I understand that creditors are in line before employees seeking severance, but why on earth aren't the equity holders required to pay the severance obligation, given that despite having lost all of their (their LPs'...) equity, Bain, KKR and Vornado took hundreds of millions out of Toys in closing and monitoring fees.
Why aren't the employees suing them as a class, or why isn't the bankruptcy court requiring the GP to pay the severance obligation?
That's not how a liquidation works. Hell you could have made 2x, 3x, 4x, etc. your money before something goes sideways and the creditors have to liquidate the company. In this case, your previously distributed proceeds (whether this is proceeds from actual dividend distributions or management fees) are not a source of recourse for the creditors or other financial obligations. Obviously there are some trivial exceptions to this, e.g., sponsor gets a dividend recap done before the liquidation and knew there was very bad news coming but withheld that information from lenders.
Regarding the severance payments...you're correct in that the secured creditors get paid first. If there aren't enough proceeds for them to be paid in full, then they should have the discretion on how the proceeds get allocated. For instance, it may be their decision that it's in their best interest to keep some of management on-board during this difficult process and to compensate them. This is likely be the explanation behind the news coverage regarding how store employees are getting no severance but some executives are receiving retention bonuses. Similarly, it would be the secured creditors' call to allocate some proceeds to paying off accrued management fees, etc. This concession would be less likely to occur compared to incentive bonuses for key executives.
You're conflating distributions with "success" (haha...) and "monitoring" fees, which are how the PE investors made money on this. I'll give you this, it's the creditors and LP's own fault for allowing the GP to take non-trivial amounts of cash out of the business before anyone else in the capital stack made a dime, but it raises an interesting question about who is speaking for the other creditors, in this case the employees. You're also conflating fees paid to the sponsors with incentives to management. The latter probably were necessary, but the former clearly weren't. The absurdity of a "success" fee for Toys R Us speaks for itself, and given what happened to the company, it's fair to say that the monitoring fees weren't exactly money well spent either... I don't claim to know bankruptcy law, but I find it very odd and unfair that employees, vendors and other unsecured creditors end up below equity holders, at all, ever, in a liquidation.
Could you force a sponsor to pay back monitoring fees through Fraudulent Conveyance? Or even as a type of preference avoidance?
Fraudulent conveyance opens up an entirely different can of worms.
What happened here was the sponsors received money through their monitoring fees. I haven't followed this deal very closely, but it looks like (at a quick glance) they actually never made any real equity distributions during their lengthy ownership period. When creditors decide to provide a sponsor-backed company with debt, they are made fully aware of the monitoring fees associated with the business. There are all sorts of terms associated with these monitoring agreements (e.g., annual caps, reasons to accrue rather than pay in cash, etc.).
Fraudulent conveyance is motivated by avoiding a debt; the result is transferring the money elsewhere so the debt does need to be paid. This doesn't really apply though -- the obligation to pay the debt here is on the company, not the sponsors. Whether the company pays the sponsors its fees or not, the company (and not the sponsors) is still on the hook for the debt. A company that pays its management fees to sponsors (which the creditors are well aware of) does not suggest any intent of hindering or defrauding creditors.
The only way I could see this concept coming into play is on the grounds of constructive fraud, which is not related to fraudulent intent. In this situation, the company may have been paying bills (such as a management fee) when it really should have been focused on preserving capital given its current financial state. However, if a sponsor-backed company is not in a stable position (read: borderline/not able to service its debt obligations), they usually forego paying out management fees and let those amounts start to accrue. I don't know enough about this specific deal, i.e., when fees stopped getting paid out in cash, what the accrual actually looks like, etc. Most firms know its not a good idea to further drain a company through management fees if the ship is truly sinking, simply because the juice just isn't worth the squeeze of all the headaches that come along with engaging in such behavior. Furthermore (and this is getting into differing opinions of returns methodology now), it doesn't help the sponsor from a deal perspective. Fee income isn't going to be included in deal-metrics like IRR and MOIC unless you include the costs associated with earning those fees. Based on what I've said above, this deal with be a donut (0) from the LPs perspective -- sponsors made an initial equity investment, collected some fees along the way, but received no distributions or residual value for said initial investment.
For reference - great real-world example of fraudulent conveyance claims in an LBO is the Caesar's deal. There have been some very informative, thorough articles on how that situation played out and the clever battle that Apollo fought.
SB. This is interesting and informed. I couldn't care less about the secured creditors. As you point out, they blessed all those fees, so tough luck. What's odd about this and similar situations, and strikes me as an unusual decoupling of risk and return, is that debt (unsecured, but still) was subordinated to equity. What's probably required is a change in the law to treat accrued severance benefits the same way accrued pensions are, and require that they be fully funded lest taxpayers or employees be left holding the bag. Sponsors recapping such a company could still take their fees, but the presence of the severance obligation would cascade through the leverage ratios and make each additional borrowed dollar more expensive or unattainable.
Thank you! This was super helpful. For anyone else, here is one of the more interesting documents I found from Caesars: https://online.wsj.com/public/resources/documents/CaesarsReport03-16-20…
This is the most millenial thread ever. I hope this is just next level trolling.
The vast majority of the employees are hourly, non-FT and get zero benefits. If you ever worked an hourly, minimum-wage gig, these employees are rarely given severance and are http://www.ncsl.org/research/labor-and-employment/at-will-employment-ov…</a">at-will employees.
"Trolling"? You seem to be operating under the assumption that the employees have just randomly asked for money. What a five second google search would have told you is that there is, or was anyway, a severance benefit at Toys R Us, which makes the eligible employees, collectively, an unsecured creditor. The bankruptcy court overseeing Toys' liquidation has recognized this, as has KKR.
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