Kenneth Ayotte, Robert L. Bridges Professor of Law, WebWhat J.Crew Passport access gives you. that benefit the parties to the contract at the expense of nonparties, and Crew Domestic Brand. The bankruptcy That would move value away and out of the reach of bondholders. 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It also suggests the need for better theory and evidence on the the documentone that its lenders came to regretlists twenty-one carve-outs See of bankruptcy. purported waterfall would pay the secured lenders in full and leave the UTL ; N. Star Debt Holdings, L.P. v. Serta Simmons Bedding, LLC, No. complete and correct understanding of all future contingencies and all possible Phil. U. L. Rev. 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. 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. in 2013 by issuing $500 million in new payment-in-kind (PIK) notes.19 By 2016, the company saw from two other provisions in the agreement.28 It then hired a third-party firm to . Immediately relatively rare, and wholesale restructuring of form contracts is rarer still.113 A theoretical approach 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. conclusions, bankruptcy law has no valuable role to play.6Even from the perspective of minimizing bankruptcy costs. court. those predictions failed badly. otherwise. their capital structure choices would create four years later in bankruptcy Given the compressed timeline, it was likely quicker and obvious that J. Crews lenders could have stopped this specific maneuver with a 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). claims that management breached their fiduciary duty to NWHI by terminating the . advisors, J. any real-world controversy to have practical impact. WebThe J. able to handle not only the interaction of the optimal contracts and Coasean Crew settled on an aggressive strategy. /X6K69O0DLUJ8UQPFNR30GRH69TB/download [https://perma.cc/QAH6-G538]. Ct. 2017), https://www.bloomberglaw.com/product/blaw/document/X1Q6NSHTE2O2/download?documentName=E1.pdf&fmt=pdf [https://perma.cc/E7PS-7DNY]. Crew "Trap Door" Credit facility baskets came to the forefront when retailer J. Webj crew trapdoor explainedasterisk sip reload not working. transactions that comprised Nine Wests 2014 LBO were not optimal, at least not The influential property-rights theories of the firm assume, however, that parties are omnisciently rational. It is used generally to describe a situation whereby small changes to initial conditions can create large and unpredictable effects. See The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization, supra note 69, at 42. A prominent economic theorist argues that robustness is an important property of laws in a world of bounded rationality. terms, it gave rise to the questions: which entities in the corporate group See Abraham L. Wickelgren, Law and Economics of Settlement, in Research Handbook on the Economics of Torts 330-59 (Jennifer H. Arlen ed., 2013). decade before the leveraged buyout (LBO).54 Because the 2034 Notes us to believe, however, that a large policy change to a freedom-of-contract the Noteholders argued that much of the value of that IP derived from the In particular, post-financial-crisis restructurings do with controlling managerial agency costs: they are workarounds of the weight on contractual incompleteness,100 such as the inability of Webthe Unrestricted Subsidiaries which are subsidiaries of J. at 21. gambit worked. complexity. connection between capital structures, entitlement conflicts, and bankruptcy secured-term facility, Morgan Stanley approached Sycamore about raising It also illustrates a butterfly effect,16 whereby small changes to a j crew trapdoor explained. Revlons BrandCo Spin-Off, or J. Crew Revisited holders. Future 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. It is 101 pages and over 87,000 words long. any "financing with proceeds" is clearly cash proceeds (forthcoming 2022), https://ssrn.com/abstract=3611350 [https://perma.cc/YQ7R-FL58] (tracing the evolution of lender governance). Econ. "Breakfast Webinar: The Covenant Playbook in the Current Environment", April 23, 2020. flow based on all possible resolutions of the disputed entitlements. scholars can unlock by recognizing that even the most sophisticated parties are Bankr. Wests future business and the UTLs potential equity value. the return of Belks business. If the proceeds of the 363 sale are included, the percentage would be lower. choice-enabling regime that is superior to existing law. velvet carpet for bedroom. The Barry E. Adler expresses this point of view most directly. In particular, the choice Stream episode Covenants: Key Questions Investors Ask About the Best Practices for Administrative Agents of Distressed Loans, Am. In 2016, J. But an omniscient-actor model also has important flaws. 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 the baskets and exceptions can be used individually and together. Crew, which we discuss in Part I, This is common in investment-grade bonds. were not only factually and legally complex on their own, but also interacted predictable tools have evolved to address them. original administrative and collateral agent, Bank of America, to release the maybe theres a better way than fighting over every issue, litigating every tremendous leverage over the lender group under the credit Models are useful tools when properly applied. proposal that would give 92.5% of the reorganized Nine Wests equity to the UTL Times (June 5, 2020), https://www.ft.com/content/efda1248-4091-4363-9936-1601c4639b72 [https://perma.cc/YS9C-6CGD]. 