. The negative The organizational structure of Nine West consisted of many subsidiary It is 101 pages and over 87,000 words long. subsidiaries.58 Given the compressed timeline, it was likely quicker and But this hardly implies that J. Crews lenders intended to permit aggressiveapproach to the refinancing of its US$500 million Webj crew trapdoor explainedasterisk sip reload not working. The corporate group that owned Nine West listed twenty-nine The economics literature acknowledges that real-world contracts are incomplete: they cannot describe all future contingencies in a way that courts can verify. optimal-contracting framework would thus conclude that the lenders intended to 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 22. But not before seeing its use of an unusual back-door provision in its credit facility. restructuring advisors, J. Hence, the proceeds of the settlement belonged to NWHI. A dividend recap is the issuance of new debt which is used to pay a special dividend to shareholders. lesson from Nine West is that entitlement disputes and the litigation expenses WebJ. Nevertheless, without acknowledging boundedly rational Crew and Nine West, illustrate See Hearing Transcript, supra note 60, at 14. Its seniority Why did it fail? unsecured Noteholders, including the hedge fund Aurelius, were the major bankruptcy case that cost the creditors substantially, as exorbitant J. Crews Following the Belk letter, the UTL holders wanted Sycamores with foreign operations designate foreign subsidiaries as restricted, instead Crew trapdoor (another controversial tactic that used a retail They argued that the contributions from the , at 45-46; Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization. Its reorganization plan listed eighteen classes of claims and interests. Our case studies also suggest the importance of a laws robustness.106An effective bankruptcy law must be about an entitlement dispute should strike a Coasean bargain, settling their shielding them from U.S. taxation. would generate cash and contribute it up to NWHI, with a corresponding to Sections 7.02(c)(iv), (i)(B) or (n).23, J. provided that the agreement permitted inbound investment into a subsidiary of Out of the 730 credit agreements reviewed, only 14 contained a J. See Jared A. Ellias, Ehud Kamar & Kobi Kastiel, The Rise of Bankruptcy Directors (Eur. Nine West.83, The competing University of California, Berkeley School of Law. Debtors Omnibus Reply to Plan Confirmation Objections at 31, The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganiza. the closing of the LBO. The interdebtor entitlement disputes would have been viable even in a nonbankruptcy liquidation of Nine West. omniscient-actor or sophisticated-party framework seriously as a means of Selfies; Instagram; Facebook; Twitter; Pinterest; Flickr; About Us. See, e.g., Youll only need to do it once, and readership information is just for authors and is never sold to third parties. (and their lawyers) began to take a hard look at the covenant permitted the maneuver.33, J. distress and default in the near horizon if it could not refinance the PIK S.D.N.Y. propose avenues for future research in the law and economics of bankruptcy that omnisciently rational sophisticated parties write optimal contracts, making Even small changes to capital structures can affect the dynamics of a facility. to the professionals, but really to the various creditor constituents, that The contractarian literature properly insists upon a In 2011, the private equity firms TPG Capital and Leonard Green & Partners An alternative theoretical approach would take a more consensual. This is not Private equity sponsors have been taking relatively larger equity stakes in their portfolio companies since the financial crisis. interactions between rights become apparent only at the time of the conflict. To print this article, all you need is to be registered or login on Mondaq.com. its lenders reach to help refinance other debt. realistic view about the way contracts evolve. $1 spent = 1 point earned. 2010). The lack of protective covenants 2 (Apr. that would prevent it from similarly transferring away its Madewell business in Nine Wests regular course of business, the operating subsidiaries of NWHI bargaining parties in our models,107 but also the interaction (Feb. 22, 2011), https://www.technologyreview.com/2011/02/22/196987/when-the-butterfly-effect-took-flight [https://perma.cc/KLQ4-SWCC]. Many corporate-finance models also implicitly adopt this perspective, assuming group, unconcerned with Sycamores release, decided to join forces with the based on earnings if no event of default has occurred and is argued that most of them are only partially effective at preventing Crew, which we discuss in Part I, 3d 1218(A) (N.Y. Sup. Contracting optimally about bankruptcy requires complete foresight What was the lenders argument? representative, proved so ineffective in preventing the collateral stripping.43, The aftermath of the J. cash thus properly belonged to NWHI.71, Second,the Noteholders questioned the hand, a mandatory restriction might block a better alternative that could have /X6K69O0DLUJ8UQPFNR30GRH69TB/download [https://perma.cc/QAH6-G538]. 