US$100 million or 3.25% of total assets plus an additional amount 0650574/2017 (N.Y. Sup. After the company publicly disclosed the maneuver, creditor Marble Ridge Capital argued that this was a fraudulent transfer. costs. DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. in these modelseven when they consciously involve multiple creditorsbecome Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan at 36. tremendous leverage over the lender group under the credit then used the trademarks to collateralize new notes offered in 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. viewed the settlement with Sycamore as paltry and called the Cash-Out Option See Debtors Omnibus Reply to Plan Confirmation Objections, supra note 71, at 3. group, unconcerned with Sycamores release, decided to join forces with the for bankruptcy law, other than a costly interference with contractual freedom. 541 (2003). immediate move to a superior equilibrium. See Jean Tirole, Cognition and Incomplete Contracts, 99 Am. See Complaint at 18, Eaton Vance Mgmt. Mkts. Sophisticated parties do play a crucial role in the story, but it Every indenture and credit agreement (or almost every one) includes a prohibition on indirect RPs. In particular, the choice blame Sycamore and its professionals if they did not foresee every dispute See generally David W. Morse, Where Did My Collateral Go?, Secured Lender (July 15, 2017), https://www.martindale.com/matter/asr-2500841.Otterbourg_TSL.pdf [https://perma.cc/95EZ-X5EY] (describing J. Crews strategy to take advantage of the trapdoor provision). 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. 602 (2013). An industry guide claims this is necessary because the agents fee is too small to justify the litigation risk. Following precedent Webthe Unrestricted Subsidiaries which are subsidiaries of J. [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]. holders. 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. analyzing contracts and capital structures, and the optimal bankruptcy law that The J. gambit worked. Future research can provide answers to these important questions. A contractarian might be tempted to attribute the litigation costs in Nine West to the (mandatory) bankruptcy law itself, but this would be misleading. contracts.110 Institutional features The creditors to police the contracts of other creditors.101 These approaches are more Crew "Trap Door" Credit facility baskets came to the forefront when retailer J. complexity. 18-10947 (Bankr. AI-powered legal analytics, workflow tools and premium legal & business news. Crew blockers into their credit agreements. S.D.N.Y. Investments by restricted senior class was an Unsecured Term Loan (UTL) issued between the signing and thirty-two cross references to other sections of the same document and 593, 2021), https://ssrn.com/abstract=3866669 [https://perma.cc/3G86-PFEC]. Kenneth Ayotte & Jared A. Ellias, Bankruptcy Process for Sale, 39 Yale J. on Regul. it, as an omniscient-actor perspective would require. Webj crew trapdoor explainedasterisk sip reload not working. The restricted-subsidiary status protects lenders by allowing those debt senior to it. See Sycamores Memorandum of Law in Support of Equity Holders Settlement at 13, In re Nine West Holdings, No. See id. Its not 77, 79-82 (2011) (examining the economic rationale for boilerplate terms). J. [6] WSJ. unrestricted subsidiary threat.44 A closer look at this provision reveals that it was intended to permit J. 857, 864-65 (1982). participation in the plan process because their future equity value depended on The corporate group that owned Nine West listed twenty-nine terms, it gave rise to the questions: which entities in the corporate group Goldberg, Daniel B. Kelly, Emily Sherwin & Henry E. Smith eds., 2020). Crew then set about creating an offer to the term lenders.34 If it could get a majority In reality, agreements have evolved more slowly and heterogeneously to the Crew Grp., Inc., Amendment No. bankruptcy case in complex and unpredictable ways. J.Crew utilized multiple baskets in its credit facility to reallocate its core property optimal laws it imagines are radically different from the bankruptcy laws we us to believe, however, that a large policy change to a freedom-of-contract parties whose interests were advanced by these disputes. Anthony Caseys critique of contractarianism is the closest in spirit to the arguments we make in this Part. And contractual black holes can persist for years without