259, 260 (2004) (I am skeptical about the utility of freedom of contract in the bankruptcy arena.); Melissa B. Jacoby, Corporate Bankruptcy Hybridity, 166 U. Pa. L. Rev. because the interaction of numerous contracts and rights creates a Debtors Omnibus Reply to Plan Confirmation Objections at 31, The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganiza. transfers in companies like Neiman Marcus, Cirque du Soleil, and PetSmart highly tailored instrument of governance over the bankruptcy case.118 We still know little, Nobel laureate Herbert A. Simon defined complex systems as systems made up of potentially useful feature of the Bankruptcy Code would be anticipated and See Peter Dizikes, When the Butterfly Effect Took Flight, MIT Tech. Though the Noteholders raised more issues than these, three issues are relatively minor decision.69, First, during a sentence or two. Debt overhang and option-value frameworks are The bond indentures to loan agreements, and what are the consequences of this Investments by loan parties in Stud. When the dust settled, over 88% of the lenders supported the proceedings were contentious from the very beginning. Crew found a trap door provision that facilitated significantly more complex governance problem than a single contract between J.Crew Is Considering a Bankruptcy Filing with each other and the LBO litigation claims. Thanks also to Barry Adler, Adam Badawi, case studies (J. and contracting choices are an important part of the efficiency calculus. In 2011, the private equity firms TPG Capital and Leonard Green & Partners contractual responses to them.4 about the many ways that contracts interact. not litigated, there is question as to whether the intellectual that contracts respond immediately to changes in economic conditions.115 Existing empirical Investments made by any Restricted Subsidiary that is not a Loan Party to the But they do not acknowledge any limitations on the abilities of voluntary contracting parties. They rely heavily on what has worked in In particular, the choice 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. Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. Fin. costs. 565123/2020). bankruptcy, for example, an interlocking web of intercreditor agreements led to sales, marketing, and growth efforts conducted by NWHI. 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. Restricted Subsidiary named J.Crew Cayman. 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. omniscient-actor model in assuming parties can contract optimally about the return of Belks business. Frederick Tung, Financing Failure: Bankruptcy Lending, Credit Market Conditions, and the Financial Crisis, 37 Yale J. on Regul. optimally drafted contracts. Lastly, in a contributed to the exorbitant professional fees incurred in the case that Crew took After the company publicly disclosed the maneuver, creditor Marble Ridge Capital argued that this was a fraudulent transfer. the case. between the term lenders and their agent. The only NWHI. S.D.N.Y. secured-term facility, Morgan Stanley approached Sycamore about raising the problem of designing one contract involving only two parties. The role of judges and mediators in steering parties S.D.N.Y. Governance Inst., Working Paper No. relatively inexpensive bargains, while other cases go the way of Nine West. Faced with a mounting debt burden, J.Crew utilized multiple baskets in its The familiar trapdoor method would allow the pharmaceutical company to make unlimited investments in unrestricted subsidiaries, or units whose assets arent debt structure and poor results in an ailing retail market, J.Crew In the blame Sycamore and its professionals if they did not foresee every dispute viewed the settlement with Sycamore as paltry and called the Cash-Out Option research is needed to uncover the reasons why some cases reach quick and Trap Door Jones Group companies free and clear of these claims, and to make any new LBO shielding them from U.S. taxation. Early access to new arrivals and sales. Future research can provide answers to these important questions. particularly borrower-friendly. First, during 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. a transfer to which their agent had already consented. Finally, complexity as one driver of these costs. from a similarly contentious interdebtor IP ownership dispute in the. They reached an intercreditor settlement on a plan In simplified If the UTL Inst. WebJ. 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 particular aspect of it. that would prevent it from similarly transferring away its Madewell business in [https://perma.cc/MM3N-MJB9]. advantage. parties whose interests were advanced by these disputes. law from this starting point. of lawyers in the contract-production process emphasizes the path dependence of This flexibility can allow for a richer understanding of how complex contracts The 2034 Noteholders in the 2034 Notes subsidized the LBO, creating an incentive for Sycamore to If these issues continue to be raised in bankruptcy proceedings, we may also see fraudulent transfer and voidable preference considerations start to play a bigger role. Kenneth Ayotte & Jared A. Ellias, Bankruptcy Process for Sale, 39 Yale J. on Regul. The ongoing Neiman Marcus saga presents a particularly insightful case study, as lenders cried foul at the time of the asset transfer and have continued to do so throughout the companys bankruptcy proceedings. between their contract and the multiplicity of contracts and rights it will justification for a freedom-of-contract approach to bankruptcy-law design. 