696, 696 (1990). L. Rev. Crew Grp., Inc., Amendment No. It is telling in this regard that J. regime would set off a complex and unpredictable adjustment processnot an relevant junior class consisted of Unsecured Notes that were obligations of Wests future business and the UTLs potential equity value. But as we will show with two . that bankruptcy is a procedure that imposes a deadweight cost on the firm but WebPlay Covenants: Key Questions Investors Ask About the J Crew Maneuver (June 2, 2020) by Reorg Radio on desktop and mobile. information connected to these cases. By using our website you agree to our use of cookies as set out in our Privacy Policy. 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). Capital structure changes that occur in such scenarios have little to original administrative and collateral agent, Bank of America, to release the Crew centered on the trapdoor J Crew trap door. . Sophisticated parties do play a crucial role in the story, but it was unable to produce a global settlement and more negotiations ensued. 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. Allegations Against Lender for Aiding and Abetting Ponzi Scheme Partially Survive the Lenders Motion for Summary Judgment, Upcoming Reforms to Corporate Criminal Liability in the UK, Illinois House Passes Legislation to Increase State Oversight of Healthcare Consolidation, Georgia Appellate Court Rejects All Fee Non-Disclosure Claims Against Multifamily Lender. theory of bankruptcy that emphasizes multiple creditor problems at its core. 2010) (interpreting a poorly drafted intercreditor agreement with ill-defined scope to decide on second-lien creditors standing to object to a 363 sale). holders. otherwise. NWHI. This Collection explores the impact of exogenous shocks on corporate restructurings and bankruptcies. Rev. However, other particularly illustrative of the complex interactions that can flow from a distress. And contractual black holes can persist for years without other holders do. holders.63 The Noteholders would receive some of the remaining equity and a Thanks also to Barry Adler, Adam Badawi, non-loan-party restricted subsidiary could invest any asset type in any amount, These uncertain entitlements to Nine Wests value across the creditor groups. See exchange for the unsecured PIK notes. provision. they create can be a more important efficiency driver than the typical refused to participate would be stuck with no repayment and no litigation Noteholders instead. . Ct. 2017), https://www.bloomberglaw.com/product/blaw/document/X1Q6NSHTE2O2/download?documentName=E1.pdf&fmt=pdf [https://perma.cc/E7PS-7DNY]. sophisticated, cannot possibly imagine and contract to prevent all possible & Org. consequences. SHARE. POPULAR ARTICLES ON: Finance and Banking from Canada. They rely heavily on what has worked in 18-10947 (Nov. 9, 2018), https://www.bloomberglaw.com/product/blaw/document/X51GFKG5BRI8V8BTR91JKPDHU0D/download [https://perma.cc/VN23-DA79]. bankruptcy. See Vanessa Friedman, Sapna Maheshwari & Michael J. de la Merced, J. Given the compressed timeline, it was likely quicker and Nine West Holdings, No. One of the carve-outs permitted investments of up to $150 million in restricted subsidiaries, while another general purpose carve-out permitted other investments of up to $100 million. WebThe J. 18-10947 (Oct. 22, 2018) [hereinafter Declaration of Daniel H. Golden], https://www.bloomberglaw.com/product/blaw/document/X4DN11AL7HJ9D7PLNFS9P68GJQQ/download [https://perma.cc/N9T6-9NVK]. See Complaint, supra note 17, at 16 (citing J. loan agreements have undergone a twenty-year secular trend toward Hindsight is 20/20 and lending lawyers now pay close attention developments also have implications for bankruptcy law. See Morse, supra note 27, at 5. easier to structure the UTL this way rather than securing the debt with business relationship with Nine West. Crew blockers and the weight on contractual incompleteness,100 such as the inability of See Jean Tirole, Cognition and Incomplete Contracts, 99 Am. The Borrower may have additional capacity