In a Jan. 27 story, PacerMonitor told readers that intellectual property would be something to watch in the retail industry after J. Crew Group Inc. and Claire’s Stores Inc. stunned their lenders by transferring IP to unrestricted subsidiaries in the second half of last year, moving a key source of value away from existing debtholders.
Well, J. Crew has gone a step further, asking a New York court to opine that a multistep IP transfer is allowed under its term loan agreement and hasn’t tripped default covenants.
J. Crew sued Wilmington Savings Fund Society FSB, the administrative and collateral agent on its term loan, in a complaint filed Feb. 1 in the commercial division of the New York State Supreme Court, asking for a declaration that its IP transfer is expressly permitted by its term loan agreement and that the move has not triggered a default under the agreement.
But James H. Millar, a restructuring-focused partner at Drinker Biddle & Reath, told PacerMonitor’s sister publication, CapitalStructure, that two words in the term loan credit agreement could undermine the validity of J. Crew’s IP transfer: “financed” and “proceeds.”
J. Crew’s first IP transfer appears to be permissible under the agreement, Millar said, but he noted there is less clarity around the second transfer.
Millar drew attention to Section 7.02 of J. Crew’s term loan credit agreement, specifically provision (t), which allows “Investments made by any Restricted Subsidiary that is not a Loan Party to the extent such Investments are financed with the proceeds received by such Restricted Subsidiary from an Investment in such Restricted Subsidiary made pursuant to Sections 7.02(c)(iv), (i)(B) or (n).”
Can a transfer of IP be an act of financing, and can unmonetized IP count as “proceeds”? Dictionary definitions of those two words tend to emphasize a fund or cash component, and “you could certainly build a very credible case that ‘proceeds’ and ‘financed’ pertain to cash,” Millar said, in which case, “you could find that what the company did is not permissible.”
Millar drew special attention to the use of “finance” as a verb, as he believes it is not a well-defined term. He said other areas of law have more to say about “proceeds,” such as the broad definition that appears in the Uniform Commercial Code.
These possibilities captured the imagination of Millar, who successfully argued for the meaning of a word in Norske Skogindustrier’s debt documents. Drinker Biddle advised Citibank as the indenture trustee for certain bondholders when it sued the Norwegian pulp and paper maker for pursuing an exchange offer, asserting, among other things, that the transaction was not permitted under the debt documents. In essence, Citibank argued the exchange offer was not a qualified securitization financing because it was a refinancing, and said that type of transaction was forbidden in another part of the credit agreement.
In a decision filed March 8, 2016, Judge Richard J. Sullivan of the U.S. District Court for the Southern District of New York agreed that the exchange offer was explicitly prohibited by the indenture, based partly on a definition of the word “financing” from Black’s Law Dictionary and also because that type of transaction was prohibited in another part of the indenture.
Only if the court determines that the language in J. Crew’s credit agreement is ambiguous would it move on to higher-level covenant analysis addressing matters such as the intent of the provisions, according to a restructuring lawyer who requested anonymity.
If a judge decides the language in J. Crew’s indenture is, in fact, ambiguous, there could be other hurdles for the retailer to clear.
Covenant Review, another sister publication to PacerMonitor, recently suggested the IP transfer could be allowed under a technical reading of the term loan investments covenant baskets. However, the firm said there could be questions about whether the company respected the intent of a so-called pass-through basket, which allows investments by nonguarantor restricted units of proceeds received using certain other baskets. Covenant Review also queried whether executing the IP transfer through multiple steps justifies what is “clearly a concerted effort” to move assets from a restricted domestic unit to an unrestricted subsidiary, when there was insufficient capacity for a one-step transfer.
The high level of uncertainty has repelled some debt investors, even those with restructuring acumen.
There is support for both broad and narrow readings of J. Crew’s documents, according to David Tawil, president of distress-focused hedge fund Maglan Capital.
“Even having been a lawyer, who drafted these types of covenants, I generally stay away from this type of investment situation,” said Tawil, who has previously worked as a restructuring attorney at Davis Polk & Wardwell and Skadden, Arps, Slate, Meagher & Flom. “It is binary—and up to a judge, who needs to be a technician,” he explained.
Weil Gotshal & Manges and Kasowitz Benson Torres & Friedman are co-counsel for the lawsuit. Jones Day is advising Wilmington Savings.
Lazard is giving J. Crew financial advice on balance sheet options.
A J. Crew spokeswoman and a TPG spokeswoman declined to comment, while representatives for Leonard Green did not respond to requests for comment.
—Lisa Allen is a writer for PacerMonitor’s sister publication, CapitalStructure.