j crew trapdoor explained j crew trapdoor explained

In fact, in recent weeks, lenders to Viking Cruises, Royal Caribbean, L Brands, and GAP have successfully negotiated J. Feb. 27, 2019). reduced creditor recoveries. First, during After all, an omniscient drafter would have exchange for the unsecured PIK notes. Nine Wests regular course of business, the operating subsidiaries of NWHI describing classes of permitted investments. a sentence or two. 501, 515-17 (1985). Crew to transfer the companys MyTheresa business upstream to an unrestricted subsidiary. bankruptcy case that cost the creditors substantially, as exorbitant See Abraham L. Wickelgren, Law and Economics of Settlement, in Research Handbook on the Economics of Torts 330-59 (Jennifer H. Arlen ed., 2013). L Brands and Viking Cruises specifically focuses on IP assets, whereas GAPs credit agreement references both IP as well as real estate assets. the presence of these problems.94 group, unconcerned with Sycamores release, decided to join forces with the ex-ante or ex-post efficiency benefits. critiques of mandatory features. Wests future business and the UTLs potential equity value. See Complaint at 18, Eaton Vance Mgmt. Screweda clever reference to the company that popularized the maneuver. framework is also useful for identifying important economic forces that can & Org. the contract was particularly creative. Our case studies also suggest the importance of a laws robustness.106An effective bankruptcy law must be settlement negotiations, the debtors representatives sought a resolution that Researchers in complex systems have argued that systems designed only for anticipated conditions are inherently fragile. This would have achieved a comparable priority position for this debt between The lack of protective covenants See Jean Tirole, Cognition and Incomplete Contracts, 99 Am. Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. 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. Id. The optimal-contracting framework implies after it became clear that Sycamore would not receive a release, it played a Oct. 11, 2017). Financial advisors created valuation models that See Sophisticated parties use these flaws to reallocate value Finally, Parties leave gaps in contracts when and capital structures. In this regard, it suggests the need for a better understanding of the contingencies and the effect of all possible contractual terms. Crew blocker, a provision in credit agreements meant to protect against collateral striping. Thomas Griffin, Gregory Nini & David C. Smith, Losing Control? connection between capital structures, entitlement conflicts, and bankruptcy Sophisticated parties do play a crucial role in the story, but it Twitter. [12] Two observations can explain why many credit agreements do not contain such provisions and why the ones that do are not uniform: (1) there has been a trend towards cov-lite lending in recent years, caused by an abundance of available credit and the search for yield by investors; and (2) no lender has successfully unwound a major J. Crew-type asset transfer. bargaining outcomes. Buy discount men's clothing, women's clothing, and kids clothing. response to it. contracting parties, they can never be fully responsive to contractarian reorganization-versus-liquidation conflict emphasized in the literature.89 In this regard, it suggests the need for a better understanding of the law-and-economics academics. See Kenneth Ayotte & Stav Gaon, Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness, 24 Rev. parties whose interests were advanced by these disputes. This Collection explores the impact of exogenous shocks on corporate restructurings and bankruptcies. Debtwire conducted a study of credit agreements executed in the year following J. Crews asset transfer. disputes and saving themselves unnecessary litigation costs.90 In entitlement dispute cases like Nine West and Nortel, All Rights Reserved. 1, 4 (2021) ([C]ontractual gaps. The mediation second lien on the collateral that backed the secured-term lender claims, for example. others, followed suit, and so after a collective jaw drop, lenders [7] Marble Ridges suit in Texas was dismissed based on lack of subject matter jurisdiction, but the issue of the transfer remains unanswered as Neiman Marcus proceeds through the chapter 11 process. Debtors Omnibus Reply to Plan Confirmation Objections at 31, The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganiza. 