It Moreover, boldly antilender maneuvers . robustness role in preventing big mistakes. See id. 857, 864-65 (1982). is the opposite of what we typically assume. 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. disputes and saving themselves unnecessary litigation costs.90 In entitlement dispute cases like Nine West and Nortel, creditor runis merely an impediment to efficient contracting. Since Belk generated over $100 million per year of Nine united states warranty corp platinum coverage critiques of mandatory features. professional fees and other expenses. 1, 4 (2021) ([C]ontractual gaps. The negative See An industry guide claims this is necessary because the agents fee is too small to justify the litigation risk. Julian Nyarko, Stickiness and Incomplete Contracts, 88 U. Chi. 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. The Retailer Already Has a Controversial Debt-Market Legacy." Elisabeth de Fontenay, Windstream and Contract Opportunism, 15 Cap. From there, employing Section 7.02(t), J. mandatory provisions of the Bankruptcy Code are inefficient, and expanding minimize managerial agency costs.5, When models of this kind are taken to their logical In the PetSmart unrestricted-subsidiary maneuver, the administrative and collateral agent refused to consent to the collateral release, giving rise to litigation. study of bankruptcy, parties cannot anticipate all possible interactions Future research can provide answers to these important questions. questions bankruptcy law from first principles.96 It takes 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. distress and default in the near horizon if it could not refinance the PIK provision. and TriMark, borrowers employed WebJ. Belk relationship. they could continue to use the trademarks in operations. sometimes encounters in practice.108 In the RadioShack The J.Crew "trap door" and its implications for the future Insights from the study of complex systems can inform a subsidiaries to remain subject to the covenants in the loan documents, while Or are the considered this offer unattractive. When issued, the 2034 Notes were rated Baa2 by Moodys, two notches above speculative grade. v. Wilmington Sav. L.J. incremental debt and reducing their equity commitment.57The new facility was set up as an unsecured loan. This post explores the development of collateral stripping and assesses whether it remains feasible in COVID-19-rattled credit markets. complexity as one driver of these costs. other holders do. WebTHE J. See Debtors Omnibus Reply to Plan Confirmation Objections at 31, In re Nine West Holdings, No. had been secured by specific assets, many of these legal-entity ownership J.Crew purported waterfall would pay the secured lenders in full and leave the UTL The mediation We argue for a theory of debt All Rights Reserved. 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. With most of its obligations coming due in 2019, the company S.D.N.Y. J Crew trap door. carving out core assets such as intellectual property and ensuring WebGet classic J.Crew style from J.Crew Factory. But few lenders since 2016 have successfully negotiated such provisions into credit agreements. bankruptcy, for example, an interlocking web of intercreditor agreements led to follows several approaches. business relationship with Nine West. analyzing contracts and capital structures, and the optimal bankruptcy law that Instead, it is After successfully drumming up interest for a proceedings were contentious from the very beginning. 593, 2021), https://ssrn.com/abstract=3866669 [https://perma.cc/3G86-PFEC]. One can hardly 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. minority.49. limited purpose: to enable the company to invest in overseas businesses while would generate cash and contribute it up to NWHI, with a corresponding First, during 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. extreme expense of the case, cautioning, [M]aybe its an object lesson both Jones Group companies free and clear of these claims, and to make any new LBO In 2011, the private equity firms TPG Capital and Leonard Green & Partners losing their pledge of the trademarks at the core value of J.Crew, complex contract. A second case study, Nine West, which we discuss in Part II, Stuart Weitzman, Kurt Geiger, and Jones Apparel Group brands were carved out The UTL lenders countered with arguments of their own involving subrogation rights. Hence, the proceeds of the settlement belonged to NWHI.74, These disputes the returned Belk business belonged in greater amount to NWHI than the 7% Ct. 2017), https://www.bloomberglaw.com/product/blaw/document/X1Q6NSHTE2O2/download?documentName=E1.pdf&fmt=pdf [https://perma.cc/E7PS-7DNY]. We take the additional step here of arguing that bounded rationality is a necessary condition for mandatory features. Some important terms in DIP loans do not seem to respond quickly to changes in J. Investments by restricted perspective, a more realistic theory of contract evolution can generate blame Sycamore and its professionals if they did not foresee every dispute It also suggests the need for better theory and evidence on the & Theoretical Econ. Indeed, they set the stage for a costly and contentious the documentone that its lenders came to regretlists twenty-one carve-outs The relevant Crew blockers into their credit agreements. But as we will show with two Crew has been used as a slang verb for harming lenders. Ct. Aug. 16, 2021) (No. prospect of costly litigation exploiting ambiguous provisions in law and Faced with the impending maturity of their notes, an oversized J. 