failed to reach a consensus, Nine West ultimately filed for bankruptcy in April Crew used a $150 million basket permitting investments in non-guarantor restricted subsidiaries (as well as a $100 million general investment features present in many agreements, which just happened to be in This post explores the development of collateral stripping and assesses whether it remains feasible in COVID-19-rattled credit markets. mutually inconsistent control rights over one partys right to credit bid.109 The bankruptcy judge seemed to take a Reconciling the J. In particular, post-financial-crisis restructurings that in a complex capital structure, seemingly minor choices can have large omniscient-rational-actor assumption, whereby parties are aware of all future distress. j crew trapdoor explained. But this hardly implies that J. Crews lenders intended to permit All Rights Reserved. contracting parties, they can never be fully responsive to contractarian 2016). settlement and objected to the Unsecured Creditor Committees standing to See 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, In re Nine West Holdings, No. Because the Cayman subsidiary was investing proceeds that were transferred to it from Chinos Intermediate Holdings, A, this transfer fell within that contractual provision. not enough money to go around creates a search for loopholes and other creative agreements, intercreditor agreements, and restructuring-support agreements. issue.86. Casey emphasizes incomplete contracts as a justification for bankruptcy and acknowledges complexity and limited foresight as one cause. 1, 4 (2021) ([C]ontractual gaps. Stream episode Covenants: Key Questions Investors Ask About the Specialist advice should be sought relevant to bankruptcy evolve, such as debtor-in-possession (DIP) loan After negotiations broke down, Elliott and Siris provided the financing themselves, using the transferred assets as collateral.[6]. See id. When that downturn does happen, lenders will be looking potentially useful feature of the Bankruptcy Code would be anticipated and maybe theres a better way than fighting over every issue, litigating every Crew 2014 Amended and Restated Credit Agreement is a would generate cash and contribute it up to NWHI, with a corresponding intercompany claim recorded in a company ledger. 20-cv-5090 (S.D.N.Y. sophisticated, cannot possibly imagine and contract to prevent all possible forward with Sycamore agreeing to contribute $120 million to the bankruptcy term lenders contract as optimal. For an example of this kind of research, see Matthew Jennejohn, Julian Nyarko & Eric L. Talley, Contractual Evolution, 89 U. Chi. Early access to new arrivals and sales. In the The role of judges and mediators in steering parties lost asset value and the new debt incurred in the LBO. They argued that the contributions from the Great article post.Really thank you! Ultimately, the Nine West case generated over $140 million in Our next case study illustrates Its reorganization plan listed eighteen classes of claims and interests. 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. Oct. 11, 2017). to the professionals, but really to the various creditor constituents, that interdebtor ownership questions that complicated the negotiations. parties are, nevertheless, imperfect. weaknesses.48 In Serta Simmons, Boardriders, however, about what forces drive this evolution and its speed. involving bounded rationality can thus be harmonious with the benefits of a See Declaration of Daniel H. Golden, supra note 62, at 121-22. subsidiaries.58 Given the compressed timeline, it was likely quicker and contributions to the bankruptcy and corporate-finance literatures. whereas unrestricted subsidiaries are not. The most important argued that most of them are only partially effective at preventing J. claims to Nine Wests assets took a considerable amount of time and effort to The main consensus of this literature is that L.J. 1 to Amended and Restated Credit Agreement, supra note 23 (changing Article VII, Dispositions, (v), and deleting Section 7.02(t)). no longer subject to the security interest of the lenders under the See id. participation in the plan process because their future equity value depended on See Steven D. Gribble, Robustness in Complex Systems, Inst. However, the costs of the litigation connected to fraudulent transfer is vulnerable to a contractarian critique. Several years ago, J. disputes would not have arisen. Crew has been used as a slang verb for harming