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In February 2019, Payless ShoeSource filed for bankruptcy for a second time. It was 63 years after the mall-centric footwear chain first got its start in Topeka, Kansas, which was, in 1956, in the midst of national attention after the Supreme Court handed down its decision in Brown v. Board of Education of Topeka – the landmark case establishing racial segregation in public schools are unconstitutional – less than two years prior. Founded by cousins Louis and Shaol Pozez, Payless, or what was first known as Pay-Less National, was something of a novelty in the market. While most shoe stores were full service at the time, the Pozez’s imagined something else. They wanted to offer low cost footwear in a self-service environment. 

The appeal of Payless was quick to catch on, and within just a handful of years, the company went public and embarked on a campaign of national expansion. The Pozez’s three stores in Topeka – which were free of any upscale retail frills, a move that enabled the brothers to keep costs low for themselves and consumers, alike – turned into almost 40 by 1969, with outposts in Oklahoma, Texas, and Nebraska. 

Aside from the draw of affordable footwear (particularly for growing baby boomer families), at least some of the company’s initial growth was fueled by a budding social movement to “casualize” in the 1950s – which saw wardrobe changes coming in the form of slightly less formal dress codes at certain offices. This also extended to the clothing that individuals would wear to restaurants and movies, as well as for traveling. These budding cultural changes enabled Payless to rake in $75 million in sales annually by the mid-1970s, up from less than $10 million per year not even a decade prior, all while it rapidly expanded by opening its own stores and bringing other footwear chains under its ownership umbrella. 

It also did not hurt, of course, that many of its outposts would come to be located in shopping malls, which by 1975, accounted for 33 percent of all retail sales in America, thereby, helping to boost “the company’s brand recognition,” according to Business Insider. With growing name recognition, annual sales followed suit. By the 1979, Pay-Less National – which was publicly traded as Volume Distributors – had more than 700 stores across the U.S., per BI, and was generating some $191 million in annual sales.  

Looking beyond cultural changes and prime locations, the core strength of the company was the shoes, themselves. “The company managed to commission the manufacture of millions of pairs of shoes, often imitating the look of more fashionable brands; ship them from factories [overseas] to distribution centers in the United States; and then, just in time, get those shoes into the stores where they would most appeal to the customer base,” as the New York Times put it early this year. “It did all this at remarkably low cost.” 

In a testament to its ability to provide private label footwear that looked just like other brands’ offerings for a fraction of the cost, Payless found itself ensnared in infringement litigation over the years with adidas, American Eagle Outfitters, Asics, K-Swiss, Reebok, and Brooks Sports, among others. At the same time, it managed to launch collaboration collections with Christian Siriano, Kendall and Kylie Jenner, Alice + Olivia, and Jeff Staple x Airwalk to further boost its appeal among a wider audience.

A $2 Billion Acquisiton

“By the time a private equity group led by Golden Gate Capital and Blum Capital took over the company” – which had been rebranded as Payless ShoeSource in 1991 – by way of “a $2 billion acquisition in 2012, Payless had 4,300 stores worldwide and $2.4 billion in revenue,” the Times reported. Even with such successes in hand, the retail giant – which called itself “the largest specialty family footwear retailer in the Western Hemisphere” – was facing “profound challenges.” 

For instance, “Many malls and shopping centers were entering a death spiral, with falling foot traffic, store closings and underinvestment,” the Times’ Neil Irwin noted. “People were increasingly buying shoes online, along with most everything else. Payless had underinvested in its information technology infrastructure.” 

“What needed doing was evident to Payless’s own managers and outside analysts alike: shutter underperforming stores, update others, and modernize its technology to compete in the digital age.” 

But beyond those issues, which have plagued no shortage of similarly-situated retailers as consumers look online and all but abandon the mall, Payless’ problems would soon run deeper: “the company [was making] huge payments to its private equity owners,” per Irwin, so much so that “for every dollar that came in the door of the company in that span, it paid out $1.09 to its owners and 26 cents to its lenders.” That means that “the company [had] less of a financial cushion to ride out any future challenges.” 

