In re Nine West: A Second Wind for the Creditors of America’s Sinking Clothing Brands
Introduction
In 2014, the era of brick-and-mortar retail in America was in its twilight, rapidly losing ground to online stores. Private-equity buyout firms snatched up known clothing brands, stripped them of the costs associated with maintaining a physical presence in malls across America, and repositioned them as online-only sellers. One of these buyout firms was Sycamore Partners, who in 2014 purchased the Nine West brand, among others.1 The acquisition took the form of a merger between Sycamore Partners subsidiaries and Nine West’s parent company, Jones Group, Inc.2 A Merger Agreement was executed and the public shareholders, directors, and officers of the Jones Group were bought out for approximately $1.2 billion (collectively, the “Transfers”).3 The surviving company was called Nine West Holdings, Inc. (hereafter, “Nine West”), and was controlled by Sycamore.4 Nine West then performed a coup de grâce on itself by selling three of its brands to Sycamore affiliates.5
During the subsequent Chapter 11 bankruptcy of Nine West, filed in Southern District of New York four years later, these Transfers came under attack by trustees (the “Trustees”) seeking to claw the money back into Nine West’s bankruptcy estate so that it could be redistributed via the reorganization plan to creditors.6 Under Chapter V of the Bankruptcy Code, a trustee, in furtherance of its fiduciary duties to the bankruptcy estate and its creditors, may bring fraudulent transfer claims and claw back sums of money wrongly transferred. The recipients of the Transfers (i.e., the public shareholders, directors, and officers) (the “Defendants”) defended themselves by arguing that the Transfers were shielded from such an attack by the Bankruptcy Code’s safe harbor provision, Section 546(e).7
The Nine West LBO Securities Litigation is the nexus of several areas of law, including bankruptcy, agency, and the law of corporations. It is about how and to whom Section 546(e)’s safe harbor protections should be applied. As to the how, the Second Circuit held that a transfer-by-transfer approach should be employed, and not a contract-by-contract approach.8
As to the whom, the Court held that in each transfer where Nine West had control over a facilitating bank, Nine West qualified as a “financial institution” under the statute and thus a covered entity protected by the safe harbor provision.9 Taking the how and the whom together, the Court concluded that when deciding the applicability of section 546(e), “courts [in the Second Circuit] must look to each transfer and determine when a bank is acting as agent for its customer for a transfer.”10 Where the customer has principal control over the bank as an agent, those transfers may be safe harbored.
Here, applying this rule to the facts, the Second Circuit concluded that the transfers of money to the Jones Group’s former public shareholders were safe harbored, whereas the transfers to the Jones Group’s former officers and directors were not.11
Inception
When the merger between the Jones Group and Sycamore Partners’ subsidiaries was consummated, the Merger Agreement between them outlined the terms for public shareholders to receive payments upon cancelation of their shares in Jones Group (the “Public Shareholder Transfers”).12 To implement those payments, the Merger Agreement called for a “paying agent” to be hired.13 Wells Fargo Bank was thus retained via a Paying Agent Agreement.14 The Merger Agreement also set forth the terms for former directors, officers, and employees of the Jones Group to receive payment for their shares at the close of the merger (the “Payroll Transfers”).15 Jones Group’s payroll processor, Automated Data Processing, Inc. (“ADP”) made these payments.16
The Trustees, seeking to reverse the Transfers, claimed that the directors and officers of Jones Group had arranged the merger and sold the company’s most valuable assets at a fraction of their value to Sycamore’s affiliates.17 In the process, they had placed the most successful product lines outside the reach of creditors and consolidated debt with the post-merger Nine West – handicapped and doomed to insolvency.18 The Defendants argued that the Transfers were shielded by the Bankruptcy Code’s Section 546(e) safe harbor provision.19
The safe harbor provision limits a trustee’s avoidance powers.20 Specifically, Section 546(e) states that “settlement payment[s] . . . made by or to (or for the benefit of) a . . . financial institution, . . . or . . . transfer[s] made by or to (or for the benefit of) a . . . financial institution . . . in connection with a securities contract ” are “precluded” from avoidance.21 The Bankruptcy Code defines “financial institution” to include not only banks, but also a customer of a bank “when [the bank] is acting as agent . . . in connection with a securities contract.”22
