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Neiman Marcus Charged with Fraudulent Transfer of $1B of Assets to PE Firms

December 11, 2018, 08:21 AM
Filed Under: Legal

Neiman Marcus Group, Inc.  and related entities have been charged in the District Court of Dallas County, Texas with, among other wrongdoings, the fraudulent transfer of assets totaling approximately $1 billion of value for no consideration. These assets were stripped from its insolvent subsidiary Neiman Marcus Group LTD LLC to benefit the private equity firms Ares Management L.P. (Ares) and the Canada Pension Plan Investment Board (CPPIB), which are the beneficial owners of Neiman Marcus Group, Inc. The transfer was orchestrated in a two-step self-enrichment scheme orchestrated by Neiman Marcus Group, Inc. and the LBO Sponsors to loot the Company of a crown-jewel asset in order to hinder, delay and defraud the creditors of the Company.

The charges of wrongdoing and the scheme have been laid out to the Court in litigation against Neiman Marcus Group, Inc. and the related entities brought by Marble Ridge Capital, LP, a value-oriented distressed debt investor and a creditor of the Company.

As described in the litigation, "Neiman Marcus Group LTD LLC is highly leveraged as a result of two successive leveraged buy-outs. After the second of these leveraged transactions occurred in 2013, the Company was saddled with approximately $4.91 billion in funded debt. This debt includes term loans under the Credit Agreement, $366.0 million of additional debt under a revolving credit facility, and approximately $1.62 billion of unsecured notes issued under the Indentures maturing in 2021. Loans under the Credit Agreement mature in October 2020. If the Company is unable to repay or refinance the Credit Agreement three months prior to the October 2020 maturity, this will trigger a "springing maturity" that will cause the Company's revolver to mature early – in July 2020. A default under the revolver will set off a cascade of events leading to bankruptcy. Because the Company is insolvent, in a bankruptcy, unsecured creditors will recover only a small fraction of the par value of the Company obligations that they hold."

The litigation reveals that "the purpose of the Scheme was to remove valuable assets from the Company, where they could have been used to satisfy the claims of the Company's creditors. Instead, as a result of the Scheme, these assets have been placed beyond the reach of the Company's creditors in order to hinder and delay creditor recovery."

"In the first step of the Scheme on March 10, 2017, the Company unilaterally removed certain controlled subsidiaries from the restrictions placed on the Company by its creditors. These subsidiaries included the entities that owned the myTheresa brand, with an estimated value of $1 billion, as well as US real estate that, according to the Company's own disclosures, is worth no less than $100 million."

"In September 2018, the Company announce the second step of the Scheme – distributing the myTheresa assets to Parent for no consideration whatsoever."

"Prior to execution of the Scheme, the Company owned, indirectly through its subsidiaries, the equity in the entities that owned myTheresa. Now that the Scheme has been completed, the myTheresa brand and related assets are owned by the Parent or by entities owned or controlled by the Parent."

The litigation highlights that "the Scheme was concocted against the backdrop of the Company's insolvency and in order to serve the interests of Parent. Prior to March 2017 when the first step in the Scheme was taken, the Company was already in financial trouble. Like other "brick and mortar" retailers, the Company's profitability was in sharp decline…Until completion of the Scheme, the myTheresa brand was a bright spot in an otherwise bleak landscape of declining profitability for the Company… The Scheme depleted an already struggling retail enterprise (i.e., the Company and its subsidiaries) by significantly reducing its overall asset value and usurping the opportunities being pursued by the Company through the myTheresa brand."

"Since completion of the Scheme, the value of the Company's assets, at a fair valuation, have fallen even further below the amount of its funded debt liabilities. The market has taken note: Debtwire reduced its recovery estimate from 43.7% to 31.6% after the Scheme occurred and Goldman Sachs published recovery estimates on Company obligations of between 7% and 26% after the Scheme occurred, indicating that the Company was and continues to be deeply insolvent."