Bankruptcy Times Two

Those challenges – which did, in fact, come into fruition in a number of forms – pushed Payless over the edge. In a Chapter 11 bankruptcy filing in April 2017, the footwear chain listed liabilities of between $1 billion to $10 billion, and assets of roughly $500 million to $1 billion. It put forth a plan to immediately close about 400 underperforming stores in the U.S. and Puerto Rico, what W. Paul Jones characterized as “a difficult, but necessary, decision driven by the continued challenges of the retail environment, which will only intensify.” 

While its filing was hardly an outlier, it was the tenth major retailer to file for Chapter 11 by February of that year, analysts pointed to the fact that its “parent company was purchased by private equity firms in 2012 for $2 billion,” leaving the company saddled with debt. And just two months prior to the filing, Moody’s downgraded its outlook on the company, stating that it showed “weaker than anticipated operating performance.”

Despite such a gloomy outlook, by that August, just four months after it first filed for bankruptcy, Payless emerged a lighter, leaner operation. “Payless’ emergence essentially gives the company a do-over after disposing of half of $847 million of debt it had built up under its private-equity ownership,” Reuters reported in 2017. “With a cleaned-up balance sheet, Payless is seeking to position itself to compete in a tight U.S. market, open more stores across Latin America – a major part of its growth strategy – and develop new franchises in Asia.” 

Some parties were optimistic about Payless’ future. Retail restructuring expert Christopher Jarvinen of law firm Berger Singerman told Reuters that the company – under the control of Alden Global Capital – “has a business plan with a future.” Others, however, were skeptical. “The company’s troubled past and the competitive retail environment still will leave little wiggle room for negative surprises,” turnaround specialists told the publication. 

The latter camp would prove to be right. After first filing for bankruptcy in April 2017, Payless filed for Chapter 11 protection again in February 2019, and revealed that it would shutter its domestic business entirely. While Payless ultimately closed its 2,300 U.S. stores and shuttered its corresponding e-commerce operations, a spokesman for the company stated that the bankruptcy “does not affect the company’s franchise operations or its Latin American stores, which remain open for business as usual.”  

All in all, Stephen Marotta, who was named as the company’s chief restructuring officer to prepare for the bankruptcy, told CNN that “Payless had too much debt, too many stores, and too much corporate overhead when it emerged from the earlier bankruptcy.” The company also pointed to “a computer system issue that hurt its 2018 back-to-school sales” and its carrying of “too much inventory for the holiday season, which forced it to cut prices.” This culminated in a $63 million loss for the company’s North American business for the 2018 fiscal year. 

Payless emerged from its second Chapter 11 bankruptcy – or what has been coined a “Chapter 22” bankruptcy for second-time Chapter 11 filers – in January, and has been off of the map, in the U.S., at least ever since. Given the disastrous state of domestic retail in light of increasing competition from the likes of Amazon and the enduring impact of the COVID-19 pandemic, which has given rise to more bankruptcies so far this year than each single year since 2011, it seemed as though it would stay that way. 

That is, until this week, when Payless revealed that it will try its hand for a third time. 

Third Time Around?

Complete with yet another rebrand (the company is now called Payless Worldwide), Payless is relaunching its website this week, and plans to open as many as 400 stores in North America over the next five years. The first location is going to be a flagship in Miami, which is slated to open its doors this fall.

In a statement on Monday, new CEO Jared Margolis said that “starting from scratch puts us in a good position.” The WSJ notes that while Payless’ shoes “will still be inexpensive—an average pair costs just $19.99, Margolis, who comes from a marketing background, wants to do a better job of building the brand.” He told the Wall Street Journal that Payless – which is not under the control of “a group of investors led by hedge fund Alden Global Capital and investment advisory firm Axar Capital Management, two of its lenders” – “never did a great job of educating consumers about its products. These are inexpensive shoes, but that doesn’t mean we can’t create a cool, fun experience.’

