Chinos Holdings, Inc. (J.Crew Group) – Creditors’ Committee Asks Court to Put Brakes on “Highly Prejudicial” DIP Financing Arrangements

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May 27, 2020 – The Debtors' Official Committee of Unsecured Creditors (the “Committee”) objected to the Debtors’ request to access the $290.0mn balance of a $400.0mn debtor-in-possession (“DIP”) financing facility, arguing that the Court should not at "this early stage of the case [issue] a host of benefits to the DIP Lenders and Prepetition Secured Parties" and approve a DIP motion that would hand to those parties (and management) "nearly all of the estates’ substantial value — including by means of a pre-arranged disposition of all of the equity in the reorganized Debtors — before this Court or other parties in interest have had any opportunity to determine the extent of that value" [Docket No. 358]. 

The Committee also argues in effect that the Debtors are using the temporary COVID-19 pandemic to prejudice unsecured creditors; that the current crisis comes quickly on the heels of a moment when the Debtors were buzzing with the talk of a $2.5-3.0bn IPO of their Madewell business and now stands to recover its business footing given that "there is light at the end of the [COVID-19] tunnel." 

The Committee's objection will be considered at a hearing scheduled for May 28th.

The Committee’s objection states, “The DIP Facility is highly prejudicial to the Debtors’ estates and should not be approved by the Court on the terms proposed. Together with the plan, with which the DIP Facility is inextricably entwined, the Debtors have proposed to hand over to the DIP Lenders, other Prepetition Secured Parties, and management, on approval of this motion, nearly all of the estates’ substantial value — including by means of a pre-arranged disposition of all of the equity in the reorganized Debtors — before this Court or other parties in interest have had any opportunity to determine the extent of that value…. In fact, the DIP Lenders are inappropriately asking for a lien on avoidance actions including the Litigation Claims not as loan collateral but purely for strategic purposes, as evidenced by the fact that the DIP Lenders and the rest of the Prepetition Secured Parties plan on releasing and extinguishing these claims under the plan for no consideration. 

They are not lending against these claims, they are going to release them for no value, so it is simply inappropriate to grant them a lien on avoidance actions, which is extraordinary in chapter 11 cases in any event….Other provisions of the DIP Facility are equally objectionable, particularly the proposed section 506(c) surcharge waiver coupled with an inadequate DIP budget that would result in the costs of the Cases being borne by the unsecured creditors. This Court should not allow the Cases to be run solely for the lenders’ benefit on the backs of general unsecured creditors. The Debtors admittedly are not paying rent on a current basis or in full on day 61 of these cases, and the surcharge waiver, in the absence of a carve out for unpaid rent or other provisions protecting landlords, will leave the landlord creditors without recourse in the event the Debtors default on the DIP Facility before rent is paid. Similarly, the Debtors’ proposed waiver of marshalling will permit the lenders to elect to look first for repayment to the unencumbered assets as of the Petition Date to the detriment of unsecured creditors. The DIP Motion must be denied unless the liens on avoidance actions and the surcharge waiver are excised, and other objectionable provisions addressed below are remedied. The Court should not countenance at this early stage of the case issuing a host of benefits to the DIP Lenders and Prepetition Secured Parties, including liens on otherwise unencumbered Litigation Claims and broad releases of all such claims, and case milestones and restrictions that would predetermine the outcome of these Cases in a manner that would deprive unsecured creditors of their day in court on key plan issues including, most importantly, that the contemplated plan violates the best-interests-of-creditors test. For these and the other reasons set forth herein, the Motion should be denied.

The objection continues, “The economic impact of shutting down the US economy for the last two months to minimize the spread of COVID-19 has created challenging liquidity issues for businesses and their creditors, including landlords, vendors, and employees. Two months ago, there was much uncertainty. There is still uncertainty, but there is light at the end of tunnel as every state has reopened its doors for business. The Debtors (‘J. Crew’), which several months prior to the economic shutdown were on the verge of issuing an IPO for their ‘Madewell’ line that purportedly was estimated to raise $2.5 billion to perhaps over $3 billion, were not spared from the shock of the COVID-19 pandemic, but they were in a far better position than other retailers, such as Pier 1, Art Van Furniture or Modells, due to the Debtors’ strong asset value, in particular its Madewell brand and intellectual property. Certain of the Debtors’ prepetition lenders (sometimes referred to in the DIP Motion as ‘Initial Consenting Support Parties’) offered up a prearranged transaction to which the Debtors have agreed subject to Court approval in exchange for receiving a $400 million DIP Facility (although only $255 million is forecast to be needed). This financing, however, comes at too exorbitant a price, a fact made evident by the Debtors’ announcement at the hearing before this Court on May 26, 2020, that, although the Initial Consenting Support Parties had offered to provide all of this financing, most of the Prepetition Secured Parties have accepted the offer to join in providing it. The DIP Facility is cross defaulted to a plan, the terms of which are set forth in the Transaction Support Agreement (‘TSA’). As such, the proposed DIP Facility and the related TSA cannot be viewed in a vacuum as the plan contemplated by the TSA, that must be pursued to comply with the DIP Facility, contains broad releases of all claims, including those arising out of certain prepetition transactions that gained great notoriety and engendered extensive prepetition litigation.