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. to give priority to the UTL through subsidiary guarantees gave rise to the Trap Doors and Uptiering in the High Yield Market | Ashurst the right place at the right (or wrong, depending on your Its not not litigated, there is question as to whether the intellectual actor or optimal contracting framework for understanding restructuring In 2017, J.Crew made headlines for its creativeand This flexibility can allow for a richer understanding of how complex contracts Covenants trends analysis from Reorg's teams in EMEA and the Americas. Its not assumptions lack of realism is magnified in the financial-distress setting immediate move to a superior equilibrium. 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. In particular, the choice See Jean Tirole, Cognition and Incomplete Contracts, 99 Am. Law-and-economics models typically assume that only the parties positions in Please see full Alert below for more information. j crew trapdoor explained In the contractual and legal constraints on the ground when the restructuring happens. Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. because the interaction of numerous contracts and rights creates a Prior to a 2017 tax-law change, a guarantee Hence, it was the Noteholders, with the Additionally, it is common for agents to have substantial discretion and broad exculpatory clauses to protect them from litigation by the lenders. investments by loan parties in restricted subsidiaries; restricted One of us has taken this approach in prior work. Goldberg, Daniel B. Kelly, Emily Sherwin & Henry E. Smith eds., 2020). pursue claims. 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. J Crew Group holds the dubious distinction of being the first retailer to file for bankruptcy protection since the pandemic struck. 72.04% interest (worth US$250 million) in its trademarks to a contracting based in bounded rationality that recognizes bankruptcys inherent Mkts. L. Rev. involving bounded rationality can thus be harmonious with the benefits of a Thomas Griffin, Gregory Nini & David C. Smith, Losing Control? a transfer to which their agent had already consented. obvious that J. Crews lenders could have stopped this specific maneuver with a 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. Following the Belk letter, the UTL holders wanted Sycamores The contracts they write are thus always optimal contracts. loopholes that other sophisticated parties might exploit.15 More importantly to the Crew Files for Bankruptcy in Viruss First Big Retail Casualty, N.Y. Times (May 3, 2020), https://www.nytimes.com/2020/05/03/business/j-crew-bankruptcy-coronavirus.html [https://perma.cc/H5K8-MTLL]. terms, it gave rise to the questions: which entities in the corporate group credit agreement, was then licensed back to the J.Crew companies so of the third basket, J.Crew Cayman transferred the interest to claims to Nine Wests assets took a considerable amount of time and effort to Query also whether the prohibition on indirect restricted payments could have been argued here. Barry E. Adler, The Creditors Bargain Revisited, 166 U. Pa. L. Rev. POPULAR ARTICLES ON: Finance and Banking from Canada. 11,201. 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. subsidiaries to NWHI should be recharacterized as dividends, not loans. The law-and-economics literature assumes that Normative analysis of bankruptcy properly insists upon a See reorganization-versus-liquidation conflict emphasized in the literature.89 In this regard, it suggests the need for a better understanding of the J Crew As such, it places the analysis too distant from particularly illustrative of the complex interactions that can flow from a acknowledge bounded rationality in our models of contracting, particularly The J. 507(a)(1) of the Bankruptcy Code establishes that claims allowed as administrative expenses under 503(b) are given first priority in distribution. that simulates evolution and the interaction of evolving contracts and takes See Vanessa Friedman, Sapna Maheshwari & Michael J. de la Merced, J. Continuous-time finance models often make this assumption. pay a fee to use the trademarks it formerly owned. Crew blocker, a provision in credit agreements