In its absence, Payless is expected to have lost its more than 60 million customers to the likes of Walmart, Target and Amazon. It is hoping to lure them back with its same low prices, a new e-commerce site, and offerings from major brands like AirWalk, American Eagle, K-Swiss, Kendall + Kylie and Aerosoles. 

As for the timing of it all, Margolis says, “We are fully aware that we’re relaunching in a time when many have lost their jobs, finances are tight, and parents nationwide are adjusting to working from home and facilitating at-home schooling for their children.” Nonetheless, “We saw an opportunity for the brand to relaunch into the U.S. market, providing our community with the affordable, value-driven products they’ve always searched for.”

Lord & Taylor, one of the oldest departments stores in the U.S., filed for bankruptcy protection with the U. S. Bankruptcy Court for the Eastern District of Virginia on August 2. The nearly 200-year old department store chain’s owner, fashion rental startup Le Tote Inc., filed for Chapter 11, as well, after acquiring Lord & Taylor from Saks Fifth Avenue owner Hudson’s Bay Co. for $71 million last year, and “taking over its 38 locations and hoping to propel the venerable department store toward new, younger shoppers,” per NPR. Le Tote revealed in a court filing that its companies reported revenue of $253.5 million in 2019.

The Lord & Taylor/Le Tote bankruptcy filing joins those of a growing list of brands and retailers that have sought out legal protection from creditors, particularly in light of the enduring impacts of COVID-19, which has accelerated the financial woes of many already-struggling companies, including well-known department store chains, such as Neiman Marcus and J.C. Penney, and individual brands like J. Crew, Brooks Brothers, John Varvatos, and G Star Raw.

Le Tote v. Urban, FTC v. Lord & Taylor

The bankruptcy filing also comes amid an enduring legal squabble for Le Tote, which filed suit against Urban Outfitters in June. In the suit, Le Tote accused Philadelphia-headquartered Urban Outfitters of gaining access to a sweeping amount of confidential information about the workings of its fashion rental business under the guise of a potential acquisition, only to up-and-abandon the M&A discussion and launch a copycat rental service of its own to “compete directly with Le Tote.” 

In doing so, Urban breached the parties non-disclosure agreement, according to Le Tote, and misappropriating an array of “business, engineering and technical information, including plans, formulas, compilations, techniques, processes, procedures, and programs, [which] constitute trade secrets.” 

That case is currently underway in a federal court in Pennsylvania. 

Hardly a stranger to legal action, itself, Lord & Taylor famously came under the microscope of the Federal Trade Commission (“FTC”) in 2015 after it enlisted 50 influencers and Nylon Magazine to participate in a “Design Lab” advertising campaign without requiring any of the parties to reveal that they were compensated for their endorsements. 

According to the complaint that the FTC filed against Lord & Taylor (none of the influencers or Nylon Magazine were named in its complaint), the department store chain “gifted the Paisley Asymmetrical Dress to 50 select fashion influencers who were paid, in amounts ranging from $1,000 to $4,000, to post on the social media platform Instagram one photo of themselves wearing the Design Lab dress during a specified timeframe during the weekend of March 27-28, 2015.” While the influencers were given the “freedom to style the dress in any way they saw fit, Lord & Taylor contractually obligated them to exclusively mention the company using the ‘@lordandtaylor’ Instagram user designation and the campaign hashtag ‘#DesignLab’ in the photo caption,” and to tag Lord & Taylor in the photos, themselves.

“Although Lord & Taylor’s Design Lab influencer contracts detailed the manner in which [it] was to be mentioned in each Instagram posting,” the FTC asserted that the contracts did not require the influencers to disclose in their postings that Lord & Taylor had compensated them, and Lord & Taylor did not “otherwise obligate the influencers” to disclose that.  

At the same time, the FTC claimed that “Nylon posted a photo of the Paisley Asymmetrical Dress, along with a Lord & Taylor-edited caption, on its Instagram account during the product bomb weekend, [and] although paid for, reviewed, and pre-approved by Lord & Taylor, Nylon’s Instagram post failed to disclose that Lord & Taylor had paid for the posting.” The same goes for an article that magazine ran about the Design Lab collection in its online magazine on March 31, 2015. 