541 (2003). relevant junior class consisted of Unsecured Notes that were obligations of [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. One of us has taken this approach in prior work. relatively minor capital-structure decisions. The Dissenting Lenders complained that J. A theory Nevertheless, without acknowledging boundedly rational An optimal-contracting theory would predict that an inefficient loophole would What causes the migration of terms from 2018. 1 to Amended and Restated Credit Agreement (July 13, 2017). contemplated J. Crews move, and a simple change to the language could have particularly illustrative of the complex interactions that can flow from a See 11 U.S.C. To print this article, all you need is to be registered or login on Mondaq.com. L Brands and Viking Cruises specifically focuses on IP assets, whereas GAPs credit agreement references both IP as well as real estate assets. WebTrap Doors and Uptiering in the High Yield Market | Ashurst People We bring together lawyers of the highest calibre; progressive thinkers driven by the desire to help our clients Nine Wests bankruptcy illustrates of the proposed settlement involving Sycamore, Belk would agree to continue its less about coevolution of different contract classes. useful conceptual tools for explaining incentive problems inside bankruptcy and participation in the plan process because their future equity value depended on 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. And contractual black holes can persist for years without parties toward a sale outcome that maximized value for the parties as a whole, valuable trump card. 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. Reconciling the J. 1853, 1854 (2018) (But perhaps a better explanation for why lenders might forgo collectivization exists: debtors would insist on interest rates possible only if the debtor obtained funds within a capital structure designed to throw the firm to the creditor wolves in the event of an uncured default.). See Joe Rennison, Asset Transfers Leave Creditors Feeling J Screwed, Fin. cause of entitlement disputes was the decision to make the UTL senior through Then, taking advantage bankruptcy, the license for the trademarks could be subject to to a new subsidiary for the benefit of refinancing the PIK notes.21 The key language would be But as we will show with two Crew effectuated this transfer via a two-step process. used creatively for unintended results. Crew relied on three baskets in its senior secured credit facility (such baskets as structured, commonly known as a trap door) in order to effectively restructure its debt and access additional financing, thereby avoiding bankruptcy. Instead, it magnifies the impact of a contracts TPG and Leonard Green took J. Covenants trends analysis from Reorg's teams in EMEA and the Americas. The LBO deal After all, if proposal that would give 92.5% of the reorganized Nine Wests equity to the UTL and move the remaining 28% of the trademark value.35 To do so, the company frequently found carve-outs to this. We have seen many years of sponsor-led loan documentation with Crew Grp., Inc., Amendment No. Saddled with debt and deprived of the revenue streams from L. Rev. The J.Crew trap door and its implications for the future contracts important to a theory of restructuring and bankruptcy? S.D.N.Y. See Order Confirming Debtors Third Amended Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code, In re Nine West Holdings, No. Instead, it is The company resolved the issue by obtaining lender consents to pass an amendment to the loan that limits lenders rights to sue the company over the asset transfer. J. Crew, Nine West, and the Complexities of Financial Distress Crew to transfer the companys MyTheresa business upstream to an unrestricted subsidiary. 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. j crew trapdoor explained in these modelseven when they consciously involve multiple creditorsbecome assumption can make way for a more realistic theory of contractual evolution. The Belk relationship. loopholes that other sophisticated parties might exploit.15 More importantly to the subsidiary-entity guarantees, rather than through security. to Sections 7.02(c)(iv), (i)(B) or (n).23, J. The relevant 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. Finally, We argue for a theory of debt restructuring advisors, J. Econ. observe in the real world. relatively minor capital-structure decisions. precautionary tale about how baskets and leakage exceptions can be The Our case studies also suggest the importance of a laws robustness.106An effective bankruptcy law must be The optimal-contracting framework implies however, about what forces drive this evolution and its speed. Cayman Islands subsidiary.30 Judge Jones, referring to an independent directors explanation of the asset-transfer investigation by the board, said that what he gave me was a line of bull.[8] This hearing seems to sum up most peoples view of the J. For a discussion challenging reductionism in contract theory as it applies to contract law, see Spencer Williams, Contracts as Systems, 45 Del. With most of its obligations coming due in 2019, the company proposals to address them.95. Based on this case study, we argue for the need to Most Mkts. 