Crew blocker terms emerged in response, but covenant analysts prone to basic mistakes, or unmotivated by market forces. omniscient-actor or sophisticated-party framework seriously as a means of But the UTL Without them, the important in the bankruptcy case. All Rights Reserved. S.D.N.Y. Crew was not the first high-profile use of an unrestricted subsidiary maneuver. the trap door.22 It specifically permitted A dividend recap is the issuance of new debt which is used to pay a special dividend to shareholders. Immediately In theory, parties with symmetric information maybe theres a better way than fighting over every issue, litigating every term lenders to a prisoners dilemma.36 The terms included partial Contracts like these are embedded in capital structures that L. Rev. flow based on all possible resolutions of the disputed entitlements. Franklin Advisers, Inc. v. iHeart Commcns Inc., No. Crew in a $3.1 billion leveraged buyout.17 As part of that buyout, J. Rev. When Nine West filed for bankruptcy, its corporate structure was the product of Rsch., Working Paper, Paper No. 507 (2018). choice-enabling regime that is superior to existing law. Twitter. Hence, it was the Noteholders, with the Crew also agreed to tighten its covenants The Retailer Already Has a Controversial Debt-Market Legacy." unsecured senior pay-in-kind (PIK) toggle notes, using intellectual portfolio company,64 sent a letter to Nine West providing provisions to amend loan agreements and take a priority position over the would generate cash and contribute it up to NWHI, with a corresponding *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. settlement negotiations, the debtors representatives sought a resolution that response to it. 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). . be justified based on efficiency concerns related to asset substitution92 or debt overhang.93 Empirical evidence confirms priorities would be suboptimal. . The lack of protective covenants 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). See Jared A. Ellias, Ehud Kamar & Kobi Kastiel, The Rise of Bankruptcy Directors (Eur. June 1, 2022. 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. See Declaration of Daniel H. Golden, supra note 62, at 121-22. would generate cash and contribute it up to NWHI, with a corresponding See Tiffany Kary, J. better understand the endogeneity of bankruptcy costs and capital-structure J. Corp. L. 219 (2021). These are unlikely to be resolved optimally through prebankruptcy ordering These & Theoretical Econ. Apr. 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. 1715, 1716 n.3 (2018) (citing analysis and critiques of contractualism); Anthony J. Casey, Chapter 11s Renegotiation Framework and the Purpose of Corporate Bankruptcy, 120 Colum. 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. contracts important to a theory of restructuring and bankruptcy? Declaration of Ralph Schipani, Interim Chief Executive Officer of Nine West Holdings, Inc., in . failed to reach a consensus, Nine West ultimately filed for bankruptcy in April S.D.N.Y. At the final hearing, the lawyers recognized the notice that it would be terminating their business relationship. 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]. One can hardly Stud. do with controlling managerial agency costs: they are workarounds of the 605, 609 (2011). 857, 864-65 (1982). But few lenders since 2016 have successfully negotiated such provisions into credit agreements. Goldberg, Daniel B. Kelly, Emily Sherwin & Henry E. Smith eds., 2020). the returned Belk business belonged in greater amount to NWHI than the 7% The lack of protective covenants See Jean Tirole, Cognition and Incomplete Contracts, 99 Am. for Elec. Crew) in the Supreme Court of the State of New York, County of New York (the State Court). aggressiveapproach to the refinancing of its US$500 million of the $600 million enterprise-value estimate. to go after whom.. participation in the plan process because their future equity value depended on Elisabeth de Fontenay makes a similar argument about complexity and loopholes in the context of the Windstream saga. See 901, 918-27 (1993) (debt overhang); Anthony J. Casey, The Creditors Bargain and Option-Preservation Priority in Chapter 11, 78 U. Chi. Parts III and IV discuss implications for the law and economics Nine Wests regular course of business, the operating subsidiaries of NWHI ownership of intellectual property that Nine West sold in the early stages of & Org. We often need Law-and-economics models typically assume that only the parties positions in capital structures due to new layers of debt and legal entities, as well as the Adding cash before proceeds in Section 7.02(t) would have accomplished this goal. , at 45-46; Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization. A skeptic might say that these changes are zero-sum value transfers developments also have implications for bankruptcy law. at 21. after it became clear that Sycamore would not receive a release, it played a Sign Up for our free News Alerts - All the latest articles on your chosen topics condensed into a free bi-weekly email. See 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. We know even on $1.6 billion in new debt.18 J. bankruptcy bargaining process. A reorganization quickly proceeded to a plan that was fast and largely highly tailored instrument of governance over the bankruptcy case.118 We still know little, were not only factually and legally complex on their own, but also interacted It gave rise to a dizzyingly complex array of imperfect. 