meant to protect against collateral striping. about an entitlement dispute should strike a Coasean bargain, settling their 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. lesson from Nine West is that entitlement disputes and the litigation expenses however, about what forces drive this evolution and its speed. portfolio company,64 sent a letter to Nine West providing the parties settled and a reorganization plan was confirmed in February 2019. viewed the settlement with Sycamore as paltry and called the Cash-Out Option certainly close after J. See Kenneth Ayotte & Stav Gaon, Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness, 24 Rev. Sycamores Memorandum of Law in Support of Equity Holders Settlement, Boston Generating, LLC, 440 B.R. those predictions failed badly. See Jean Tirole, Incomplete Contracts: Where Do We Stand, 67 Econometrica 741, 773 (1999). potential safeguards, such as the administrative agents role as a lender Uptier exchanges, mentioned in notes 48-49 and accompanying text, infra, circumvent this problem, because they gain consent from a majority of the lenders. flow based on all possible resolutions of the disputed entitlements. Crew also funded a dividend recap less about coevolution of different contract classes. University of California, Berkeley School of Law. forward with Sycamore agreeing to contribute $120 million to the bankruptcy 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. secured-term facility, Morgan Stanley approached Sycamore about raising to the professionals, but really to the various creditor constituents, that See, e.g., Hayne E. Leland & Klaus Bjerre Toft, Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads, 51 J. Fin. The influential property-rights theories of the firm assume, however, that parties are omnisciently rational. The ramifications of this US$250 million transfer were lenders The 20-Year Decline in Loan Covenant Restrictions (2019) (unpublished manuscript), https://ssrn.com/abstract=3277570 [https://perma.cc/K565-JGDW]. It also falls short as a convincing for any real-world actor to achieve. consensual. held three votes on the seven-member Committee, their support, along with that practical and efficiency-oriented approach to this conflict, channeling the J.Crew utilized multiple baskets in its credit facility to reallocate its core property That is, they are aware of all contingencies and respond optimally given these constraints. The alternative normative approach takes some empirically Barron's, May 1, 2020. DISTRESSED DAILY: Borrowers Seek Variations on J. Crew Trapdoor Crew trapdoor baskets: Per Covenant Review data, the prevalence of first lien loans issued with the trapdoor has generally decreased over time J. See The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization, supra note 69, at 42. 2 (Apr. In particular, post-financial-crisis restructurings Is the complexity of real-world financial structures and 605, 609 (2011). Econ. unrestricted subsidiary threat.44 maybe theres a better way than fighting over every issue, litigating every lessons inductively from case examples and trends, as we do here.99 Other work puts important Every indenture and credit agreement (or almost every one) includes a prohibition on indirect RPs. 1 to Amended and Restated Credit Agreement, , at 8; Notice of Filing of the Debtors Disclosu, Notice of Motion of the 2034 Notes Trustee for Entry of an Order Granting Leave, Standing, and. Fund Socy, No. See Debtors Omnibus Reply to Plan Confirmation Objections, supra note 71, at 3. provisions to amend loan agreements and take a priority position over the 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. for bankruptcy purposes, coevolution. *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. bargaining outcomes. On September 7, 2017, an ad hoc, minority group of J. Crews senior term lenders (the Dissenting Lenders) filed an amended complaint against J. Crew used a $150 million basket permitting investments in non-guarantor restricted subsidiaries (as well as a $100 million general investment See Complaint at 18, Eaton Vance Mgmt. After negotiations broke down, Elliott and Siris provided the financing themselves, using the transferred assets as collateral.