The Plan to which the DIP Facility seeks to bind the Debtors would provide the Term Loan Lenders and IPCo Noteholders 82% of the common stock of a reorganized J. Crew and approximately 18% thereof to Initial Consenting Support Parties and/or the DIP Lenders, giving these groups essentially 100% of the reorganized company without ascribing any values to unencumbered asset values. Committing to this premium recovery for the Initial Consenting Support Parties and/or DIP Lenders appears premature and unjustified in part because it is just too rich and commits all of the equity now to the DIP Lenders and Initial Consenting Support Parties, predetermining that nothing is left for others. 

Another reason this premium recovery is unwarranted is because the DIP Lenders are only projected to put at risk $255 million of their so-called commitment of $400 million before confirmation of a plan, as reflected in the filed Budget (that cannot be increased without the reasonable consent of the DIP Lenders). As part of such premium, certain DIP Lenders would receive the Backstop Premium of $40 million worth of reorganized common stock (3.4% at the pro forma equity value). Also, on rolling their debt through a plan and putting in the additional projected $145 million (after a plan cleanses the balance sheet and thereby reduces risk), the DIP Lenders would receive an additional fee of approximately 15% of the common stock of a reorganized J. Crew, worth an estimated $174 million at the Debtors $1.75 billion total enterprise value. This $214 million premium is in addition to repayment of the $255 million loan and represents 84% of the $255 million budgeted DIP Loan. The DIP Lenders would also receive, as a further fee for the rollover, warrants for another 15% of the reorganized company stock. Moreover, neither this Court nor the Committee presently have any means to evaluate the pricing of these committed equity grants. The Committee needs the opportunity (to occur in the context of the Plan, where such an inquiry is appropriate, not before the final DIP financing hearing) to conduct an independent valuation of the Debtors’ enterprise value and equity value, and to investigate the assumptions underlying the assumed $1.75 billion figure used as a pro forma enterprise value by the Debtors and Initial Consenting Support Parties. This massive and unusual DIP fee is in addition to $6.9 million of interest proposed to be paid to the DIP Lenders (and $10.4 million of ‘Adequate Protection Payments’ for the Term Loan Lenders). At the same time, as part of creating value for the equity to which they seek to swap, the Initial Consenting Support Parties’ goal is to wipe out hundreds of millions of general unsecured claims for a pittance—having committed the Debtors, through the TSA, to support a plan that provides only $1 to $3 million for those general unsecured creditors not selected as go-forward parties, and even the go-forward trade would recover from a pot of $50 million, but only if they sign a trade agreement by June 3, 2020, which is well before the disclosure statement could be approved by this Court.”

Further Background

DIP Financing

On May 4, 2020, the Debtors requested $400.0mn in DIP financing, including $110.0mn on an interim basis, from a group of prepetition lenders and noteholders led by Wilmington Savings Fund Society, FSB (the “DIP Lenders”). On May 5th, the Debtors were granted access to the interim borrowings with the $290.0mn balance set to be considered at a May 28th final DIP hearing.

As currently envisaged by the Debtors’ restructuring support agreement (the “TSA,” see below), the DIP financing will be converted into new senior secured first lien term loans (the “New Term Loans,” with this exit facility totaling $400.0mn and comprised of drawn and undrawn amounts under the DIP facility) on the Plan’s effective date with the DIP Lenders receiving a 10% “Backstop Premium” in the form of the common stock of the emerged Debtors.

Prepetition Indebtedness 

As of the Petition date, the Debtors’ prepetition capital structure includes approximately $2.0bn in funded debt. 

Debt Instrument

Approximate Principal Amount ($ millions)

ABL Facility

$311.0mn

Term Loans

$1,337.4mn

IPCo Notes

$347.6mn

Total Funded Debt

$1,996.02mn

 