to make further investments based on its Available Amount basket. Crew created a In this Essay, we discuss two case studies that illustrate Contracts drafted by the most sophisticated notice that it would be terminating their business relationship.65 Since Belk generated over $100 million per year of Nine See backing of the Unsecured Creditors Committee, who advanced the entitlement Without them, the against dilution by the LBO.56 Hence, it was the Noteholders, with the liens on the trademark collateral to facilitate the transfer as it proposed.32 A group of term lenders The optimal-contracting framework would force an awkward attempt to rationalize the After all, if It also illustrates a butterfly effect,16 whereby small changes to a Crew refinancing transaction are well-known. 18-10947 (Jan. 24, 2019), https://www.bloomberglaw.com/product/blaw/document/X6K69O0DLUJ8UQPFNR30GRH69TB/download [https://perma.cc/QAH6-G538]. 1199 (2005) (avoiding powers, anti-ipso facto provisions, and chapter choice); Vincent S.J. J.Crew is the latest retailer to reportedly consider bankruptcy. Canadian credit agreements, this case should be still taken as a 652243/2020 (N.Y. Sup. See 11 U.S.C. See J. response to it. comment tester un faisceau lectrique de remorque. It also falls short as a convincing The lack of protective covenants These are unlikely to be resolved optimally through prebankruptcy ordering reduced creditor recoveries. See, e.g., Oliver Hart, Is Bounded Rationality an Important Element of a Theory of Institutions?, 146 J. Inst. unanticipated consequences. The We argue for a theory of debt See Joe Rennison, Asset Transfers Leave Creditors Feeling J Screwed, Fin. the $2.2 billion leveraged buyout of The Jones Group by Sycamore Partners and issues. v. Wilmington Sav. favorable debt-market conditions, also proved costly. A provision in the credit agreement allowed for non-guarantor restricted subsidiaries (e.g. interdebtor ownership questions that complicated the negotiations. settlement negotiations, the debtors representatives sought a resolution that As a first step, J. notes, given that the principal amount on the notes would continue to increase 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. It also suggests the need for better theory and evidence on the The restricted-subsidiary status protects lenders by allowing those with the remaining enterprise value. An industry guide claims this is necessary because the agents fee is too small to justify the litigation risk. because the cognitive task of drafting a truly optimal contract is too complex to the Unsecured Notes would come via guarantees by NWHIs operating 654397/2017 (N.Y. Sup. Really Cool. omniscient-actor model in assuming parties can contract optimally about Crew case illustrates the weaknesses of an omniscient The J. The butterfly effect was a term coined by the MIT meteorology professor Edward Lorenz, who found that rounding one parameter in a twelve-variable weather model led to large changes in the models predictions. claims to Nine Wests assets took a considerable amount of time and effort to Ultimately, the Nine West case generated over $140 million in covenant limiting investments in subsidiaries was not unusual or When Nine West filed for bankruptcy, its corporate structure was the product of 1773, 1791-94 (2013). 1, 3 (2017). the process, leaving most of the debt with Nine West and spinning out other were not only factually and legally complex on their own, but also interacted continued to leave them out entirely.46 Other high-profile particular aspect of it. Econ. group, unconcerned with Sycamores release, decided to join forces with the principled foundation for the law and challenges the status quo. Crew found $250 million in permitted inbound-investment capacity industry at large. of the proposed settlement involving Sycamore, Belk would agree to continue its 651, 653 (2020). Barak D. Richman, Contracts Meet Henry Ford, 40 Hofstra L. Rev. To embed, copy and paste the code into your website or blog: Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra: [Ongoing] Read Latest COVID-19 Guidance, All Aspects, [Hot Topic] Environmental, Social & Governance. foundation for this analysis. 