"The Company is facing looming short term debt maturities and has insufficient assets to pay its debts as they become due. Additionally, the Company is inadequately capitalized."

As noted in the litigation: "The Scheme was enabled by a corporate governance structure of Parent [and related entities]… engineered to avoid liability for breach of fiduciary duties and to attempt to insulate the LBO Sponsors from any responsibility for their misdeeds. The Company is a member-managed limited liability company. Instead of having a board of managers or other similar governing body, the sole managing member of the Company is Holdings.  Holdings is an entity under the direct control of the Parent and hence, under the control of the board of directors of the Parent (the "Parent Board"), which is controlled by the LBO Sponsors.  Although Holdings, in its capacity as sole manager, owes a duty of good faith and loyalty to the Company, it is inherently incapable of discharging such duty and has in fact breached its fiduciary duties by causing the Company, advised by conflicted professionals, to distribute valuable assets for the benefit of the Parent even though the Company was insolvent.  At the same time, this Board-level conflict has been magnified by the role of the legal professionals at Kirkland & Ellis LLP and Proskauer Rose LP, which stand on opposite sides of the same transaction through their representation of both the Parent and the Company at the same time throughout these transactions."

"Normally, if a subsidiary becomes insolvent, a separate and independent governing body exists (or can be formed) that is capable of making independent decisions affecting the insolvent subsidiary, as such body's applicable legal duties require. By design, as a result of the corporate structure implemented by the LBO Sponsors [Ares and CPPIB], no such independent body exists here. The members of the Parent Board are the only natural persons with fiduciary duties even capable (were they so inclined) of exercising fiduciary duties owed to the Company. Yet, as fiduciaries of the Parent, each of them are inherently and deeply conflicted."

Accordingly, as a result of the fraudulent transfer and these other wrongdoings, Marble Ridge is seeking through the litigation, among other remedies, the appointment of an Equity Receiver under Texas law for Holdings and the Company to preserve and bring claims against the Parent, Ares, CPPIB and conflicted legal counsel for breach of fiduciary duty, aiding and abetting breach of fiduciary duty and for any other claims arising from this misconduct

"The appointment of a receiver here would allow a neutral third party to address this misconduct, inter alia, by bringing claims with respect to the misconduct alleged herein" the litigation asserts.

The litigation demonstrates that "the Company, under the control of the LBO Sponsors and/or the Parent has taken extraordinary steps to obstruct the ability of creditors to lawfully challenge the Scheme."

In summary, the following badges of fraud occurred:

(i)            "Transfer to an Insider. The purpose of the Scheme was to benefit the LBO Sponsors and/or the Parent. As a result of the Scheme, these insiders will, directly and indirectly hold the Transferred Assets free of the liens of the Company's creditors.

(ii)           Retention of Control by the Debtor. Despite its transfer, the myTheresa assets will continue to be operated by the Company and its management. From an operational aspect, the Scheme was a complete sham in that it had no operational effect or other legitimate, articulated business purpose.

(iii)          Concealment of the Transfer. As alleged above, despite repeated requests, the Company, the LBO Sponsors, the Parent and their respective advisors have failed and have refused to provide information for Marble Ridge to ascertain whether the Scheme transfers constituted a breach of the Indebtedness. This willful silence is sufficient basis to conclude that the Company is well aware that it has acted in violation of the covenants of its debt instruments.

(iv)         Absence of the Exchange of Reasonably Equivalent Value. As alleged, upon information and belief, the Transfers did not involve a reasonably equivalent value exchange because the Company received no consideration for the Transferred Assets."

"The misconduct of Parent for the benefit of the LBO sponsors, in looting approximately $1 billion in assets of the insolvent Company pursuant to the Scheme, and other misconduct alleged herein which raise grave prospect of further waste or dissipation of assets, warrants immediate appointment of a receiver for Holdings and the Company, to address this misconduct, inter alia, by bringing claims with respect to the misconduct alleged herein," the litigation states.

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