Investigations and the J.Crew trapdoor
Earlier in the year Aperio had the opportunity to work on a disputes support matter which presented an interesting variation from traditional asset tracing cases. Asset tracing is very much a “bread and butter” type of case for disputes support; investigators, however, are usually brought on to such cases once the subject of the investigation is suspected of already having effected the asset dissipation. In this case, however, our client suspected the subjects of planning such a dissipation of assets to remove collateral from an existing debt agreement, and tasked Aperio with unearthing information to support this theory. This manoeuvre, called a “J.Crew trapdoor” or more colloquially, “getting J.Crew’d,” is a key risk to lenders structuring debt deals, usually as part of leveraged private equity transactions.
J.Crew is a US-headquartered clothing store chain. Founded in the post-war period, the chain had a presence across the US as well as six stores in the UK, but financial difficulties exacerbated by the COVID-19 pandemic forced it to file for Chapter 11 bankruptcy protection in May 2020. While J.Crew was able to exit Chapter 11 in September 2020 after reaching an agreement with creditors, the transaction which gave the name to the trapdoor financial transaction took place in 2016, when, facing maturing loan facilities of some USD 540 million, the group successfully transferred its J.Crew trademark – valued at hundreds of millions of dollars – from a subsidiary covered by its debt agreements to a subsidiary which was not. It was consequently able to take on more debt, using the assets of this new subsidiary as collateral, and was also able to renegotiate its existing debt portfolio with lenders, leading to a total indebtedness reduction of USD 340 million.
Although it was the subject of virtually no media coverage outside of specialist finance news publications, the J.Crew trapdoor has led to significant changes in the way debt agreements are structured in the US and internationally. The inclusion of “J.Crew blockers” in debt contracts, especially where intellectual property is an important part of the asset base put up as collateral. Despite this, a 2019 study by S&P found that fewer than 20% of the US debt contracts in its sample size had included such language around blockers.
While, as outlined in this 2020 presentation by King & Spalding, the trapdoor manoeuvre had been mostly used in US debt deals, it has also more recently allegedly been used in Europe. This presents a different challenge to lawyers and investigators than a traditional asset stripping or dissipation case.
Investigative framework and best practice
Carrying out dispute support work relating to a suspected J.Crew manoeuvre presents specific challenges compared to wider asset tracing or disputes support assignments. Notably, a focus is likely to be on identifying evidence of the asset stripping before it has happened, or as it is happening, rather than tracing assets following a concluded asset stripping or dissipation. By cooperating closely with law firms and creditors, there are a number of elements which investigators should remain attentive to as possible evidence of getting “J.Crew’d.”
First and perhaps most obviously, removing assets from companies covered by a debt covenant requires the presence of a “destination” company to move these assets to. In order for these companies to fall outside existing agreements, they are likely to have been created after the debt agreement was concluded. Should a client already harbour suspicions of the debtor effecting this strategy, they can point the investigator towards the suspected destination companies, or jurisdictions in which these companies are suspected of having been registered. Should this not be the case, human source enquiries with individuals close to the company can help target public record research.
In the case of J.Crew, for example, the vehicles used as destinations for the stripped assets were located in the Cayman Islands; while the information available on Cayman-registered companies through the territory’s e-services portal can be limited, a direct online search could confirm the existence of the company and basic information such as its date of incorporation and its directors. Further research in more transparent jurisdictions can also help confirm the ownership structure of these companies, allowing the investigator and their client to locate them within the debtor companies’ wider corporate structure. Because the origin and destination companies are unlikely to be registered in the same jurisdiction, multi-jurisdictional expertise in the public record landscape is likely to be essential in establishing the most accurate picture possible.
Publicly available information can also often help map out the networks of individuals appointed by the debtor company to effect the asset stripping. Such financial operations are complex and require specialised professionals, who often specialise in these kinds of operations rather than in the sector in which the subject company might be operating. Analysing the appointments of such directors, such as their dates, the directors’ professional backgrounds, existing ties between new directors if more than one has been appointed, and any evidence of these directors having previously participated in asset stripping operations, can be of significant value in building a legal case against the debtor.
Financial filings from companies can sometimes provide further evidence of asset stripping should this already have begun to take place. The clear caveat to this is that, in most jurisdictions, such financial information is not available, and even in jurisdictions where companies are required to file annual statements disclosing their asset status, these are only required to be filed yearly, and as such are unlikely to present an up-to-date picture.
While much of the same research techniques can be applied to a suspected J.Crew asset dissipation case as would be to a more typical asset tracing matter, speed, extensive knowledge of public record landscapes, and close cooperation between the creditor, their legal team and investigators, is likely to be essential in quickly and effectively gathering information to stymy efforts to complete the asset dissipation.
Pierre le Jeune D’Allegeershecque, Head of Africa Practice