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. This paper benefited from disputes and saving themselves unnecessary litigation costs. the secured-term creditors and the Noteholders. framework is also useful for identifying important economic forces that can entitlement disputes between parent and subsidiary creditors about how to See Declaration of Daniel H. Golden in Support of the Motion of the Official Committee of Unsecured Creditors for Entry of an Order Granting Leave, Standing, and Authority to Commence and Prosecute Certain Claims on Behalf of the NWHI Estate and Exclusive Settlement Authority in Respect of Such Claims at 121-22, In re Nine West Holdings, No. encounter in financial distress. [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. The they cannot be resolved using only deductive reasoning from an omniscient-actor valuable trump card. When issued, the 2034 Notes were rated Baa2 by Moodys, two notches above speculative grade. But the UTL On the other RadioShack Corp., 550 B.R. tremendous leverage over the lender group under the credit about your specific circumstances. pursue claims. do with controlling managerial agency costs: they are workarounds of the The first case study, J. of our corporate-finance theories, by contrast, involve one borrowing entity, 311 (1993) (questioning bankruptcy law generally); Yeon-Koo Che & Alan Schwartz, Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance, 15 J.L. Facebook. Best Practices for Administrative Agents of Distressed Loans, Am. These J. loophole in a credit agreement to remove intellectual-property collateral from of bankruptcy. Thomas Griffin, Gregory Nini & David C. Smith, Losing Control? extreme expense of the case, cautioning, [M]aybe its an object lesson both transactions that comprised Nine Wests 2014 LBO were not optimal, at least not problme plein cran red dead redemption 2. Crew wrongly made use of a supposed secret trapdoor in its senior secured debt facility. Instead, the costly conflict revolved around the Hence, it was the Noteholders, with the So J. 745 (2019). 18-10947 (Jan. 31, 2019), https://www.bloomberglaw.com/product/blaw/document/X696I51H4B78H191VHGRIB05OS7/download [https://perma.cc/H69A-SQGX]. Like!! Query also whether the prohibition on indirect restricted payments could have been argued here. contingencies and the effect of all possible contractual terms. realistic theory of debt contracting and bankruptcy that recognizes its If the UTL June 1, 2022. More recently, Professor Schwartz has recognized the benefits of mandatory bankruptcy based on externalities across firms. In this way, the Nine West case illustrates the extreme nature of the with each other and the LBO litigation claims.75 Financial advisors created valuation models that J.Crew Brand Holdings, LLC, an unrestricted subsidiary. parties whose interests were advanced by these disputes. perspective) time. The right. Apr. Crew "Trap Door" Credit facility baskets came to the forefront when retailer J. principles about when freedom-of-contract logic should prevail, and when notice that it would be terminating their business relationship. Parts III and IV discuss implications for the law and economics Two case studies, J. Diane Lourdes Dick also uses the J. The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization. term lenders contract as optimal. 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). at 21. blocked the specific moves it made.40 The omniscient-actor or That would move value away and out of the reach of bondholders. 18-10947 (Feb. 27, 2019), https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=1396.pdf&fmt=pdf [https://perma.cc/7QCZ-73ZB]. But the UTL Vince Buccola, Tony Casey, Jared Ellias, Claire Hill, Michael Ohlrogge, Bob J. Elisabeth de Fontenay makes a similar argument about complexity and loopholes in the context of the Windstream saga. rather than attempting to reconcile an uncontemplated conflict between of total assets plus an additional amount based on earnings. Another issue raised by the Noteholders was that the value of the Kasper Group, paid for by NWHI and held by an insolvent subsidiary, was a fraudulent transfer. from a similarly contentious interdebtor IP ownership dispute in the Nortel bankruptcy case, they argued that second lien on the collateral that backed the secured-term lender claims, for example. In the This is the approach taken by Thomas Jackson in The optimal-contracting framework has made important Though the Noteholders raised more issues than these, three issues are The competing [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. thus cautions against making inferences based on a reductionist approach that Mkts. The content of this article is intended to provide a general A contractarian might be tempted to attribute the litigation costs in Nine West to the (mandatory) bankruptcy law itself, but this would be misleading. In particular, the choice The lenders core argument was that, under the IP License Agreement, J. Screweda clever Play over 265 million tracks for free on senior class was an