The FTC asserted that thanks to the influencers in play (from Something Navy’s Arielle Charnas and Natalie Off Duty’s Natalie Lim Suarez to Cara Santana and Marianna Hewitt), the Design Lab Instagram campaign was a success – reaching 11.4 million individual Instagram users, and resulting in 328,000 brand engagements with Lord & Taylor’s own Instagram user handle. All the while, the dress sold out. The problem, according to the FTC: the campaign ran afoul of the law. To be exact, the government agency found that because the influencers’ posts and Nylon’s post/article lacked the proper disclosures (i.e., #ad or #sponsored, etc.), they were potentially misleading to consumers, and deceptive in accordance with the terms of the FTC Act. 

Fast forward to March 2016, and the FTC revealed that Lord & Taylor had “agreed to settle charges that it deceived consumers by paying for native advertisements, including [influencer endorsements and] a seemingly objective article in the online publication Nylon and a Nylon Instagram post, without disclosing that the posts actually were paid promotions for the company’s 2015 Design Lab clothing collection. “In settling the charges, Lord & Taylor is prohibited from misrepresenting that paid ads are from an independent source,” the FTC asserted. As part of the settlement, Lord & Taylor was also “required to ensure that its influencers clearly disclose when they have been compensated in exchange for their endorsements.”

Speaking about the settlement at the time, which was headline-making in that it was one of the first efforts (if not the first effort) by the FTC to specifically focus on the role of influencer marketing in advertising, Jessica Rich, Director of the FTC’s Bureau of Consumer Protection, said “Lord & Taylor needs to be straight with consumers in its online marketing campaigns. Consumers have the right to know when they’re looking at paid advertising.”

Since then, the FTC has paid increased attention to influencer marketing, releasing supplement guidance to its Endorsement Guides that is directed exclusively at influencers and the disclosures they must make when endorsing brands/products with which they have a “material connection.” The FTC has also taken to sending letters to influencers and brands that it suspects have such a connection but that have failed to notify consumers about by way of their social media posts.

From Neiman Marcus and Barneys New York to J. Crew and Brooks Brothers, big-name bankruptcies have made headlines with increasing frequency over the past year. In fact, the number of Chapter 11 filings that have been initiated in the first half of 2020, alone, rang in at nearly 3,600, according to the American Bankruptcy Institute. That 6-month tally is more than any single year since 2012. While the ultimate fate of the bankruptcy-filing companies, themselves, depends on a number of factors, including the type of bankruptcy proceeding at play, one thing is true: companies’ names, their branding, and other competitive elements of their operations are proving to be among the biggest draws for bankruptcy bidders. 

It has long been the case that aside from a company’s offerings, much of the value of a consumer-facing entity comes in the form of its intellectual property – whether that be trademark-protected names and logos (and the goodwill that comes with those source-identifying elements), trade dress-centric product packaging, copyright-protected imagery and content, patented technology, or trade secret elements, such as customer data, supplier lists, and advertising strategies. 

This value is due, in part, to the fact that many consumer products are not all that different from one company to those of its competitors, particularly in spaces like fashion, modern-day “luxury” (i.e., mass-market luxury), and sportswear, given that handbags and footwear can only be designed so many ways, and tend to follow the same general trends. As such, intellectual property tends to be what enables companies to distinguish themselves from rival brands in a crowded market, build value around their products in the minds of consumers, and ultimately, gain a competitive advantage. As such, things like trademark rights and trade secret-protected tactics are routinely among the core assets that bidders have their eyes on when it comes to bankruptcy auctions. 

While certainly not novel, the placement of value on intangible assets like intellectual property is proving to be increasingly significant in recent years in light of a larger-scale retail shift: companies are moving away from all-but-unchecked brick-and-mortar expansion and instead, placing greater focus on their e-commerce capabilities. This existing trend has been significantly accelerated by the onset of COVID-19. Consumers – many of whom are now more comfortable relying on e-commerce than before the pandemic – are expected to do more shopping online in the later stages of the pandemic and post-pandemic even after stores have re-opened, thereby, standing to make brick-and-mortar real estate less valuable (and less of an attractive selling-point in a bankruptcy auction) than it was in the past. 

