J Crew Blocker: Don’t Believe the Hype

11 May 2018
A recent Reuters' article indicated that lenders are successfully negotiating a provision to block borrowers from transferring material intellectual property out from under secured lenders. Reuters reported that “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.” We’ve reviewed 730 credit agreements since the J Crew maneuver and only 14 contain a J Crew blocker. So this is clearly not widespread.
 
And not all J Crew blockers are created equal. Not only are there a number of different types of J Crew blocker provisions, but most of them don’t fully block the transfer of material IP away from secured lenders. The different types of blockers we’ve seen and our thoughts on each are below.
 
Ex. 1 - Designation from Restricted to Unrestricted: “no Restricted Subsidiary that owns Material IP may be designated as an Unrestricted Subsidiary.” This provision doesn’t fully protect lenders. Material IP can still be transferred to unrestricted subsidiaries after their designation.
 
Ex. 2 - Designation and also a Block on Transfers: In combination with the language in example 1, one particular agreement also includes language at the end of the investment covenant that states “no Loan Party shall be permitted to make any new Investment in any Unrestricted Subsidiary in the form of Material IP”. This language gets closer to plugging the loophole, but it still fails to prevent a two-step approach where the IP is first transferred to a non-guarantor restricted subsidiary and then to an unrestricted subsidiary.
 
Ex. 3 Ability of an Unrestricted Subsidiary to Prepay Debt. “no Unrestricted Subsidiary may engage in any transaction described in subsections 8.8 [RPs] (with respect to the prepayment of any Senior Notes) or 8.15 [Debt Prepayment] if the Borrower is prohibited from engaging in such transaction.” This language deals with the J Crew issue in a different way. Instead of blocking the transfer of material IP it restricts the ability to use an unrestricted subsidiary to engage in a distressed exchange. But this tactic doesn’t deal with the stripping of material IP out of the secured lenders collateral.
 
Ex. 4 – Transfers to Unrestricted Subsidiaries: “no Intellectual Property that is material to the business operations of Holdings and its Subsidiaries and no licenses that are necessary to run their business (the foregoing, collectively, “Material IP”) shall be permitted to be transferred to any Unrestricted Subsidiary, whether by designation hereunder or other transfer or disposition”. This approach leaves room to transfer material IP to non-guarantor restricted subsidiaries. And many agreements these days (44% in large sponsor loans and 30% in middle market sponsor loans) permit unlimited investments in non-guarantor restricted subsidiaries.
 
Ex. 5 – Transfers Outside Credit Group: “no Material Intellectual Property owned by any Loan Party may be contributed as an Investment by any Loan Party to any non-Loan Party.” This is the best approach for lenders since it ring fences the material IP within the group of entities that guarantees the loan. Notice that none of the other blockers restrict the ability to transfer material IP to non-guarantor restricted subsidiaries (foreign subsidiaries or a holdco of a foreign subsidiary).
 
Ex. 6 – Asset Sales: “the Borrower shall not, nor shall it permit any Restricted Subsidiary to, directly or indirectly, make any Disposition of Material IP Assets to any Person other than the Borrower or a Domestic Subsidiary.” This provision only restricts sales of Material IP and doesn’t restrict transfers by way of the investment covenant. Another way sponsors are attempting to water down the J Crew blocker is in the definition of “Material IP”. The current market practice is to define it as “IP material to the business or operations of the Borrower or its Restricted Subsidiaries.” However, we’ve recently seen attempts to weaken this definition to “IP owned by any Loan Parties that, if disposed, would reasonably be expected to result in a Material Adverse Effect.” This second definition has two problems. It’s entirely possible that a Material Adverse Effect may not be triggered by transferring material IP and it captures material IP owned by Loan Parties (the entities that guarantee the loan) as opposed to all restricted subsidiaries.
 
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Justin has over 15 years of experience as a finance attorney and worked closely with the founders to build this leading covenant research product. He previously worked at Sidley Austin and Morgan Lewis.