Heavily indebted retailers J. Crew Group Inc. and Claire'sStores Inc. are delving into their loan agreements to findcreative ways to raise or reconfigure their debt. Andcreditors, who often have the most to lose, may not be able tostop them.

Take the case of preppy clothing maker J. Crew. The NewYork-based company is said to be seeking to take advantage of aclause in its loan agreement allowing it to shift its brand name,the crown jewel of its intellectual property, to an unrestrictedentity in the Cayman Islands. By doing this, it may now be possiblefor J. Crew to borrow against the assets and use the proceeds tobuy back a portion of its roughly $2 billion in debt at adiscount.

“There may be other situations, but we haven't seen retailcompanies using IP assets and investment baskets like this before,”said Steven Ruggiero, head of research at R.W. Pressprich & Co.“They are taking advantage of valuable assets that haven't beenoptimally utilized to find new creative ways to create liquidity toextend their existence.”

Transferring assets and investments to unrestricted entities canhurt creditors because new secured debt issued against them can getpriority over their claims, potentially lowering the value of theirholdings and preventing them from being paid first in case ofbankruptcy. In industry parlance, they would have been'primed'.

So J. Crew's term lenders are said to be talking to lawyers andpreparing for a potential fight. Specifically, they're digging intothe lending documents to see whether they can push back on thetransfer.

A spokeswoman for J. Crew declined to comment on the company'sborrowing.

“It's a gray area,” Ruggiero said. “Creditors will get legalhelp to start analyzing what can be contended. But the reality islitigation may be hard unless it is determined that there was abreach of the lenders' contracts. In most cases, they arelegal.”

These asset-shielding tactics aren't exactly new to indebtedretailers — Sears Holdings Corp. used a similar maneuver nine yearsago in the spinoff of its popular Craftsman, Kenmore and DieHardlines.

And companies in other industries use them as well. Cellularcarrier Sprint Corp. created an unrestricted entity and moved itswireless spectrum assets into it. In October, it sold $3.5 billionof secured notes backed by those assets. Sprint has an option toissue another $3.5 billion of securities if it chooses.

Just last week, lenders to Core Media Group Inc., the AmericanIdol producer that filed for bankruptcy in April, filed a suit in aCalifornia court arguing that owner Apollo Global Management hadinappropriately shifted assets out of the business without thelenders being repaid.

“The lawsuit is without merit and we intend to defend ourselvesvigorously,” Apollo spokesman Charles Zehren said in astatement.

And consider iHeartMedia Inc. The company transferred sharesfrom its billboard unit to an unrestricted subsidiary triggering alegal fight with noteholders. The company won that lawsuit.Disputes involving IHeartMedia and bondholders may set significantprecedents for other indebted borrowers, Anthony Canale, head ofhigh-yield research at Covenant Review, said in a Nov. 29 webinarwith Bloomberg Intelligence.

Monitoring Litigation

A number of high-yield issuers “are actively monitoring thislitigation with an eye toward using this concept and this strategyof unrestricted subsidiaries to opportunistically address theircapital structures,” Canale said.

Claire's Stores, the tween jewelry chain also owned by Apollo,used a similar tactic earlier this year when it set up anunrestricted subsidiary and got a $130 million loan agreement tosupport a distressed debt exchange.

“So the takeaway from Claire's is that even though incrementalfirst lien debt capacity was very limited in this credit, thecompany was able to still significantly prime existing first-lienbondholders in large part by moving this value to an unrestrictedsubsidiary and incurring the debt there,” Bloomberg Intelligence'sRichard Bourke said in the webinar.

A spokeswoman for iHeart declined to comment. Representativesfor Claire's Stores didn't immediately respond to requests seekingcomment.

On Dec. 12, Fitch Ratings listed Claire's as one of theretailers that's “challenged to maintain share, liquidity andpositive comps” after earlier naming it as one of seven chains athigh risk of defaulting on its debt. And despite all the debtcreativity, these moves still don't address the company's muchwider problem: declining traffic in malls.

“It doesn't fix that,” Bloomberg Intelligence analyst NoelHebert said in the same webinar. “And it doesn't really fix theneed to kind of repair the balance sheet.”

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