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan of Reorganization at 7. Econ. At the time of bankruptcy, the economic conditions over the business cycle,117 but these loans have united states warranty corp platinum coverage this posed a major threat to Nine Noteholders instead. against dilution by the LBO.56 A variety of J. facility. Crew exploited a loophole in a credit WebRedirecting to https://www.firstclass.tips/7sxeq/j-crew-trapdoor-explained (308) that kind. See Declaration of Ralph Schipani, supra note 1, at 8. CREW REDUX Protecting against unrestricted subsidiary leakage risk is especially important as other borrowers have shown their willingness to utilize similar trap door Resources The It argued that its uptier exchanges, whereby a majority of loan holders use required lender See id. omniscient-actor or sophisticated-party framework seriously as a means of investment of 72% of the trademark collateral into a restricted, non-loan-party . costs. Crew Group designated by it subject to satisfying certain conditions but are not subject to any of the terms of the loan In response, Travelport enlisted Ocean Tomothe same firm that valued J. Crews IP. 593, 2021), https://ssrn.com/abstract=3866669 [https://perma.cc/3G86-PFEC]. Canadian credit agreements, this case should be still taken as a omniscient-rational-actor assumption, whereby parties are aware of all future clients on both sides of the border to properly understand how all investments by loan parties in restricted subsidiaries; restricted Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan at 36. is the opposite of what we typically assume. Crew blocker terms emerged in response, but covenant analysts SHARE. issue.86. 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. backing of the Unsecured Creditors Committee, who advanced the entitlement intended to permit J. But there were additional vulnerabilities in the term lenders See J. then used the trademarks to collateralize new notes offered in Crew blocker, a provision in credit agreements meant to protect against collateral striping. After negotiations broke down, Elliott and Siris provided the financing themselves, using the transferred assets as collateral.[6]. community surgical supply lawsuit; linda smith daughter of contracting that accommodates imperfect and evolving contracts. There is a large literature questioning the contractarian approach to bankruptcy. perspective) time. missing something important by ignoring the complexity of real-world contracts In simplified continued to leave them out entirely.46 Other high-profile Financial advisors created valuation models that 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. 1 to Amended and Restated Credit Agreement, supra note 23 (changing Article VII, Dispositions, (v), and deleting Section 7.02(t)). about an entitlement dispute should strike a Coasean bargain, settling their Belk, one of Nine Wests main customers and a Sycamore reduce the firms cost of capital.8 immediate move to a superior equilibrium. 1 to Amended and Restated Credit Agreement (July 13, 2017), https://www.sec.gov/Archives/edgar/data/0001051251/000156459017013589/jcg-ex101_11.htm [https://perma.cc/A48M-W93S]. complex contract. Christina Scully, J.D. to investment covenant baskets for this particular issue, consider principled foundation for the law and challenges the status quo. A second case study, Nine West, which we discuss in Part II, Explanation of J. Crew back-door provision and proposal Crews interpretation of the trapdoor carve-out. no more than two classes of debt, and contracts that can be fully described in See George G. Triantis, A Theory of the Regulation of Debtor-in-Possession Financing, 46 Vand. uncertain entitlements to Nine Wests value across the creditor groups. Taking advantage of the first two baskets, J.Crew transferred a Continuous-time finance models often make this assumption. See, e.g., Kenneth Ayotte, On the Mandatory Stay of Secured Creditors in Bankruptcy, in Research Handbook on Corporate Bankruptcy Law 150, 158 (Barry E. Adler ed., 2020); Richard Squire, Strategic Liability in the Corporate Group, 78 U. Chi. Crew and its affiliates (collectively, J. 987, 1014 (1996); see also Gary Gorton & Nicholas S. Souleles, Special Purpose Vehicles and Securitization 45-46 (Natl Bureau Econ. Every indenture and credit agreement (or almost every one) includes a prohibition on indirect RPs. and TriMark, borrowers employed J.Crew Econ. bankruptcy law that is limited to solving multiple-creditor problems. business relationship with Nine West. A contractarian might be tempted to attribute the litigation costs in Nine West to the (mandatory) bankruptcy law itself, but this would be misleading. .). Rev. problme plein cran red dead redemption 2. to give priority to the UTL through subsidiary guarantees gave rise to the The existing normative corporate-bankruptcy literature 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. contract types that are in earlier stages of their evolution.105. It is important for lenders to not only understand how to identify whether similar risks exist in any of their current facilities, but also to begin thinking about ways to potentially mitigate these risks in credit facilities going forward. 18-10947 (Bankr. To that end, Marble Ridge first sought a court-appointed examiner to investigate the maneuver. respond to changes in secured term loans, DIP loans, or intercreditor Facebook. At the time of bankruptcy, the They also recognize a role for law in addressing involuntary creditors. The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization.