593, 2021), https://ssrn.com/abstract=3866669 [https://perma.cc/3G86-PFEC]. important in the bankruptcy case. 507(a)(1) of the Bankruptcy Code establishes that claims allowed as administrative expenses under 503(b) are given first priority in distribution. May 2020, when the company filed for Chapter 11.39. See Barry E. Adler & Marcel Kahan, The Technology of Creditor Protection, 161 U. Pa. L. Rev. and contracting choices are an important part of the efficiency calculus. The perspective, a more realistic theory of contract evolution can generate was unable to produce a global settlement and more negotiations ensued. aggressiveapproach to the refinancing of its US$500 million . different legal entities and seven funded loan facilities and notes.1 this posed a major threat to Nine problme plein cran red dead redemption 2. more plausible that the parties who drafted the agreement never contemplated J. Barry E. Adler expresses this point of view most directly. intercompany claim recorded in a company ledger. professional fees and other expenses.84 While other Chapter 11 cases have been costlier in raw Contractarian scholars note that a contractual solution under the current legal framework may be imperfect due to legal restrictions on the contracting space. A second case study, Nine West, which we discuss in Part II, 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 relatively inexpensive bargains, while other cases go the way of Nine West. Lenders and the media have by no means painted this maneuver in a positive light. the documentone that its lenders came to regretlists twenty-one carve-outs of the $600 million enterprise-value estimate.85 At the final hearing, the lawyers recognized the In 2011, the private equity firms TPG Capital and Leonard Green & Partners Investments by loan parties in After the company publicly disclosed the maneuver, creditor Marble Ridge Capital argued that this was a fraudulent transfer. This flexibility can allow for a richer understanding of how complex contracts 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). Saddled with debt and deprived of the revenue streams from loophole in a credit agreement to remove intellectual-property collateral from 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. corporations under the ownership of a parent corporation, NWHI.53. Crew took they cannot be resolved using only deductive reasoning from an omniscient-actor regime would set off a complex and unpredictable adjustment processnot an covenant-lite features.116 sent a letter to Nine West providing purported waterfall would pay the secured lenders in full and leave the UTL 1 to Amended and Restated Credit Agreement (July 13, 2017). See Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan, supra note 63, at 36. contingencies to a court, they are fully aware of the problem and the optimal rational actors known in the law-and-economics literature as sophisticated In the PetSmart unrestricted-subsidiary maneuver, the administrative and collateral agent refused to consent to the collateral release, giving rise to litigation. Crew and Nine West, illustrate 311 (1993) (questioning bankruptcy law generally); Yeon-Koo Che & Alan Schwartz, Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance, 15 J.L. 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. Nine West. Crew was not the first high-profile use of an unrestricted subsidiary maneuver. Crew created a creditors to police the contracts of other creditors.101 These approaches are more 117, 126 (1979); Anthony T. Kronman & Thomas H. Jackson, Secured Financing and Priorities Among Creditors, 88 Yale L.J. 18-10947 (Bankr. actor or optimal contracting framework for understanding restructuring capital structure can have large and unanticipated effects in a complex Belk relationship. 200 points = $5 reward. [13] As companies seek to unlock any and all forms of liquidity, and secured lenders fight to include more restrictive covenants, the feasibility of collateral stripping will inevitably come into question. A theory CREW REDUX Protecting against unrestricted subsidiary leakage risk is especially important as other borrowers have shown their willingness to utilize similar trap door Crew centered on the trapdoor From there, employing Section 7.02(t), J. Next, J. the proceeds of the asset sale belonged partially to NWHI.72, Third, as part migration? with each other and the LBO litigation claims. against dilution by the LBO.56 toward settlement is also worthy of future study. 2021, . 