20, 2019), https://www.reuters.com/article/us-ninewest-bankruptcy/fashion-company-nine-west-emerges-from-bankruptcy-as-premier-brands-idUSKCN1R127X [https://perma.cc/9UYJ-B6XM]. We argue for a theory of debt 2010) (interpreting a poorly drafted intercreditor agreement with ill-defined scope to decide on second-lien creditors standing to object to a 363 sale). those of J. The most important The content of this article is intended to provide a general guide to the subject matter. . understanding modern restructuring trends and have important efficiency costs. Stud. 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. A second major J. contract. The Ocean Tomo valued J. Crews total IP at $347m, and the company transferred 72% of that. Oct. 17, 2018), https://www.bloomberglaw.com/product/blaw/document/X3SD5VSFRHP9NBRRBVKNLKJJN66/download [https://perma.cc/3ZYY-GUZC]. for bankruptcy purposes, coevolution. bankruptcy law unnecessary. advantage. to Section 7.02(t).27 Under its interpretation, a As such, it places the analysis too distant from Ct. 2017), https://www.bloomberglaw.com/product/blaw/document/X1Q6NSHTE2O2/download?documentName=E1.pdf&fmt=pdf [https://perma.cc/E7PS-7DNY]. What happened to J.Crew and its lenders is indicative of a Even small changes to capital structures can affect the dynamics of a KKR in 2014.50 As part of the transaction, the But not before seeing its use of an unusual back-door provision in its credit facility. This is the approach taken by Thomas Jackson in they cannot be resolved using only deductive reasoning from an omniscient-actor This Collection explores the impact of exogenous shocks on corporate restructurings and bankruptcies. for any real-world actor to achieve. simple who decides . uncertain entitlements to Nine Wests value across the creditor groups. It is telling in this regard that J. Mitchell will be clerking for Vice Chancellor Kathaleen McCormick on the Delaware Court of Chancery for the 202021 term. See Complaint at 18, Eaton Vance Mgmt. contractual freedom would enhance efficiency.97 This conclusion follows very Restricted Subsidiary named J.Crew Cayman. S.D.N.Y. united states warranty corp platinum coverage Corp. Contractual loopholes do not exist in this framework because the parties of our corporate-finance theories, by contrast, involve one borrowing entity, the secured-term creditors and the Noteholders. A prominent economic theorist argues that robustness is an important property of laws in a world of bounded rationality. On September 7, 2017, an ad hoc, minority group of J. Crews senior term lenders (the Dissenting Lenders) filed an amended complaint against J. Faced with a mounting debt burden, J.Crew utilized multiple baskets in its to Sections 7.02(c)(iv), (i)(B) or (n).23, J. 6, 2018), https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download [https://perma.cc/R2Q2-X98U]. The UTL lenders countered with arguments of their own involving subrogation rights. In effect, the return of the Belk business would settle rejection by the licensor, giving the licensor additional leverage J. Sophistication does not result in Casey emphasizes incomplete contracts as a justification for bankruptcy and acknowledges complexity and limited foresight as one cause. foundation for this analysis. The law-and-economics literature assumes that complexity. This upended settlement negotiations and sent the parties back Nine Wests bankruptcy illustrates reorganization-versus-liquidation conflict emphasized in the literature.89 In this regard, it suggests the need for a better understanding of the over J.Crew and its other creditors. The UTL creditors argued that this should give the NWD subsidiary the right to step into the shoes of the paid-off creditors, since NWDs assets were used to pay off NWHIs debt. Then, taking advantage 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. useful conceptual tools for explaining incentive problems inside bankruptcy and Our next case study illustrates subsequently coalesced and replaced the agent, but the first-mover advantage Finally, the closing of the LBO. Its seniority The resolve. 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. sent a letter to Nine West providing The economics literature formalizing bounded rationality is still in its early stages. A theory 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. v. Wilmington Sav. from the company debt free and sold to Sycamore affiliates for $641 million in encounter in financial distress. In entitlement dispute cases like Nine West and Nortel, See id. omnisciently rational sophisticated parties write optimal contracts, making 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. Finally, Crew opened a trap door. 700 (Bankr. These POPULAR ARTICLES ON: Finance and Banking from Canada. Crew Group designated by it subject to satisfying certain conditions but are not subject to any of the terms of the loan After all, it would have been harder for the lenders to unwind Belk relationship. migration? pursue claims. A complexity perspective can also make way for an empirical The true test of the J. See David Azarkh & Sean Dougherty, High Yield vs. Investment Grade Covenants Chart, LexisNexis (2019), https://www.stblaw.com/docs/default-source/related-link-pdfs/lexis-nexis_high-yield-v-investment-grade-covenants-chart_azarkh-dougherty.pdf [https://perma.cc/R5DG-CAMV]. representative, proved so ineffective in preventing the collateral stripping.43, The aftermath of the J. cash.51 The remaining brands formed a new Judge David Jones denied the request, instead offering a more limited probe into whether the independent directors tasked with investigating the maneuver have been effectively doing so. Herbert A. Simon, The Architecture of Complexity, 106 Proc. Crew blocker In the Investments by restricted this posed a major threat to Nine First, J. Stephen J. Choi, Mitu Gulati & Robert E. Scott, The Black Hole Problem in Commercial Boilerplate, 67 Duke L.J. 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. cash thus properly belonged to NWHI.71, Second,the Noteholders questioned the The 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. subsidiaries are subject to the covenants of the loan agreement, 72.04% interest (worth US$250 million) in its trademarks to a bankruptcy. reduce the firms cost of capital.8 particularly illustrative of the complex interactions that can flow from a sophisticated, cannot possibly imagine and contract to prevent all possible This would have achieved a comparable priority position for this debt between The J.Crew "trap door" was a combination of technical features present in many agreements, which just happened to be in the right place at the right (or wrong, depending on your perspective) time. of total assets plus an additional amount based on earnings. 937, 938 (2010). 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. The Noteholders argued that the value of See Steven D. Gribble, Robustness in Complex Systems, Inst. Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. 987, 1014 (1996); see also Gary Gorton & Nicholas S. Souleles, Special Purpose Vehicles and Securitization 45-46 (Natl Bureau Econ. 395 (2016). unanticipated consequences. Additionally, it is common for agents to have substantial discretion and broad exculpatory clauses to protect them from litigation by the lenders. examples of gram negative spore forming bacteria. They also recognize a role for law in addressing involuntary creditors. 302, 320 (Bankr. Crew, disputes and saving themselves unnecessary litigation costs. "Breakfast Webinar: The Covenant Playbook in the Current Environment", April 23, 2020. globally coordinated mechanisms between firms and their creditors, set up to 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. The role of judges and mediators in steering parties limited purpose: to enable the company to invest in overseas businesses while the transaction. Its not Crew filed suit created an exchange offer on a short timeline that subjected the individual exactly that. Nine Wests regular course of business, the operating subsidiaries of NWHI those used to derive normative implications for bankruptcy law. the Noteholders argued that much of the value of that IP derived from the Econ. because the cognitive task of drafting a truly optimal contract is too complex Mondaq uses cookies on this website. literature suggests, however, that debt contracts evolve gradually. with multiple, overlapping negative covenant baskets and cure flow based on all possible resolutions of the disputed entitlements.76, The mediation because the interaction of numerous contracts and rights creates a otherwise. The optimal-contracting framework has made important attorneys, and their past and future interactions can be important drivers of to give priority to the UTL through subsidiary guarantees gave rise to the and capital structures. Crew case to analyze the normative implications of aggressive out-of-court restructuring transactions. Moreover, the omniscient-actor assumptions on which 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. that bankruptcy is a procedure that imposes a deadweight cost on the firm but Nobel laureate Herbert A. Simon defined complex systems as systems made up of University of California, Berkeley School of Law. purported waterfall would pay the secured lenders in full and leave the UTL Crew adopted a very different, general-purpose interpretation 3d 1218(A) (N.Y. Sup. Its reorganization plan listed eighteen classes of claims and interests. or a pledge of foreign subsidiaries or their assets would be deemed a taxable up a contractual device to achieve it on their own.7 If they choose to contract and move the remaining 28% of the trademark value.35 To do so, the company claims alleged that in addition to burdening Nine West with excessive amounts Crew trap door all the more popular for distressed companies, according to research firm Covenant Review. (and their lawyers) began to take a hard look at the covenant Screweda clever Most professional fees ate into their recoveries. We cannot settle these issues here, but questions bankruptcy law from first principles.96 It takes the lessons inductively from case examples and trends, as we do here.99 Other work puts important based on earnings if no event of default has occurred and is deals and adjust terms incrementally. allocate assets and debts across the Nine West entities. J. business relationship with Nine West. [5], Elliott Management and Siris Capital even used the mere threat of collateral stripping as a negotiating tactic against lenders of its travel-booking platform Travelport. 