Wednesday, September 17, 2008
Bankruptcy Finangling-Retail Style
"When a high-profile group including Cerebus Capital Management and Sun Partners purchased Mervyn's for $1.26 billion in 2004, the deal was structured as two separate transactions--one for the retailer and a second one for the retailer's real estate. This complicated structure, the suit alleges, enriched the private-equity firms while leaving the retail operations insolvent. ... The case against Sun and Cerebus is especially fraught for the private-equity industry, which is trying to shake off decades of criticism that the funds 'strip' healthy companies with little regard for employees or insititutions. It is a dynamic that forms the basis of the company's complaint. ... Mervyn's was originally sold by former parent Target Corp. for $1.26 billion. The new owners then leased many of the stores to Mervyn's and sold or leased some properties to other retailers. ... Mervyn's ... alleges that the arrangement strangled its profitability, and that it was a 'helpless pawn.' That was because the new arrangement nearly doubled the company's annual lease payments, to $172 million. In addition, it was required to pay a special dividend to the real-estate company. Furthermore, Mervyn's couldn't close unprofitable stores without the consent of the private-equity firms and the real estate company", my emphasis, Jeffrey McCracken & Peter Lattman at the WSJ, 4 September 2008.
All Mervyn's rents paid the real estate company over its pre-purchase rents should go to Mervyn's creditors. This is a "transfer pricing" problem. By increasing Mervyn's rents the real estate company could siphon off Mervyn's profits and apparently did. Where's the DOJ on this? This looks like another case where indictments should be passed out like Halloween candy. I won't hold my breath. Isn't this a variant of "equity skimming"? I'll explain. 12 USC 1709 provides, "Whoever, with intent to defraud, willfully engages in a pattern or practice of --purchasing one-to four-family dwellings ... which are subject to a loan in default at the time of purchase or in default within one year subsequent to the purchase and the loan is secured by a mortgage or deed of trust insured or held by the Secretary of [HUD] ... failing to make payments under the mortgage or deed of trust as the payments become due, ... applying or authorizing the application of rents from such dwellings for his own use, ... shall be fined not more than $250,000 or imprisoned not more than 5 years or both". I realize Mervyn's properties were commercial, not 1-4 family homes. So? We have old standbys: 18 USC 1341, 1343 and 1344, mail, wire and bank fraud to work with. Also 18 USC 152, bankruptcy fraud. The "two-company split" was found criminal in Switzer. I'm sure a diligent AUSA could find something to indict Cerebus and Sun for. Of course such AUSA will never get a "NY Big Law" partnership in the future, but he's working for the DOJ today. Isn't he? Well, DOJ, how about it?