In re Aéropostale, Inc.

• Decision Date: 26 August 2016
• Docket Number: Case No. 16-11275 SHL Jointly Administered
• Citation: 555 B.R. 369
• Parties: In re: Aéropostale, Inc., et al., Debtors.
• Court: U.S. Bankruptcy Court — Southern District of New York

555 B.R. 369

In re: Aéropostale, Inc., et al., Debtors.

Case No. 16-11275 SHL Jointly Administered

United States Bankruptcy Court, S.D. New York.

Signed August 26, 2016

WEIL, GOTSHAL & MANGES LLP, Counsel for the Debtors, 767 Fifth Avenue, New York, New York 10153, By: Ray C. Schrock, Esq., Richard W. Slack, Esq., Patrick O'Toole, Jr., Esq., Jacqueline Marcus, Esq., Garrett A. Fail, Esq., Layne S.R. Behrens, Esq.

KIRKLAND & ELLIS LLP, Counsel for the Term Lenders, 601 Lexington Avenue, New York, New York 10022, By: Robert A. Britton, Esq., and 300 North LaSalle Street, Chicago, Illinois 60654, By: James A. Stempel, Esq., Robert B. Ellis, Esq., Stephen C. Hackney, Esq., Martin L. Roth, Esq., Alec Solotorovsky, Esq., Jeffrey Lula, Esq.

PACHULSKI STANG ZIEHL & JONES LLP, Counsel for the Official Committee of Unsecured Creditors, 780 Third Avenue, 34th Floor, New York, New York 10017, By: Robert J. Feinstein, Esq., Bradford J. Sandler, Esq.

MEMORANDUM OF DECISION

SEAN H. LANE, UNITED STATES BANKRUPTCY JUDGE

Before the Court is a motion by the above-captioned debtors and debtors-in- possession (collectively, the “Debtors”) seeking to (i) equitably subordinate the claims of Aero Investors LLC (“Aero Investors”) and MGF Sourcing Holdings, Limited (“MGF Holdings” and, together with Aero Investors, the “Term Lenders”), pursuant to Section 510(c) of the Bankruptcy Code, (ii) disqualify the Term Lenders from credit bidding in a sale of the Debtors' assets, pursuant to Section 363(k) of the Bankruptcy Code, and (iii) recharacterize the Term Lenders' claims, pursuant to Section 105 of the Bankruptcy Code (the “Motion”) [ECF No. 496]. The Debtors seek this relief based on their allegations of inequitable conduct by the Term Lenders and certain of their affiliates and the impact on this case of a credit bid by the Term Lenders.

The Court held a trial with fourteen live witnesses from August 15, 2012 to August 23, 2012 (the “Trial”). In support of its case, the Debtors filed declarations in lieu of direct testimony for six witnesses, together with over 400 accompanying exhibits. Those same six witnesses also presented extensive live testimony: Julian R. Geiger (Chief Executive Officer of Aéropostale, Inc.); David J. Dick (Chief Financial Officer of Aéropostale, Inc.); Robert J. Duffy (managing director at Berkeley Research Group, LLC); Deborah Palmer Keiser (founding owner of Rituel Inc. and president of Alabama Chanin); James Doak (managing director at Miller Buckfire & Co., LLC); and Allen Ferrell (economist and Greenfield Professor of Securities Law at Harvard Law School).

In response to the Debtors' case, the Term Lenders presented declarations for seven witnesses, along with some 500 accompanying exhibits. All of these witnesses also presented live testimony: Stefan Kaluzny (co-founder and managing director of Sycamore Partners); James Schwartz (Chief Executive Officer of MGF Sourcing US, LLC, and member of the board of directors of MGF Sourcing Holdings, Limited); Peter Morrow (co-founder and managing director of Sycamore Partners); Joseph J. Sciametta (managing director at Alvarez & Marsal North America, LLC); Alan D. Bell (certified public accountant and retired Ernst & Young LLP audit partner); Holly Felder Etlin (managing director at AlixPartners, LLP); and Adam C. Pritchard (Frances and George Skestos Professor of Law at the University of Michigan).

The parties also submitted deposition designations of an additional six individuals who did not appear as live witnesses: Mark D. Miller (Chief Operating Officer of Aéropostale, Inc.); Elizabeth Ratto (head of the retail finance group at Bank of America, N.A.); Karin Hirtler-Garvey (chairman of the Aéropostale, Inc. board of directors); Kent Kleeberger (former member of the Aéropostale, Inc. board of directors); Dary Kopelioff (principal of Sycamore Partners); Kevin Burke (senior associate at Sycamore Partners); and Jennie Wilson (Chief Financial Officer of MGF Sourcing US, LLC and MGF Sourcing Holdings, Limited).