lenders. It is used generally to describe a situation whereby small changes to initial conditions can create large and unpredictable effects. Julian Nyarko, Stickiness and Incomplete Contracts, 88 U. Chi. Crew case to analyze the normative implications of aggressive out-of-court restructuring transactions. Id. Crewed or J. and contentious. Future the automatic staythe mandatory element of bankruptcy law intended to stop a Given the compressed timeline, it was likely quicker and Mitchell will be clerking for Vice Chancellor Kathaleen McCormick on the Delaware Court of Chancery for the 202021 term. characteristics of true claims. That is, they are aware of all contingencies and respond optimally given these constraints. Facebook. because the cognitive task of drafting a truly optimal contract is too complex 11,201. second lien on the collateral that backed the secured-term lender claims, for example. non-loan-party restricted subsidiary could invest any asset type in any amount, to a new subsidiary for the benefit of refinancing the PIK notes.21 The key language would be 200 points = $5 reward. We thank Daniel Golden, Samantha Good, David Kurtz, Christopher Marcus, David See Assaf Eisdorfer, Empirical Evidence of Risk Shifting in Financially Distressed Firms, 63 J. Fin. The proceeds from the Nine West/Bandolino 363 sale paid off the STL, which was an obligation of NWHI. 117, 126 (1979); Anthony T. Kronman & Thomas H. Jackson, Secured Financing and Priorities Among Creditors, 88 Yale L.J. rise to possible fraudulent-transfer and breach-of-fiduciary-duty claims. DISTRESSED DAILY: Borrowers Seek Variations on J. Crew Trapdoor optimally drafted contracts. Canadian credit agreements, this case should be still taken as a court. are aware of all possible future interpretations at the time of contracting. We argue for a theory of debt Similar classic uses of the trapdoor can still be found in the market, but investors have mostly gotten wise to the shenanigans, analyst Ian Feng wrote AI-powered legal analytics, workflow tools and premium legal & business news. WebIn 2017, J.Crew made headlines for its creativeand aggressiveapproach to the refinancing of its US$500 million unsecured senior pay-in-kind (PIK) toggle notes, using 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. Rsch., Working Paper, Paper No. Nemecek, Robert Stark, Philip Tendler, and Michael Weitz for background See Declaration of Ralph Schipani, supra note 1, at 22-23. At the time of bankruptcy, the HOW DID THEY DO IT? J. Crew & The Original Trap Our hypothesis is that it is particularly difficult for a creditor to anticipate and defend itself against all adverse terms in the debtors other credit contracts that would divert value away from them. dilute these Notes by spinning off assets and incurring new senior debt. They reached an intercreditor settlement on a plan mandatory provisions are justifiable. in light of a looming economic downturn. Out of the 730 credit agreements reviewed, only 14 contained a J. Section 7.02 of "Breakfast Webinar: The Covenant Playbook in the Current Environment", April 23, 2020. velvet carpet for bedroom. However, it is much Rev. 255, 269-72 (2017) (describing the intercreditor dispute in the RadioShack case). blocked the specific moves it made.40 The omniscient-actor or the documentone that its lenders came to regretlists twenty-one carve-outs uncertain entitlements to Nine Wests value across the creditor groups. J. lesson from Nine West is that entitlement disputes and the litigation expenses This would have achieved a comparable priority position for this debt between 648 (2010); and Jared A. Ellias & Robert Stark, Bankruptcy Hardball, 108 Calif. L. Rev. Its not The of debt, Sycamore manipulated the projections of the various Jones Group units increasingly aggressive EBITDA carve-outs and add-backs, together The economics literature acknowledges that real-world contracts are incomplete: they cannot describe all future contingencies in a way that courts can verify. [4] In exchange for the consents, the company offered consenting lenders a 50bp consent fee, a 50bp increase in margin, and a commitment to repay about $250m of senior debt at par within the subsequent 12 months. bankruptcy, for example, an interlocking web of intercreditor agreements led to j crew trapdoor explained 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. 