In August of 2020, consolidated litigation resulted in the dismissal of the Trustee’s claims.23 The District Court, adjudicating the safe harbor defense on a contract-by-contract basis, held that (a) the Transfers were indeed settlement payments in connection with a securities contract and (b) Nine West was a “financial institution,” as contemplated by the statute.24
An appeal at the Second Circuit followed with the Trustees and the Defendants disagreeing as to the scope of the term “financial institution” in the safe harbor provision.25 The Trustees argued that the definition as enumerated by the Bankruptcy Code encompassed bank customers, such as the Jones Group, only in transactions where the bank is acting as their agent, while Defendants argued that it applies more broadly to “any transaction related to a securities contract so long as the bank acted as their agent at one point in connection with that contract.”26 Additionally, the parties disputed whether Wells Fargo, the bank which served as paying agent to the merger, acted as Nine West’s agent in the Transfers.27
The Second Circuit’s Majority Opinion
The Court concluded that the qualification of a “financial institution,” as contemplated by the statute, must be determined using a transfer-by-transfer approach.28
The Court first pointed out that the language of Section § 101(22)(A) “creates a link between a bank ‘acting as agent’ and its customer with respect to a transaction.”29 “To satisfy that link, the plain language of 101(22)(A) indicates that courts must look to each transfer.”30 Although not stated outright, the Court seems to imply that whether a financial institution qualifies under the statute, turns not on whether its agent is acting in connection with a securities contract generally, but instead whether they are acting as such in connection with the specific transfer at issue.31 Further, the Court reasoned that “[a] contract-by-contract interpretation . . . would lead to the absurd result of insulating every transfer made in connection with an [leveraged buyout], as long as a bank served as agent for at least one transfer.”32
Second, the Court noted that because the Code’s structure allows for the limitation of avoidance actions, to apply a contract-by-contract approach would “undermine the avoidance powers that are so crucial to the Bankruptcy Code.”33 “Interpreting the safe harbor . . . broadly . . . would limit the avoidance power even where it would not threaten the financial system.”34
Third, the Court explained that “Congress enacted the safe harbor in 1982 to shield certain transfers that, if avoided by trustees, could trigger systemic risk in financial markets.”35 By applying a contract-by-contract approach, “transfers not implicating banks acting as agents would be shielded, although they did not pose such a risk, whereas a transfer-by-transfer would more precisely target those transfers which did.”36 “[T]he Payroll Transfers were not paid through Wells Fargo and Congress’s concerns about the settlement of securities transactions are not implicated.”37 Therefore, “the purpose of the safe harbor provision further supports the transfer-by-transfer interpretation.”38
Applying this transfer-by-transfer approach, Nine West’s Transfers only qualified for protection where they were facilitated by a bank operating as their agent.
Focusing on agency, the Court sought a “control element” in each of the Transfers, to determine whether Wells Fargo acted as Nine West’s agent. Citing the Restatement (Third) of Agency, the Court held that because Wells Fargo primarily facilitated the Public Shareholder Transfers “on behalf of Nine West, and Nine West maintained control over the transactions,” whereas the Payroll Transfers were instead primarily facilitated through ADP, only the Public Shareholder Transfers facilitated by Wells Fargo were protected per the plain meaning of the statute.39
Conclusion
In conclusion, merger transactions in which banks are retained to facilitate money transfers may be safe harbored in Second Circuit bankruptcy proceedings on a transfer-by-transfer basis, not a contract-by-contract basis. Therefore, the prudent take-over manager may consider structuring major transfers such that they are each expressly facilitated by banks operating as their explicit agents. For those transfers which have already occurred, transfer recipients should likewise consider their exposure to avoidance attacks in the Second Circuit on a more conservative, transfer-by-transfer basis.
* Elias is an associate attorney in the Houston office of McGinnis Lochridge, L.L.P. and serves as the Liaison of Public Education for the Young Lawyers Committee of the SBOT Bankruptcy Law Section.