  • Prepetition ABL: The Debtors are party to an April 2011 credit agreement (the “ABL Credit Agreement”) with Bank of America, N.A. as administrative agent, collateral agent, lender and issuer, further to which BoA and other lenders have furnished the Debtors with an asset-based revolving credit facility (the “ABL Credit Facility”). As of the Petition date, there was approximately $311.0mn in principal amount outstanding under the ABL Credit Facility and approximately $64.0mn of outstanding but undrawn letters of credit to secure the Debtors’ obligations with respect to their workers’ compensation policies, certain leases, customs bonds, and inventory. The ABL Credit Facility matures on December 4, 2020. 
  • Term Loans: The Debtors are party to a March 2014 amended and restated credit agreement (the “Term Loan Agreement”) with Wilmington Savings Fund Society, FSB as administrative agent and collateral agent, and the other lenders from time to time party thereto (collectively, the “Term Lenders”), pursuant to which the Term Lenders agreed to provide the Debtors with a term loan in the initial principal of approximately $1.57 billion (the “Term Loans”). As of the Petition date, approximately $1.34bn in principal amount of Term Loans remain outstanding. The Term Loans will mature on March 5, 2021. 
  • IPCo Notes: Pursuant to the terms of a pair of July 13, 2017 indentures (U.S. Bank National Association serving as trustee and collateral agent), Debtors J. Crew Brand, LLC (“Brand”), J. Crew Brand Corp. (“Brand Corp., and together with Brand, the “IPCo Issuers”), the Debtors issued $97.0mn of 13.00% Senior Secured Notes due 2021 (collectively, the “IPCo New Money Notes”) and $250.0mn of 13.00% Senior Secured Notes due 2021 (the “IPCo Exchange Notes”, and together with the IPCo New Money Notes, the “IPCo Notes”).The IPCo Notes mature on September 15, 2021. 

Plan Overview and RSA

The Debtors have finalized the terms of a restructuring support agreement (the “TSA,” attached to the Nicholson Declaration at Exhibit B) with an ad hoc committee of prepetition lenders and noteholders (collectively, the “Ad Hoc Committee”) and the Debtors’ prepetition equity sponsors that collectively own or control approximately 71% of the Term Loans, 78% of the IPCo Notes, 66% of the Series A Preferred Stock, 92% of the Series B Preferred Stock, and 85% of the Common Stock. 

The TSA, among other things, provides for $400 million of new money financing commitments and significant value to the Debtors’ stakeholders.

More specifically, under the TSA: 

  • Approximately $2 billion of the Debtors’ prepetition secured term loans and prepetition secured notes will be equitized into approximately 82% of the Debtors’ reorganized equity;
  • Members of the Ad Hoc Committee have agreed to provide (a) DIP financing in an aggregate principal amount of up to $400 million (the “DIP Loans”), the principal amount of which will be converted into new senior secured first lien term loans (the “New Term Loans”) on the effective date of a plan and (b) on the effective date, any additional New Term Loans not provided as DIP Loans during the chapter 11 cases (the “Additional New Term Loans”); 
  • Holders of Term Loans and IPCo Notes that are qualified institutional buyers or accredited institutional investors (each, an “Eligible Holder”) and that join the TSA within 10 business days of the Petition Date may elect to provide a portion of the DIP Loans and New Term Loans as set forth in the TSA;
  • As consideration for the undertakings in the TSA, lenders of the New Term Loans will receive 15% of the common equity of the reorganized Debtors (the “New Common Shares”) and warrants to acquire additional New Common Shares after the effective date; 
  • General unsecured creditors that provide goods and services necessary to the operation of the reorganized Debtors and enter into a trade agreement with the Debtors within 30 days of the Petition Date will receive their pro rata share of cash in an aggregate amount equal to $50 million, subject to a 50% cap on claims;
  • Other general unsecured creditors, including for claims on account of the Debtors’ rejection of unexpired executory contracts and lease agreements, will receive their pro rata share of cash in an aggregate amount equal to (a) $3 million if the class votes to accept the plan and otherwise (b) $1 million if the class votes to reject the plan, subject to a 50% cap on claims; and
  • All prepetition equity will be cancelled and will receive no recovery.

About the Debtors

J. Crew Group, Inc. is an internationally recognized omni-channel retailer of women’s, men’s and children’s apparel, shoes and accessories. As of May 4, 2020, the Company operates 181 J. Crew retail stores, 140 Madewell stores, jcrew.com, jcrewfactory.com, madewell.com and 170 factory stores. Certain product, press release and SEC filing information concerning the Company are available at the Company’s website www.jcrew.com.

The Nicholson Declaration adds: “Today, the Debtors are an internationally recognized multi-brand apparel and accessories retailer for young professionals and fashion-conscious men and women. With the J. Crew brand recognized as a household name for nearly four decades, the Debtors enjoy a strong reputation for providing their customers with stylish and quality products. In recent years, the Debtors have also seen fast and innovative growth from their Madewell brand, which offers a full product assortment rooted in premium denim and packaged in a cool, unexpected, and artful aesthetic.

The Debtors operate their retail stores under two distinct brands: (a) the J. Crew brand, which is the Debtors’ primary global brand used for both J. Crew stores and J. Crew factory outlet stores, and (b) the Madewell brand. The Debtors sell their merchandise in stores, online, as well as through partnered wholesalers, such as Nordstrom. The differentiation across the business lines allows the Debtors to operate multiple store locations in close proximity and to serve a wider demographic.

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