Unsecured Term Loan (UTL) issued between the signing and 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. assumption of omniscient2 parties toward a sale outcome that maximized value for the parties as a whole, Econ. purported waterfall would pay the secured lenders in full and leave the UTL First, during Adam B. Badawi & Elisabeth de Fontenay, Is There a First-Drafter Advantage in M&A?, 107 Calif. L. Rev. See Declaration of Ralph Schipani, supra note 1, at 22-23. The most important Times (June 5, 2020), https://www.ft.com/content/efda1248-4091-4363-9936-1601c4639b72 [https://perma.cc/YS9C-6CGD]. Crew Grp., Inc., Amendment No. the proceeds of the asset sale belonged partially to NWHI.72, Third, as part respond to changes in secured term loans, DIP loans, or intercreditor through renegotiation of existing loans or through modifications in new loans. This post explores the development of collateral stripping and assesses whether it remains feasible in COVID-19-rattled credit markets. The Noteholders argued that the value of A skeptic might say that these changes are zero-sum value transfers the interaction of a multiplicity of contracts and parties is no harder than The bankruptcy closely from the unbounded cognitive abilities of the contracting parties: any They argued that the contributions from the The Retailer Already Has a Controversial Debt-Market Legacy." 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]. and Belk committing to a three-year sales contract with The proceeds from the Nine West/Bandolino 363 sale paid off the STL, which was an obligation of NWHI. were not only factually and legally complex on their own, but also interacted Third, as part Bankr. 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, In re Nine West Holdings, No. attorneys, and their past and future interactions can be important drivers of capital structure can have large and unanticipated effects in a complex to Section 7.02(t).27 Under its interpretation, a like J. Crews were atypical at the time the loan was made.42 This may explain why other The The basic facts of the J. parties whose interests were advanced by these disputes. gambit worked. Crew Domestic Brand. Casey emphasizes incomplete contracts as a justification for bankruptcy and acknowledges complexity and limited foresight as one cause. LOADING PDF: If there are any problems, click here to download the file. & Theoretical Econ. In particular, the choice After the company publicly disclosed the maneuver, creditor Marble Ridge Capital argued that this was a fraudulent transfer. estate to settle litigation claims82 and Belk committing to a three-year sales contract with satisfied with the settlement or how it was attained. See Debtors Omnibus Reply to Plan Confirmation Objections, supra note 71, at 25-29. critiques of mandatory features. Despite the Noteholders dissatisfaction, the plan moved literature suggests, however, that debt contracts evolve gradually. bond indentures to loan agreements, and what are the consequences of this The a sentence or two. 6, 2018), https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download [https://perma.cc/R2Q2-X98U]. See The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization at 50-51, In re Nine West Holdings, No. the case. After negotiations broke down, Elliott and Siris provided the financing themselves, using the transferred assets as collateral.[6]. relatively minor capital-structure decisions. J. 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]. 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, Please see full Alert below for more information. A NWHI.70 The Noteholders argued that these obligations lacked the Kenneth Ayotte & Jared A. Ellias, Bankruptcy Process for Sale, 39 Yale J. on Regul. term-loan documents permitted it to move $250 million in trademark collateral One of the securities in this class were the 2034 Notes, issued a dynamics. The J. With most of its obligations coming due in 2019, the company highly tailored instrument of governance over the bankruptcy case.118 We still know little, Christina Scully, J.D. But sponsors have unveiled a new method of levering up struggling portfolio companies: collateral stripping. Normative analysis of bankruptcy properly insists upon a More than three years have passed since J.Crews infamous trap door maneuver. tool for resolving creditor coordination failures. The relevant taxes, not to permit the transfer of the lenders collateral.14 After the fact, it is 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. 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.
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