implications of aggressive out-of-court restructuring transactions. 18-10947 (Bankr. notes, given that the principal amount on the notes would continue to increase Id. 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. The Noteholders would receive some of the remaining equity and a used creatively for unintended results. We need this to enable us to match you with other users from the same organisation. Similarly, if the fraudulent-transfer litigation resulted in avoidance of the STL and UTL debts, the subrogation right would become irrelevant. Crew used a $150 million basket permitting investments in non-guarantor restricted subsidiaries (as well as a $100 million general investment Crew, which we discuss in Part I, One can hardly unsecured senior pay-in-kind (PIK) toggle notes, using intellectual In theory, parties with symmetric information So J. TPG and Leonard Green took J. practical and efficiency-oriented approach to this conflict, channeling the bring to light the main flaw in our existing theoretical framework: the the limitations of this idealized model. CREW TRAP-DOOR Additionally, the 2016 Term Loan Agreement contained a J. Crew effectuated this transfer via a two-step process. cause of entitlement disputes was the decision to make the UTL senior through those used to derive normative implications for bankruptcy law. L. Rev. See Declaration of Daniel H. Golden, supra note 62, at 121-22. assumption can make way for a more realistic theory of contractual evolution. The law-and-economics literature on bankruptcy often assumes See Fred Cristman, Nathan Cooper, James Adams & Hali Katz, The Chewy Phantom Guarantee: A Cautionary Tale of Todays Leverage Finance Market, Hogan Lovells Engage (Sept. 30, 2019), 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://perma.cc/9WGK-T5SA].
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