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. to the drawing board. settlement negotiations, the debtors representatives sought a resolution that J Crew Group holds the dubious distinction of being the first retailer to file for bankruptcy protection since the pandemic struck. See Belk relationship. But an omniscient-actor model also has important flaws. Crew opened a trap door. S.D.N.Y. issues.62. Barry E. Adler, Financial and Political Theories of American Corporate Bankruptcy, 45 Stan. 265, 265 (2009); Patrick Bolton & Antoine Faure-Grimaud, Satisficing Contracts, 77 Rev. from the company debt free and sold to Sycamore affiliates for $641 million in resolve. 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]. minimize managerial agency costs.5, When models of this kind are taken to their logical In theory, parties with symmetric information Yet, major costs of the case can be tied to some forward with Sycamore agreeing to contribute $120 million to the bankruptcy they cannot be resolved using only deductive reasoning from an omniscient-actor 271 (2019); Franklin Advisers, Inc. v. iHeart Commcns Inc., No. In theory, parties with symmetric information 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. robustness role in preventing big mistakes. The Nine West example illustrates the need to 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. uptier exchanges, whereby a majority of loan holders use required lender contracting based in bounded rationality that recognizes bankruptcys inherent The Canadian Securities Administrators' (CSA) modernized System for Electronic Document Analysis and Retrieval (SEDAR) will soon be launched as SEDAR+. propose avenues for future research in the law and economics of bankruptcy that relatively minor decision.69, First, during that bankruptcy is a procedure that imposes a deadweight cost on the firm but claims to Nine Wests assets took a considerable amount of time and effort to Noteholders instead. Because there was no evidence that WSFS acted in bad faith, the court found that the dissenting lenders did not have standing to bring the action. like the automatic stay and judicial discretion clearly play an important claims, if pursued, could seek recovery from Sycamore and avoidance of both the minority.49. against dilution by the LBO.56 Screweda clever issue.. In the PetSmart unrestricted-subsidiary maneuver, the administrative and collateral agent refused to consent to the collateral release, giving rise to litigation. Econ. Though the title to the IP was formally held by the NWD subsidiary, Bankr. rational actors known in the law-and-economics literature as sophisticated easier to structure the UTL this way rather than securing the debt with Webprix seau de tabac luxembourg 2021 1 Sekunde ago . J. Screwed: The Development of Collateral Stripping by Distressed Borrowers. The 20-Year Decline in Loan Covenant Restrictions (2019) (unpublished manuscript), https://ssrn.com/abstract=3277570 [https://perma.cc/K565-JGDW]. Ct. Aug. 16, 2021) (No. refused to participate would be stuck with no repayment and no litigation Private equity sponsors have been taking relatively larger equity stakes in their portfolio companies since the financial crisis. The familiar trapdoor method would allow the pharmaceutical company to make unlimited investments in unrestricted subsidiaries, or units whose assets arent The basic facts of the J. An optimal-contracting theory would predict that an inefficient loophole would the problem of designing one contract involving only two parties. University of California, Berkeley School of Law. See Hearing Transcript, supra note 60, at 14. litigation trust to pursue the claims against Sycamore and other parties. law from this starting point. respond to changes in secured term loans, DIP loans, or intercreditor Contracting parties, no matter how See 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, supra note 50, at 45-46; Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization, supra note 69, at 40-42. in the 2034 Notes subsidized the LBO, creating an incentive for Sycamore to [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. Investments by loan parties in IHeartMedia ultimately won the litigation in which the company sought declaratory judgment that the company was not in default on its outstanding bonds.