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ABRACADABRA

Courtesy of Grant's Almost Daily

Could a recent bombshell legal decision upend the leveraged buyout industry?  On Dec. 4, the Financial Times reports today, Senior United States District Judge Jed S. Rakoff ruled that creditors of apparel retailer Nine West can pursue damages against the company’s board of directors for a $2 billion, 2014 leveraged buyout which went awry, leading to a Chapter 11 filing four years later. 

While a higher court could eventually reverse that ruling, the damage may be done.  Ryan Preston Day, partner at law firm Ropes & Gray, tells the FT that “even a trial and ‘vindication on the facts’ will still leave this preliminary ruling out there stating that a board acts ‘recklessly’ by failing to adequately assess an LBO-buyers post-transaction solvency.” “It could be a game stopper for the private equity business,” adds Brian Quinn, corporate law professor at Boston College. 

The subsequent bankruptcy has been an acrimonious one, with spurned junior creditors contending that the new p.e. ownership stripped Nine West of its two most valuable brands to the benefit of Sycamore Partners in 2017, leaving the now-diminished entity unable to withstand a crippling debt load of nearly eight times Ebitda.  

Those jilted creditors have company, as the extended period of easy money and lax documentation in the post-2008 era in tandem with this year’s pandemic-related corporate distress have combined to deal some unpleasant surprises. 

The recent experience of restaurant supplier TriMark USA LLC stands as another such example. TriMark, which was taken private in a 2017 leveraged buyout led by Centerbridge Partners, fell into distress during the pandemic, necessitating a rescue financing package. The company and a lender consortium negotiated an amended credit agreement during the fraught spring, infusing TriMark with $120 million in fresh capital while simultaneously vaulting participating lenders ahead of first-lien creditors in the capital structure. 

Those nonparticipating plaintiffs contend they were shut out of the opportunity to swap their first-lien credits for the newly issued debt and are now facing steep losses. Citing data from S&P, Institutional Investor notes that the now “primed” first-lien obligations are expected to recover no more than 10 cents on the dollar in asset value in the event of bankruptcy, instead of the 50 cents to 70 cent range prior to the debt swap. One line from the lawsuit sums things up in evocative fashion: “This breach-of-contract case arises from a cannibalistic assault by one group of lenders in a syndicate against another.” 

The ongoing case of Citigroup, a lender group and a disputed $900 million payment marks another such sign of the times. Recall that, in August, administrative agent Citi mistakenly wired some $900 million to a cadre of Revlon hedge fund creditors who believed they were entitled to those monies, spurring the standoff.  

The lenders assert that Revlon, with Citi’s help, borrowed additional funds via a revolving credit facility against their wishes, using investment bank Jefferies’ status as a (temporary) creditor to tip the voting scales in favor of the debt exchange, thus subordinating the hedge funds in the capital structure. The bank has recovered only about $390 million of that sum. For its part, Citi maintains the payment was clearly sent in error, while the defendants note that the wired sum was the exact principal outstanding on a leveraged loan issued in 2016.

One recent snippet from the trial could serve as something of a motto for those in the deep end of the credit pool. Bloomberg reports that yesterday’s court proceedings highlighted an Aug. 14 conversation among a pair of vice presidents at Revlon creditor HPS Investment Partners, in which one used a classic rock call-back to reference the imbroglio: “As Steve Miller said, take the money and run.” 

RECAP DEC. 15

A powerful rally erased some creeping risk aversion, as the S&P snapped a four-day losing streak with a 1.3% surge, while the VIX sank 8% to finish below 23 after reaching a one-month high yesterday. Treasurys saw some modest bear-steepening with the long bond climbing two basis points to 1.65%, gold jumped about 1.5% to $1,857 an ounce, and WTI crude rose to near $48 barrel, its best finish in more than nine months.  

- Philip Grant

 

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