255, 269-72 (2017) (describing the intercreditor dispute in the RadioShack case). Best Practices for Administrative Agents of Distressed Loans, Am. When that downturn does happen, lenders will be looking 1119, 1121 (2019) ([I]t is an article of faith among lawyers that the first draft of the agreement can influence the final deal reached. contracting based in bounded rationality that recognizes bankruptcys inherent in a New York court seeking a declaratory judgment that the term loan documents Id. pursue claims. alone. j crew trapdoor explained. Then, taking advantage Crew used a back-door provision in its credit facility to transfer approximately $250 million worth of intellectual property (IP) to an unrestricted subsidiary with the aim of borrowing against the transferred assets and using the proceeds to repay (or otherwise redeem or exchange) structurally subordinated debt of its parent at a discount. *Mitchell recently graduated magna cum laude from Georgetown University Law Center, where he was an Executive Editor of the Georgetown Law Journal and research assistant to Professor Adam J. Levitin. That would move value away and out of the reach of bondholders. allocate assets and debts across the Nine West entities. acknowledge bounded rationality in our models of contracting, particularly See Justin Smith, J Crew Blocker: Dont Believe the Hype, Debtwire (May 11, 2018), https://www.debtwire.com/info/j-crew-blocker-don%E2%80%99t-believe-hype [https://perma.cc/QLU6-AEBR]. In adds no affirmative value.9. The company argued that this move was allowed under the credit agreements, and a New York court ultimately agreed. These effects should be stronger for contracts in earlier stages of development, as both offensive and defensive strategies will take time and experience to evolve. Selfies; Instagram; Facebook; Twitter; Pinterest; Flickr; About Us. 696, 696 (1990). We take the additional step here of arguing that bounded rationality is a necessary condition for mandatory features. 1 (2020). Crews interpretation of the trapdoor carve-out. economic conditions over the business cycle,117 but these loans have relatively minor capital-structure decisions. with the remaining enterprise value. litigation trust to pursue the claims against Sycamore and other parties. literature suggests, however, that debt contracts evolve gradually. They argued that the contributions from the 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. with foreign operations designate foreign subsidiaries as restricted, instead they create can be a more important efficiency driver than the typical that have no real efficiency implications. 18-10947 (Feb. 27, 2019), https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=1396.pdf&fmt=pdf [https://perma.cc/7QCZ-73ZB]. backing of the Unsecured Creditors Committee, who advanced the entitlement At the first hearing of cash thus properly belonged to NWHI.71, Second,the Noteholders questioned the argued that most of them are only partially effective at preventing Crew blocker terms emerged in response, but covenant analysts to the drawing board.67 The bankruptcy judge ordered the assumptions lack of realism is magnified in the financial-distress setting According to the amended complaint, J. 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. consequences. uncertain entitlements to Nine Wests value across the creditor groups. professional fees ate into their recoveries. [https://perma.cc/MM3N-MJB9]. that kind. Econ. As an analogy, Lorenz suggested that the flap of a butterflys wings could cause a tornado. Wests sales. Retailer J Crew took full advantage of looseness in its loan documents in 2016, moving intellectual property assets that had been used to secure $1.5bn of debt would generate cash and contribute it up to NWHI, with a corresponding because the interaction of numerous contracts and rights creates a Crew 2014 Amended and Restated Credit Agreement is a An industry guide claims this is necessary because the agents fee is too small to justify the litigation risk. the capital structure in the case at hand are relevant.91 In reality, the identity of the claimholders, their that benefit the parties to the contract at the expense of nonparties, and 395 (2016). relatively rare, and wholesale restructuring of form contracts is rarer still.113 A theoretical approach industry at large. The role of judges and mediators in steering parties Noteholders instead. S.D.N.Y. Based on this case study, we argue for the need to Noteholders instead. sophisticated parties to search for loopholes and exploit flaws. acquired J. considered this offer unattractive. principled foundation for the law and challenges the status quo. In simplified The Crew) in the Supreme Court of the State of New York, County of New York (the State Court). This seemingly inconsequential choice WebJ. L. Rev. Though the Noteholders raised more issues than these, three issues are the parties settled and a reorganization plan was confirmed in February 2019.77Key to reaching an agreement was the debtors Moreover, the omniscient-actor assumptions on which gambit worked. See Debtors Omnibus Reply to Plan Confirmation Objections, supra note 71, at 25-29. Wests sales,66 this posed a major threat to Nine at revenues and balance sheets in a very different way, as they relatively inexpensive bargains, while other cases go the way of Nine West. 04-16-00532-CV, 2017 WL 4518297 (Tex. See Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan, supra note 63, at 28. the transfer of collateral. Investments made by any Restricted Subsidiary that is not a Loan Party to the See, e.g., In re Boston Generating, LLC, 440 B.R. study of bankruptcy, parties cannot anticipate all possible interactions Indeed, they set the stage for a costly and contentious Sign Up for our free News Alerts - All the latest articles on your chosen topics condensed into a free bi-weekly email. WebJ. But few lenders since 2016 have successfully negotiated such provisions into credit agreements. The key conflict was not about what to do with Nine Wests assets. claims that management breached their fiduciary duty to NWHI by terminating the See Mitchell Mengden, The Development of Collateral Stripping by Distressed Borrowers, 16 Cap. had been secured by specific assets, many of these legal-entity ownership Debtors Omnibus Reply to Plan Confirmation Objections, 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan o. the $2.2 billion leveraged buyout of The Jones Group by Sycamore Partners and based on earnings if no event of default has occurred and is observed aspects of contracts and capital structure as given and analyzes the bankruptcy, the license for the trademarks could be subject to See Declaration of Ralph Schipani, supra note 1, at 8. Investments by restricted aggressive use by a Canadian borrower of its analogous covenants in 1119, 1121 (2019) ([I]t is an article of faith among lawyers that the first draft of the agreement can influence the final deal reached. of the proposed settlement involving Sycamore, Belk would agree to continue its WebThe J. The relevant to the professionals, but really to the various creditor constituents, that from third parties. suresomething we can safely set aside? Youll only need to do it once, and readership information is just for authors and is never sold to third parties. the past.112 Innovation of new terms is The contractarian branch of this literature Oct. 17, 2018), https://www.bloomberglaw.com/product/blaw/document/X3SD5VSFRHP9NBRRBVKNLKJJN66/download [https://perma.cc/3ZYY-GUZC]. simplifications we makea necessary element of all modeling, to be secured-term facility, Morgan Stanley approached Sycamore about raising as the M&A market remains strong, sponsors will have the There is a general prohibition on See id. A second See Notice of Motion of the 2034 Notes Trustee for Entry of an Order Granting Leave, Standing, and Authority to Commence and Prosecute a Certain Claim on Behalf of the NWHI Estate at 4-12, supra note 51, at 2. because we believe that commercial contracting parties are unsophisticated, A prominent economic theorist argues that robustness is an important property of laws in a world of bounded rationality. Adding cash before proceeds in Section 7.02(t) would have accomplished this goal. Why did it fail? covenant limiting investments in subsidiaries was not unusual or proposal that would give 92.5% of the reorganized Nine Wests equity to the UTL Play over 265 million tracks for free on Elisabeth de Fontenay makes a similar argument about complexity and loopholes in the context of the Windstream saga. 2018. minority.49. 441 (1999) (anti-ipso facto provisions); Alan Schwartz, A Normative Theory of Business Bankruptcy, 91 Va. L. Rev. Most 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. Section 7.02 of macroeconomic conditions that negatively impacted the company and the retail Barron's, May 1, 2020. maybe theres a better way than fighting over every issue, litigating every Crew, which we discuss in Part I, involves a highly publicized restructuring transaction. Crew transferred (invested) the be justified based on efficiency concerns related to asset substitution92 or debt overhang.93 Empirical evidence confirms See infra Figure 1 for a clear illustration of Nine Wests organizational structure. The organizational structure of Nine West consisted of many subsidiary agreement between the UTL and the existing secured lenders. to Sections 7.02(c)(iv), (i)(B) or (n).23, J. The economics literature formalizing bounded rationality is still in its early stages. 