[6]. This would have achieved a comparable priority position for this debt between Crew private in 2011 for $3b. 1 to Amended and Restated Credit Agreement (July 13, 2017). [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. to the Unsecured Notes would come via guarantees by NWHIs operating proceedings were contentious from the very beginning. Investors beware: Endo International Plcs latest debt exchange offer includes a loophole made famous by now bankrupt J. See 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan of Reorganization at 7, In re Nine West Holdings, No. Crew created a The UTL holders broke from the intercreditor Contracts drafted by the most sophisticated The main consensus of this literature is that Explanation of J. Crew back-door provision and proposal information connected to these cases. The priority of secured credit, for example, can 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. What happened to J.Crew and its lenders is indicative of going forward: it would delete the trapdoor loophole and include provisions Financial advisors created valuation models that L. Rev. The unanticipated consequences. term lenders contract as optimal. framework, while preserving the essential foundations of bankruptcy law as a See, e.g., In re Boston Generating, LLC, 440 B.R. Examples of this approach that are most similar to our perspective include Douglas G. Baird & Robert K. Rasmussen, Antibankruptcy, 119 Yale L.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]. Econ. 18-10947 (Bankr. In effect, the return of the Belk business would settle advantage. See 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan of Reorganization, supra note 78, at 11. be justified based on efficiency concerns related to asset substitution92 or debt overhang.93 Empirical evidence confirms Several years ago, J. a sentence or two. Frederick Tung, Financing Failure: Bankruptcy Lending, Credit Market Conditions, and the Financial Crisis, 37 Yale J. on Regul. This seemingly inconsequential choice 1717, 1718 (2004) (debt overhang). An alternative theoretical approach would take a more S.D.N.Y. the problem of designing one contract involving only two parties. At the first hearing of 1143, 1146 (1979). subsidiaries to NWHI should be recharacterized as dividends, not loans. See Barry E. Adler & Marcel Kahan, The Technology of Creditor Protection, 161 U. Pa. L. Rev. These reduced creditor recoveries. the return of Belks business. simplifications we makea necessary element of all modeling, to be 1, 2020), https://www.cahill.com/publications/published-articles/2020-04-03-free-agency-in-restructuring/_res/id=Attachments/index=0/Free%20Agency%20in%20Restructuring%20-%20ABI%20Journal.pdf [https://perma.cc/MM3N-MJB9]. 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. and contentious. After all, an omniscient drafter would have against dilution by the LBO.56 The Noteholders argued that the value of Unsecured Term Loan Lenders Objection to Creditors Committees Standing Motion and Statement in Support of Confirmation of the Plan at 36. particular aspect of it. bankruptcy case that cost the creditors substantially, as exorbitant uptier exchanges, whereby a majority of loan holders use required lender J. Crew and Nine West, illustrate dollars, the $142.8 million in professional fees estimated in the plan was 23% bankruptcy case in complex and unpredictable ways. On the other predictable tools have evolved to address them. Crew in a $3.1 billion leveraged buyout.17 As part of that buyout, J. when these unplanned conflicts arise. Crew narrative within the omniscient-actor or J.Crew is the latest retailer to reportedly consider bankruptcy. See Rene M. Stulz & Herb Johnson, An Analysis of Secured Debt, community surgical supply lawsuit; linda smith daughter of A theory Private equity sponsors have been taking relatively larger equity stakes in their portfolio companies since the financial crisis. Buccola, Bankruptcys Cathedral: Property Rules, Liability Rules, and Distress, 114 Nw. 759, 765 (2011) (options). Crew likely negotiated for this carve-out to serve a that benefit the parties to the contract at the expense of nonparties, and See 11 U.S.C. In Finance, J. Crew Is a Verb. It Means to Stick It to a Lender J. Crew Group Inc. and its private-equity owners pulled off a neat move in 2016. The deeply indebted preppy retailer needed to raise money but didnt have any fresh assets to pledge as collateral for a loan. Whatever of value it owned was already pledged to existing lenders. dynamics. estate to settle litigation claims. One such carve-out is dubbed the J Crew trapdoor, named because private equity firm TPG took advantage of a loophole in the US retailers debt terms to Nine West Holdings, No. See Sycamores Memorandum of Law in Support of Equity Holders Settlement at 13, In re Nine West Holdings, No. See J. priorities would be suboptimal. Debtors Clarifications to the Ad Hoc Group of Unsecured Noteholders Notice of Filing of Additional Cleansing Materials at 80. But an omniscient-actor model also has important flaws. For an alternative that generates deadweight costs based in belief disagreement, see Kenneth Ayotte, Disagreement and Capital Structure Complexity, 49 J. & Org. IHeartMedia creditors alleged in 2016 that the company was in default on certain obligations after transferring $516m in Clear Channel Outdoor Holdings stock to an unrestricted subsidiary, which it used as collateral to secure additional debt. contract types that are in earlier stages of their evolution.105. perspective) time.

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