(Recent quarterly reports from luxury giants like LVMH Moët Hennessy Louis Vuitton, Gucci’s parent company Kering, and Hermès confirm that while stores are beginning to reopen, e-commerce traffic continues to grow, nonetheless).

Against this background, “Bankrupt or liquidating retailers’ [intellectual property] assets that would otherwise have been frittered away or dumped for meager sums in the past” – likely due to their inextricable ties to physical retail – are in something of a different position. As a result of the enduring rise of e-commerce (and the potential for diminished value of stores), these companies “are fetching relatively high dollars in auctions” for their intellectual property, according to Bloomberg Law, as their physical retail operations (or at least, most of their physical retail operations) are winded down for good.

Need proof? Look no further than Barneys New York. The upscale department store reached a $271 million deal in the fall of 2019 with Authentic Brands Group (“ABG”) and investment firm B. Riley Financial Inc., which acquired the bankrupt retailer’s intellectual property, data, and other assets related to its e-commerce business. With the company’s outposts closed and its inventory completely liquidated, ABG and B. Riley leveraged Barneys intellectual property to enter into a deal in which Saks Fifth Avenue-owner Hudson’s Bay Co. is licensing the Barneys name for use in connection with its own business, hence, the “Barneys as Saks” section on the Saks site, and the redirect of the Barneys.com domain to Saks. 

In much the same way as ABG and B. Riley derived value from Barneys that is distinct from its retail network and now-liquidated designer inventory, other retailers – such as Pier 1 – have “also have found buyers for their [intellectual property] assets while store operations have shuttered.” This is a testament, Bloomberg states, to the fact that “investors increasingly see lucrative opportunities in buying bankrupt retailers’ trademarks, customer lists and other intellectual property” in lieu of the burden of their real estate portfolios and inventory, the latter of which has also been particularly plagued, as brands have struggled to sell off their stock during COVID-19 lockdown.  

Citing a number of intellectual property and bankruptcy attorneys, Bloomberg’s Matthew Bultman asserts that “compared to assets like real estate and inventory, [intellectual property] is a relatively new value driver when retailers go bankrupt,” particularly as “investors have realized that reshaping brick-and-mortar retailers into online companies is doable.” (Luckily, assets can usually be parsed and auctioned separately, as indicated in the case of Sonia Rykiel. The Paris-based brand offered bidders the option to separately acquire its intellectual property rights (namely, its various global trademark registrations, and decades of archives and product prototypes); the commercial leases for its brick-and-mortar outposts in France – from its Saint Germain flagship to a glitzy boutique in Cannes, among others; and its remaining stock of garments and accessories. The winning bidders, brothers Eric and Michael Dayan bid for all of the offerings).

More than the most obvious forms of intellectual property, though, is the sizable pools of data at play, which likely fall within the realm of trade secret law, that certainly prove a huge draw for bankruptcy bidders. Consumer data – from customer addresses and emails to their purchase histories – is a potential goldmine for acquiring parties and a valuable asset for bankrupt brands.

While intellectual property as the key draw in a bankruptcy setting may be relatively novel, according to Bultman, it, nonetheless, appears to be part of a larger trend that will carry on for the foreseeable future. As we noted in early 2017, a handful of retail bankruptcy deals were underscoring “the interest that the e-commerce businesses and intellectual property of even bankrupt retailers [was] attracting, and the value that they can garner” for both the companies, themselves, and ultimately, the acquiring parties. This continues to be increasingly true several years later. 

Neiman Marcus has been busy making headlines this week in connection with the announcement that it will permanently close a number of stores, including its 180,000-square foot outpost in New York City’s glitzy Hudson Yards complex, which cost a reported $80 million to build and which Neiman Marcus occupied for just a year and a half. At the same time, the upscale retailer is also at the center of an ugly battle in a Houston, Texas bankruptcy court over MyTheresa, the buzzy e-commerce business it acquired in September 2014. At issue in the high-stakes legal scuffle? Whether Neiman Marcus inflated its valuation by billions of dollars in connection with a transfer of MyTheresa, and thus, ran afoul of the law and removed the company from its impending bankruptcy proceedings in the process.