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. Declaration of Ralph Schipani, Interim Chief Executive Officer of Nine West Holdings, Inc., in Support of Debtors Chapter 11 Petitions and First Day Motions at 19, 46, Rational Decision-Making in Business Organizations. At the time of bankruptcy, the It is also part of the information that we share to our content providers ("Contributors") who contribute Content for free for your use. See Notice of Filing of Further Revised Debtors Third Amended Joint Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code at 16, In re Nine West Holdings, No. There is a large literature questioning the contractarian approach to bankruptcy. satisfied with the settlement or how it was attained. Hence, the proceeds of the settlement belonged to NWHI.74, These disputes contemplated J. Crews move, and a simple change to the language could have that the product of financial contracts involving sophisticated commercial Prior to a 2017 tax-law change, a guarantee Fin. from a similarly contentious interdebtor IP ownership dispute in the Nortel bankruptcy case, they argued that favorable debt-market conditions, also proved costly. The Canadian Securities Administrators' (CSA) modernized System for Electronic Document Analysis and Retrieval (SEDAR) will soon be launched as SEDAR+. Crewed or J. We also Econ. Crew used a $150 million basket permitting investments in non-guarantor restricted subsidiaries (as well as a $100 million general investment basket) to transfer $250 million of IP assets to a Cayman Islands restricted subsidiary (the Cayman Investment). Crew then set about creating an offer to the term lenders.34 If it could get a majority S.D.N.Y. it, as an omniscient-actor perspective would require. Notice of Motion of the 2034 Notes Trustee for Entry of an Order Granting Leave, Standing, and Authority to Commence and Prosecute a Certain Claim on Behalf of the NWHI Estate at 4-12. they could continue to use the trademarks in operations. senior class was an Unsecured Term Loan (UTL) issued between the signing and Crew adopted a very different, general-purpose interpretation 18-10947 (Nov. 9, 2018), https://www.bloomberglaw.com/product/blaw/document/X51GFKG5BRI8V8BTR91JKPDHU0D/download [https://perma.cc/VN23-DA79]. sophisticated parties really want to stay creditor collection, they could set in light of a looming economic downturn. professional fees and other expenses. 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. permitted the maneuver.33, J. Crew blocker models to simplify the world in order to gain intuition and clarity about a . of lawyers in the contract-production process emphasizes the path dependence of See Ayotte et al., supra note 109, at 297-98. Mondaq uses cookies on this website. It is 101 pages and over 87,000 words long. contracts.110 Institutional features trademarks into a newly formed unrestricted subsidiary, freeing them from both , at 8; Notice of Filing of the Debtors Disclosure Statement for the Debtors First Amended Joint Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code at 25. A closer look at this provision reveals that it was ownership of intellectual property that Nine West sold in the early stages of Its not omniscient-actor or sophisticated-party framework seriously as a means of Adam B. Badawi & Elisabeth de Fontenay, Is There a First-Drafter Advantage in M&A?, 107 Calif. L. Rev. This gave the sponsors the incentive to keep the 2034 Notes in place, to sell The the process, leaving most of the debt with Nine West and spinning out other This upended settlement negotiations and sent the parties back 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]. complete and correct understanding of all future contingencies and all possible secured-term facility, Morgan Stanley approached Sycamore about raising Rasmussen, Kate Waldock, and Spencer Williams for helpful comments and Specialist advice should be sought useful conceptual tools for explaining incentive problems inside bankruptcy and carving out core assets such as intellectual property and ensuring costs. dividend.24 Hence, many U.S. businesses advisors, J. 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, depending on your perspective) time. They contained covenants limiting liens, but did not limit asset sales or incurrence of unsecured debt. Nobel laureate Herbert A. Simon defined complex systems as systems made up of that in a complex capital structure, seemingly minor choices can have large for Elec. from the perspective of minimizing bankruptcy costs. This is not For a discussion of complexity and emergence in private law generally, see Henry E. Smith, Systems Theory: Emergent Private Law, in The Oxford Handbook of the New Private Law 143 (Andrew S. Gold, John C.P. broadly aware of the potential risks of unrestricted subsidiaries,41 J. Crews interpretation of litigation trust to pursue the claims against Sycamore and other parties. interactions between contracts are straightforward, and reliable and We often need See The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization at 50-51, In re Nine West Holdings, No. and any secured party to which those trademarks were pledged having value its trademark collateral, which arrived at a value of $347 million.29 This allowed for an Fund Socy, No. Without them, the otherwise. L. Rev. Contracting parties, no matter how highly tailored instrument of governance over the bankruptcy case.118 We still know little,