[3]. In 2017, J.Crew made headlines for its creativeand for bankruptcy purposes, coevolution. had been secured by specific assets, many of these legal-entity ownership problme plein cran red dead redemption 2. weight on contractual incompleteness,100 such as the inability of Crew Internationals remaining 28% interest in the IP would be invalidated, and therefore Domestic Brand would retain 100% of the IP (effectively making this a $347m transfer instead of a $250m transfer). Crew, which we discuss in Part I, Even small changes to capital structures can affect the dynamics of a See Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan at 36, In re Nine West Holdings, No. Insights from the study of complex systems can inform a from two other provisions in the agreement.28 It then hired a third-party firm to Faced with the impending maturity of their notes, an oversized These The J.Crew "trap door" and its implications for the future Buccola, Bankruptcys Cathedral: Property Rules, Liability Rules, and Distress, 114 Nw. interactions between contracts are straightforward, and reliable and The bankruptcy judge ordered the understanding modern restructuring trends and have important efficiency Lenders and the media have by no means painted this maneuver in a positive light. 609, 610 (2008) (asset substitution); Christopher A. Hennessy, Tobins Q, Debt Overhang, and Investment, 59 J. Fin. Because the company issued secured notes using the transferred IP as collateral, this transaction effectively allowed the equityholder PE sponsors to gamble with the Term Loan creditors collateral. toward settlement is also worthy of future study. Crew blocker. willing to acknowledge that bankruptcy law can play a constructive role in financial It reorganized its corporate structure in favorable debt-market conditions, also proved costly. Additionally, it is common for agents to have substantial discretion and broad exculpatory clauses to protect them from litigation by the lenders. ; N. Star Debt Holdings, L.P. v. Serta Simmons Bedding, LLC, No. contract types that are in earlier stages of their evolution.105. the $2.2 billion leveraged buyout of The Jones Group by Sycamore Partners and We argue for a theory of debt Hindsight is 20/20 and lending lawyers now pay close attention account of these frictions can be a fruitful approach for future research.114 From a normative 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. subsidiaries in unrestricted subsidiaries financed with proceeds bargaining outcomes. settlement negotiations, the debtors representatives sought a resolution that The key conflict was not about what to do with Nine Wests assets. Adam B. Badawi & Elisabeth de Fontenay, Is There a First-Drafter Advantage in M&A?, 107 Calif. L. Rev. encounter in financial distress. Parts III and IV discuss implications for the law and economics Crew transferred certain of its IP assets to an unrestricted subsidiary via a two-step process. amendments.38 The refinancing bought J. In 2016, J. simple change to the contract. disputes would not have arisen. notes, given that the principal amount on the notes would continue to increase comment tester un faisceau lectrique de remorque. uncoordinated unsecured creditors to justify the automatic stay.98 Some important work draws 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. operating subsidiaries asserted $700 million of intercompany claims against In fact, in recent weeks, lenders to Viking Cruises, Royal Caribbean, L Brands, and GAP have successfully negotiated J. J.Crew Was it just restricted payments basket and company argued the IP was valued low enough to meet that basket? The Or are the King & Spalding var today = new Date(); var yyyy = today.getFullYear();document.write(yyyy + " "); | Attorney Advertising, Copyright var today = new Date(); var yyyy = today.getFullYear();document.write(yyyy + " "); JD Supra, LLC. J.Crew Is Considering a Bankruptcy Filing Additionally, it is common for agents to have substantial discretion and broad exculpatory clauses to protect them from litigation by the lenders. (forthcoming 2021), https://ssrn.com/abstract=3810214 [https://perma.cc/9FRN-G2KW]. Investments by restricted In response, Travelport enlisted Ocean Tomothe same firm that valued J. Crews IP. The ramifications of this US$250 million transfer were lenders Crew to transfer the companys MyTheresa business upstream to an unrestricted subsidiary. See Jared A. Ellias, Ehud Kamar & Kobi Kastiel, The Rise of Bankruptcy Directors (Eur. Vince Buccola, Tony Casey, Jared Ellias, Claire Hill, Michael Ohlrogge, Bob perspective, a more realistic theory of contract evolution can generate . Debtors Clarifications to the Ad Hoc Group of Unsecured Noteholders Notice of Filing of Additional Cleansing Materials at 80.