Investors tighten loan documents with J Crew blocker

NEW YORK, May 3 (LPC) - Lenders are tightening up US leveraged loan documents to stop issuers from removing security by transferring intellectual property into new subsidiaries and raising additional debt, an issue which surfaced last year when retailer J Crew did precisely that.

Senior secured lenders are now including language in loan documents, known as the ‘J Crew blocker,’ to stop companies transferring intellectual property, including their brands, into unrestricted subsidiaries after the retailer’s high profile clash with investors in 2017.

“Since J Crew, it’s definitely come into focus more, especially (on deals) where there is a big intellectual property component. I don’t see it going away,” a banking source said.

At least three recent loan deals have included the language, including engineering firm McDermott International’s US$2.3bn term loan. The deal priced in early April after lenders asked the company to protect its technology licensing as it purchases Chicago Bridge & Iron, the banking source said.

Similar language was added in January to a US$1.575bn term loan backing Arby’s Restaurant Group’s purchase of Buffalo Wild Wings and it also featured in another restaurant deal in late 2017 for Chinese food chain P.F. Chang’s.

High-yield bond investors are also seeking to include the language in bond documentation and added it to Arby’s and McDermott bonds as well as an offering from Guitar Center in March.

The new language offers lenders a simple way to solve a complicated problem, said Ross Hallock, an analyst at Covenant Review.

J Crew was able to create an unrestricted subsidiary to receive its intellectual property, which it then used as collateral for US$250m of new bonds that it wanted to use to repay PIK bonds valued at US$567m. The company had to lure lenders into the deal by offering to buy debt back at par, which was trading at a discount.

Although other companies had done similar transfers, this was a high stakes move given the larger US$250m size of J Crew’s deal. Investors were surprised by the request, which succeeded when lenders agreed not to fight the move in return for buying back US$150m of the paper at par.

The new language from the J Crew blocker gives investors two options to stop companies from creating unrestricted subsidiaries.

Investors can review all sources of unrestricted subsidiary capacity, demand that they are limited and hope that other investors make similar requests, or they can ask for a J Crew blocker provision, which is a much simpler fix. “Investors could attempt to disentangle all the various covenants, carveouts, defined terms, and cross-references. Or they could cut the Gordian knot with the J. Crew blocker,” Hallock said.

The ability to transfer assets into new subsidiaries is not new risk, said Derek Gluckman, a vice president at Moody’s Investors Service, adding that a more relevant issue is how much value can be transferred away from the control of secured lenders.

The ability to do this is more or less ubiquitous now in leveraged loans. While issuers are reluctant to give it up, investors may be able to select which assets they want to protect, and are currently focusing on intellectual property.

“My suspicion is that absolute asset transfer blockers will not become commonplace, but we’ll see more partial blockers addressing the J Crew scenario,” Gluckman said.

J Crew declined to comment. (Reporting by Jonathan Schwarzberg Editing by Tessa Walsh and Michelle Sierra)