Secured lenders have welcomed a ruling recently handed down by the U.S. Bankruptcy Court for the Southern District of New York in the chapter 11 cases of Aéropostale, Inc. and its affiliates (collectively, "Aéropostale"). In In re Aéropostale, Inc., 2016 BL 279439 (Bankr. S.D.N.Y. Aug. 26, 2016), Bankruptcy Judge Sean H. Lane denied motions by Aéropostale to: (i) equitably subordinate the secured claims of term lenders that were affiliated with a private equity sponsor; (ii) limit the lenders' ability to credit bid their secured claims in a bankruptcy sale of the company; and (iii) recharacterize the lenders' $150 million secured claim as an equity investment.
Aéropostale is a retailer of child and young adult casual apparel and accessories with more than 800 stores. In 2013, private equity firm Sycamore Partners ("Sycamore") acquired eight percent of Aéropostale stock through a subsidiary for approximately $54 million.
One of Aéropostale's largest merchandise suppliers was TSAM (Delaware) LLC (d/b/a MGF Sourcing US LLC) ("MGF"), a global apparel and accessory sourcing company indirectly owned and controlled by Sycamore.
Aéropostale's secured debt included a $150 million term loan extended by two Sycamore affiliates (collectively, the "term lenders").
An investor rights agreement entered into in connection with the term loan gave a term lender the right to nominate two directors to Aéropostale's board and to select a third independent director jointly with Aéropostale.
The term loan contained a $70 million minimum liquidity covenant. A separate sourcing agreement between Aéropostale and MGF gave MGF the right to declare a "credit review period" if Aéropostale's liquidity dropped below $150 million.
In February 2016, MGF informed Aéropostale that the $150 million minimum liquidity threshold under the sourcing agreement had been breached and that MGF was declaring a credit review period. MGF also informed Aéropostale that it was adjusting the payment terms for sourced merchandise, as was permitted by the sourcing agreement.
Aéropostale commenced a chapter 11 case on May 4, 2016, with a plan to shutter unprofitable stores, trim costs, and pursue a sale of the company.
Claiming that Sycamore forced the company into bankruptcy for the purpose of acquiring it at a discount, Aéropostale filed a motion requesting that the court: (i) equitably subordinate the claims of the term lenders under section 510(c) of the Bankruptcy Code due to their inequitable conduct (e.g., imposing new lending terms that violated an "objective reasonableness" standard, pursuing a secret and improper plan to buy Aéropostale "on the cheap," and trading Aéropostale's stock while possessing material non-public information); (ii) limit the term lenders' right to credit bid their $150 million secured claim in any sale of the company pursuant to section 363(k) of the Bankruptcy Code; and (iii) recharacterize the term lenders' claims as equity under section 105 of the Bankruptcy Code.
The court denied the motion.
The court concluded that Aéropostale, which did not deny breaching the liquidity covenant, was attempting to impose an "objective reasonableness" standard on MGF that was not present in the language of the agreement. It also found that, given the potential that MGF might default on its own debt, MGF acted reasonably in imposing new credit terms after the minimum liquidity threshold was triggered.
The court characterized as "not credible" Aéropostale's "allegation of a secret plan" to "push [the company] into bankruptcy and thus buy Aéropostale on the cheap."
The court also denied Aéropostale's motion to limit the term lenders' right to credit bid their secured claim. It found no evidence of inappropriate behavior by the term lenders, such as "allegations of collusion, undisclosed agreements, or any other actions designed to chill the bidding or unfairly distort the sale process."
According to the court, none of the cases commonly cited as a basis for limiting a credit bid, such as Free Lance-Star or Fisker Auto. Holdings, has involved bid chilling as the sole factor warranting such a limitation. Without any evidence of misconduct on the part of the term lenders or other factors that might justify limiting a credit bidding right, the court ruled that there was no "cause" to limit the term lenders' right to credit bid under section 363(k). Moreover, there was actually active interest in Aéropostale's assets rather than chilled bidding.
Finally, Judge Lane ruled that there was no basis to recharacterize the term loan as an equity investment in Aéropostale.