Given the extensive trial record and the applicable law, the Court must deny the Debtors' Motion. The Court concludes that there is not a basis to equitably subordinate the Term Lenders' claims, limit their ability to credit bid, or recharacterize their loans. The Court is mindful of the high stakes in this case for Aéropostale. But the Court is duty bound to apply the applicable law to the facts of the case, and the Court's equitable powers are not boundless. This opinion constitutes the Court's findings of fact and conclusions of law.¹

BACKGROUND

I. The Parties

Aéropostale, Inc. (“Aéropostale” or the “Company”) is a retailer of casual apparel and accessories, serving children and young adults through its stores and website. (Dick First Day Affidavit ¶ 12).² Aéropostale, Inc. is a publicly traded company, and was until recently listed on the New York Stock Exchange. (Dick First Day Affidavit ¶ 29). Aéropostale, Inc. is the direct or indirect corporate parent of each of the other Debtors. (Dick First Day Affidavit ¶ 30). As of the end of fiscal year 2015, the Debtors operated 811 stores in all 50 states and Puerto Rico and 41 stores in Canada. (Dick First Day Affidavit ¶ 13). The Debtors also have license agreements with unaffiliated third-party operators outside of the United States, under which the Debtors receive a percentage of inventory purchases or sales as royalty income, in return for the use of their trademarks, trade name and branding. (Dick First Day Affidavit ¶ 13). The Debtors receive buying commissions for inventory purchases made by these international licensees from the Debtors' vendors. (Dick First Day Affidavit ¶ 13). While the Debtors design the products sold in their stores, these products are manufactured by the Debtors' merchandise suppliers. (Dick First Day Affidavit ¶ 22). As of the Debtors' bankruptcy filing, their two largest merchandise suppliers were LF Sourcing (Millwork) LLC (“Li & Fung”) and TSAM (Delaware) LLC (d/b/a/ MGF Sourcing US LLC) (“MGF”). (Dick First Day Affidavit ¶ 22).

Sycamore Partners is a private equity firm specializing in retail and consumer investments. (Kaluzny Decl. ¶ 2). Stefan Kaluzny and Peter Morrow are Co-Founders and Managing Directors of Sycamore Partners. (Kaluzny Decl. ¶¶ 1-2; Morrow Decl. ¶ 3). In 2013, Sycamore Partners created Hummingbird LLC (later renamed Lemur LLC (“Lemur”)), to purchase stock in Aéropostale. (Kaluzny Decl. ¶ 10). In the summer and fall of 2013, Lemur acquired approximately 8% of Aéropostale's common stock in the open market. (Dick First Day Affidavit ¶ 29). Lemur paid roughly $8.00 per share, for an approximate total cost of $54 million. (Kaluzny Decl. ¶¶ 9, 10). The purchase did not provide Sycamore Partners or Lemur with any rights to name board members or otherwise participate in Aéropostale management. (Kaluzny Decl. ¶ 11).

MGF is a global sourcing company that specializes in apparel and accessories. (Schwartz Decl. ¶ 2). It has relationships with more than 100 factory organizations, mainly in Asia and Central and South America. (Schwartz Decl. ¶ 2). Customers place orders with MGF, which then arranges for factories to manufacture the merchandise. (Schwartz Decl. ¶ 2). MGF oversees the manufacturing process to ensure that merchandise conforms to a customer's specifications and then arranges shipment of the merchandise to its customer's U.S. distribution centers. (Schwartz Decl. ¶ 2). MGF and its predecessors have been in business for over 40 years and it employs over 750 people in 13 countries. (Schwartz Decl. ¶ 3). Since November 1, 2011, MGF has been indirectly majority-owned by an affiliate of Sycamore Partners. (Schwartz Decl. ¶ 3). The managing member of MGF—MGF Holdings—maintains a board of directors (the “MGF Board”) that monitors performance, sets strategic direction and approves budgets, and provides input to management regarding significant decisions to be made with respect to MGF. (Schwartz Decl. ¶ 4). MGF Holdings is, in turn, majority-owned by an investment fund affiliated with Sycamore Partners and Sycamore Partners therefore has the power to elect the MGF Board. (Schwartz Decl. ¶ 6). James Schwartz is the Chief Executive Officer and President of MGF and the President of MGF Holdings and has been employed by MGF and its predecessors for more than 33 years. (Trial Tr. 99:8-19, Aug. 16, 2016 (Schwartz)). Jennie Wilson is Chief Financial Officer of MGF and MGF Holdings and reports to Mr. Schwartz. (DX 407, Wilson Dep. Tr. 9:8-10:4.)

As of their bankruptcy filing, the Debtors had outstanding debt obligations of around $223 million, which were secured by substantially all of the Debtors' assets. (Dick First Day Affidavit ¶ 33). This debt was comprised of (i) an asset-based revolving credit facility (the “Prepetition ABL Agreement”) with Bank of America, N.A., and (ii) a term loan (the “Prepetition Term Loan Agreement”) with the Term Lenders. (Dick First Day Affidavit ¶¶ 33, 37). The two Term Lenders are both affiliates of Sycamore Partners. The first, Aero Investors, is an investment vehicle that was formed by Sycamore Partners' domestic investment funds for the purpose of funding the Prepetition Term Loan transaction. (Kaluzny Decl. ¶ 24). The second, MGF Holdings, is indirectly majority-owned by Sycamore Partners' offshore investment funds. (Kaluzny Decl. ¶ 24). MGF Holdings is the direct parent of MGF. (Kaluzny Decl. ¶ 24).³

II. The Term Loan, the Sourcing Agreement, and the Credit Review Provision

In fiscal year 2013, the company had negative earnings before interest, taxes, depreciation, and amortization (“EBITDA”) of $69.1 million. (Trial Tr. 19:21-23, Aug. 17, 2016 (Dick)). Additionally, in fiscal year 2013 there was a decline in Aéropostale's working capital of $100 million and a loss of $185.2 million. (CEX 509, Miller Dep. Tr. 35:21-36:14). In January 2014, therefore, the Debtors hired Barclays to provide advice on transactions to provide liquidity and aid in...