555 B.R. 369
Bankr. S.D.N.Y.2016Background
- Aéropostale and affiliates (Debtors) entered bankruptcy after severe sales declines and liquidity problems; prepetition debt included a $150 million financing package with an asset-based ABL and a $150 million term loan (Tranche A $100M at 10% by Aero Investors; Tranche B $50M at 0% by MGF Holdings).
- The term loan package included (i) an Investor Rights Agreement giving Aero Investors board seats, and (ii) a ten-year Sourcing Agreement between Aéropostale Procurement and MGF obligating minimum purchase volumes and containing a $150 million “Liquidity” trigger that allowed MGF to declare a “Credit Review Period” and change payment terms (including cash-in-advance) exercising its “reasonable credit judgment.”
- In February 2016, MGF declared a Credit Review Period, demanded cash-in-advance (or letters of credit) for orders, and withheld shipments; Debtors disputed the trigger but later conceded liquidity had fallen below $150M (Debtors had systematically overstated liquidity by including FILO availability).
- Debtors sued Term Lenders (Aero Investors and MGF Holdings, affiliates of Sycamore Partners) seeking (1) equitable subordination of claims, (2) disqualification/limitation of credit-bidding under §363(k), and (3) recharacterization of Tranche B as equity — alleging MGF breached the Sourcing Agreement, that Sycamore had a scheme to acquire Aéropostale cheaply (including insider trading), and that Term Lenders’ conduct chilled the sale process.
- Court held a multi-day trial with extensive fact and expert testimony; Court found MGF’s invocation of the Credit Review Period was contractually permitted and commercially reasonable given Aéropostale’s deteriorating liquidity and MGF’s exposure, and that Debtors failed to meet the high standards for equitable remedies.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Equitable subordination of Term Lenders’ claims | Sycamore/MGF engaged in inequitable conduct (breach of Sourcing Agreement, secret plan to force bankruptcy, insider trading) that harmed creditors; claims should be subordinated | Actions were contractual, commercially reasonable, disclosed to Term Lenders, and not egregious or fraudulent; Debtors bore burden to prove injury/unfair advantage | Denied — Debtors failed to prove inequitable conduct causing creditor harm; non-insider standard not met |
| Limitation/disqualification of credit-bid under §363(k) | Credit-bidding should be limited because Term Lenders’ conduct chilled bidding and they gained unfair advantage | Credit-bidding is statutory right; no evidence of collusion, lien disputes, or process interference; Term Lenders cooperated in sale process | Denied — no cause shown to restrict credit bid; alleged chilling alone insufficient absent other inequitable conduct |
| Recharacterization of Tranche B (loan vs equity) | Tranche B economically functioned as equity (zero interest, tied to sourcing/rebates) | Tranche B documented as loan, had repayment schedule, secured by liens, and parties intended debt treatment | Denied — AutoStyle factors predominantly support characterization as a loan |
| Insider trading / alter-ego attribution | Sycamore affiliates sold equity while possessing material non-public liquidity info; MGF/Lemur actions attributable to Term Lenders; this supports subordination/limits | Sales did not produce market advantage (Lemur lost money); information’s market significance disputed; no alter-ego showing to attribute MGF conduct to Term Lenders | Denied — no showing of harm or unfair advantage from trades; alter-ego not established; insufficient basis for equitable relief |
Key Cases Cited
- Pepper v. Litton, 308 U.S. 295 (U.S. 1939) (bankruptcy court’s equitable power to examine claims to prevent injustice)
- Benjamin v. Diamond (In re Mobile Steel Corp.), 563 F.2d 692 (5th Cir. 1977) (three‑part test for equitable subordination)
- RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (U.S. 2012) (credit‑bidding is a protection for secured creditors; restrictions constrained by statute)
- In re Sunbeam Corp., 284 B.R. 355 (Bankr. S.D.N.Y. 2002) (equitable subordination of non‑insiders requires egregious misconduct)
- In re LightSquared Inc., 511 B.R. 253 (Bankr. S.D.N.Y. 2014) (doctrine of equitable subordination and high bar for non‑insiders)
- In re AutoStyle Plastics, Inc. (Bayer Corp. v. MascoTech), 269 F.3d 726 (6th Cir. 2001) (factors for recharacterization of debt as equity)