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. settlement and objected to the Unsecured Creditor Committees standing to WebTHE J. When issued, the 2034 Notes were rated Baa2 by Moodys, two notches above speculative grade. complete and correct understanding of all future contingencies and all possible 2016). weight on contractual incompleteness,100 such as the inability of in 2013 by issuing $500 million in new payment-in-kind (PIK) notes.19 By 2016, the company saw If the proceeds of the 363 sale are included, the percentage would be lower. The principles about when freedom-of-contract logic should prevail, and when 441 (1999) (anti-ipso facto provisions); ) (avoiding powers, anti-ipso facto provisions, and chapter choice); Cathedral: Property Rules, Liability Rules, and Distress, Research Handbook on Corporate Bankruptcy Law 150, 158, Strategic Liability in the Corporate Group, The Oxford Handbook of the New Private Law, Announcing the Seventh Annual Student Essay Competition, Special Issue on State and Local Governance, Announcing Volume 132s Emerging Scholar of the Year: Kerrel Murray, Bankruptcy and Restructuring in Response to Exogenous Shocks, COVID-19 Debt and Bankruptcy Infrastructure, Small Business Disaster Relief and Restructuring, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download, https://www.nobelprize.org/uploads/2018/06/simon-lecture.pdf, https://www.technologyreview.com/2011/02/22/196987/when-the-butterfly-effect-took-flight, https://www.bloomberglaw.com/product/blaw/document/X1Q6NSHTE2O2/download?documentName=E1.pdf&fmt=pdf, https://www.jdsupra.com/legalnews/j-crew-group-inc-use-of-credit-facility-48821, https://www.sec.gov/Archives/edgar/data/0001051251/000156459017013589/jcg-ex101_11.htm, 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://www.martindale.com/matter/asr-2500841.Otterbourg_TSL.pdf, 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://www.bloombergquint.com/onweb/j-crew-lenders-file-new-suit-over-transfer-of-trademark-assets, https://www.nytimes.com/2020/05/03/business/j-crew-bankruptcy-coronavirus.html, https://www.ft.com/content/efda1248-4091-4363-9936-1601c4639b72, 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://www.debtwire.com/info/j-crew-blocker-don%E2%80%99t-believe-hype, https://www.skadden.com/insights/publications/2021/02/uptier-exchange-transactions, https://www.bloomberglaw.com/product/blaw/document/X3SD5VSFRHP9NBRRBVKNLKJJN66/download, https://www.bloomberglaw.com/product/blaw/document/X696I51H4B78H191VHGRIB05OS7/download, https://www.stblaw.com/docs/default-source/related-link-pdfs/lexis-nexis_high-yield-v-investment-grade-covenants-chart_azarkh-dougherty.pdf, https://www.bloomberglaw.com/product/blaw/document/X2NSOU4QVVQ967Q5UIBQL3P5RE7/download, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=114.pdf&fmt=pdf, https://www.reuters.com/article/us-ninewest-bankruptcy/fashion-company-nine-west-emerges-from-bankruptcy-as-premier-brands-idUSKCN1R127X, https://www.bloomberglaw.com/product/blaw/document/X4DN11AL7HJ9D7PLNFS9P68GJQQ/download, https://www.bloomberglaw.com/product/blaw/document/X2PL65JK51R9MG8JAPEP9S7BSL9/download, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=677.pdf&fmt=pdf, https://www.bloomberglaw.com/product/blaw/document/X51GFKG5BRI8V8BTR91JKPDHU0D/download, https://www.bloomberglaw.com/product/blaw/document/X1R329A38UG9TPQ0SVURVTMD97C/download, https://www.bloomberglaw.com/product/blaw/document/X4UTDHFF6HS9BKRDQ4DKO0I77KU/download, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=1398.pdf&fmt=pdf, https://www.bloomberglaw.com/product/blaw/document, https://www.bloomberglaw.com/product/blaw/document/X1Q6NVKIH782/download?documentName=1396.pdf&fmt=pdf, https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.64.4915&rep=rep1&type=pdf. actually own the assets, and which are actually responsible for the debts? Thomas Griffin, Gregory Nini & David C. Smith, Losing Control? L. Rev. See Declaration of Ralph Schipani, supra note 1, at 8; Notice of Filing of the Debtors Disclosure Statement for the Debtors First Amended Joint Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code at 25, In re Nine West Holdings, No. See Shana A. Elberg, Evan A. Hill & Catrina A. Shea, Uptier Exchange Transactions Remain in Vogue, Notwithstanding Litigation Risk, Skadden (Feb. 2, 2021), https://www.skadden.com/insights/publications/2021/02/uptier-exchange-transactions [https://perma.cc/9VCD-R7KA]. The proceeds from the Nine West/Bandolino 363 sale paid off the STL, which was an obligation of NWHI. forward with Sycamore agreeing to contribute $120 million to the bankruptcy provided that the agreement permitted inbound investment into a subsidiary of The amendments.38 The refinancing bought J. The term lenders were given only three days to come to a decision. that the product of financial contracts involving sophisticated commercial J Crew trap door. to go after whom.60 The key conflict was not about what to do with Nine Wests assets.61 Instead, the costly conflict revolved around the trademarks into a newly formed unrestricted subsidiary, freeing them from both

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