According to a group of Neiman Marcus bankruptcy creditors, the Dallas,Texas-based chain “inflated its own value by billions of dollars before its 2018 spinoff of fast-growing e-commerce businesses MyTheresa so it could carry out what they say was an improper transaction,” as first reported by the Wall Street Journal. That transaction saw Neiman Marcus – which filed for Chapter 11 bankruptcy in May – transfer its European e-commerce division, namely, MyTheresa, to an unrestricted subsidiary in 2017. The retailer then transferred ownership of Munich-based MyTheresa again in September 2018 – this time to Neiman Marcus Group Ltd.’s parent company, Neiman Marcus Group Inc. – allegedly in an attempt to shield the company’s assets from creditors. 

The crux of the issue actually took place before the second transfer, though, in early 2018 when Neiman Marcus put a $7 billion-plus valuation on its business. According to the group of bankruptcy creditors, that sum is quite a bit more than the $3.9 billion price tag that an independent valuation (summoned by the creditors) came up with for the 112-year old retailer. The $3.1 billion difference is significant because if the creditors’ valuation is correct, it would mean that Neiman Marcus was insolvent at the time of the MyTheresa transfer (i.e., the sum of its debts was greater than all of its assets), and thus, the company ran afoul of U.S. federal bankruptcy law, which prohibits asset transfers by insolvent entities. 

In other words, the creditors argue that Neiman Marcus’ board inflated the total assets of the company to enable the company to appear as though it was solvent and therefore, legally above-board in making the transfer of MyTheresa. 

In previously-redacted court documents, which were released on Friday, Neiman Marcus’ creditors argue that “there is ample indirect evidence of fraudulent intent and multiple badges of fraud” to be found in connection with the $7 billion valuation and subsequent MyTheresa transfer. “In approving and effectuating the distribution, [Neiman Marcus’] Board was presented with various alternatives, including the option of paying fair value for the MyTheresa asset, but chose to upstream the asset for no consideration,” they assert. 

As such, they are claiming legal rights in MyTheresa, which is not technically part of Neiman Marcus’ U.S. bankruptcy proceedings but which legally may be clawed back from its current ownership if the valuation and transfer are found to be fraudulent in nature. 

In addition to questioning the valuation methodology used in the creditors’ report, a representative for Ares Management LP – one of the two private equity firms that acquired Neiman Marcus in September 2013 for $6 billion leveraged buyout – said this week, as reported by the WSJ, that the recently “unsealed creditors’ report provides no new evidence,” and that “two national law firms advised Neiman Marcus that the MyTheresa spinoff was legal and permissible under the company’s debt documents.”

Hardly the first fight over MyTheresa, Neiman Marcus has been facing off against creditor Marble Ridge Capital, which filed suit against it in a Texas state court in 2018, accusing the retailer of fraud in connection with the MyTheresa transfer. In that suit, the Manhattan-based distressed debt investor characterized the transfer as an attempt by Neiman Marcus to prevent its domestic creditors from accessing an estimated $1 billion in assets, and a move that enables Neiman Marcus owners, Ares Management LP and Canada Pension Plan Investment Board, to “usurp this massive benefit” for no consideration to the company.

In response, Neiman Marcus sought to have Marble Ridge’s case tossed out, while also lodging claims of its own, namely for defamation, citing Marble’s practice of “recklessly [making] false statements regarding the company’s compliance with its debt documents with the intent of damaging the company.” On the heels of a Texas state court dismissing Marble Ridge’s case in March 2019 due to the investment firm’s lack of the requisite subject matter jurisdiction to bring such a suit, the court allowed Neiman Marcus’ defamation suit to move forward in a decision in April 2019.

When John Varvatos filed for bankruptcy in May, the fashion brand’s largest creditor was not the owner of any of its respective brick-and-mortar store real estate, such as its outpost in East Hampton, New York, its store in Caesar Palace in Las Vegas or its shop in Malibu Country Mart. It similarly was not any of its suppliers that provide the necessary textiles that the brand uses to make its rock-n-roll inspired jackets or distressed denim. No, it was a group of class-action lawsuit claimants, who are collectively seeking $5.2 million of the more than $100 million that Varvatos owes to creditors. 

As it turns out, the money is owed to the group of women stems from the class action sex discrimination lawsuit that former John Varvatos employee Tessa Knox filed against the brand in a New York federal court in February 2017 on behalf of herself and similarly-situated female sales associates. Knox and nearly 70 other current and former John Varvatos employees accused the brand of pay discrimination on the basis of gender due to the fact that its clothing allowance significantly favors male employees at the expense of female employees. To be exact, Varvatos had a practice of providing male employees with a $12,000 clothing allowance so they could wear the brand’s apparel while working (in accordance with company policy), while female employees would receive a 50 percent discount to shop at Varvatos’s sister brand, AllSaints, the value of which was capped at $5,000 per year. 

In late March, on the heels of a jury trial centering on the gender discrimination claims, Judge Gabriel Gorenstein, a federal magistrate judge for the U.S. District Court for the Southern District of New York, ordered that Varvatos pay over $5.2 million in damages and legal fees to the class of female employees.

Within a couple of months of the jury verdict and subsequent attorney’s fees award, Varvatos had filed for bankruptcy protection without paying the multi-million dollar sum it owed to the plaintiffs. As a result, Knox sought to gain an upper hand in terms of the $5.2 million by asking the Delaware bankruptcy court to essentially downgrade the secured claim held by Varvatos’ existing private equity backer Lion Hendrix Cayman Ltd. (“Lion”). In an inter-bankruptcy complaint filed in June, Knox argued that she and the other class action plaintiffs are entitled to “equitable subordination,” a bankruptcy mechanism that would preserve their right to payment by reordering their claim and that of secured creditor Lion Capital. 

Lion, as a secured creditor, has priority over Knox and the other class action plaintiffs, which is a problem, she argued, given that Lion “fully understood that [Varvatos] engaged in intentional and illegal sex discrimination through its [employee] clothing allowance policy.” Because “Lion currently controls the [Varvatos’] Board of Directors, and therefore controls  the company,” it “not only encouraged [Varvatos] to continue that discrimination, but facilitated it,” Knox argued.

Against that background and in light of the fact that Varvatos has “disclosed that its proposed sale [to Lion] would all but extinguish [Varvatos’] unsecured creditors,” Knox argued that equitable subordination – or a reordering of the relative priority of claims due to the misconduct of one creditor that causes injury to others – is warranted here since in order to ensure that she and other plaintiffs are paid before Lion acquires Varvatos and thereby, forgives some $76 million in existing debt. 

Unfortunately for Knox, the U.S. Bankruptcy Court for the District of Delaware did not agree. In a decision dated July 10, Bankruptcy Judge Mary F. Walrath dismissed the complaint after asserting in a virtual hearing that the plaintiffs failed to make their case as to Lion’s involvement in Varvatos’ discriminatory clothing allowance policy. Unsatisfied with the outcome, counsel for Knox has since appealed the court’s decision, and in the meantime, Knox has joined a number of other unsecured creditors of Varvatos that are seeking to block the Lion deal by filing a motion on July 11 to “join the objection of the Official Committee of Unsecured Creditors” on the basis that “she is entitled to equitable subordination of the asserted liens of the proposed credit bidder, Lion Hendrix Cayman Ltd. as requested in [her previous] adversary proceeding.” 

The pool of unsecured creditors is taking issue with Varvatos’ motion for an order approving the sale of its assets to Lion “free and clear of claims, liens, and encumbrances.” 

*The case is Tessa Knox v. Lion/Hendrix Cayman Limited, 20-50623 (U.S. Bankruptcy Court for the District of Delaware).