Mervyn's Creditors Land $166M Deal in PE Buyout Suit (Law360)

Creditors of Mervyn's LLC scored a $166 million settlement in litigation over a 2004 leveraged buyout where several private equity firms allegedly leeched valuable real estate assets out of the department store chain, according to documents filed Friday in Delaware bankruptcy court.

In 2008, Mervyn's unsecured creditors sued Sun Capital Partners Inc., Cerberus Capital Management LP, Lubert-Adler and Klaff Partners LP and others involved in the $1.26 billion acquisition of the chain from Target Corp., claiming the deal left Mervyn's insolvent after the buyers stripped owned real estate and favorable leases from the company to back $800 million in buyout loans.

The defendants — which also include Target — continue to deny the allegations after agreeing to resolve the litigation, maintaining that Mervyn's was adequately capitalized and solvent in the wake of the buyout, according to settlement papers filed by the company's official committee of unsecured creditors.

"In an effort to avoid further costs and lengthy time associated with the expensive and protracted prosecution of the estate actions, the parties engaged in extensive, arm's-length and good faith negotiations that concluded in the settlement presently before the court," the committee said.

The settlement still requires the approval of U.S. Bankruptcy Judge Kevin Gross.

Mervyn's filed for bankruptcy in July 2008 and liquidated its 175 stores later that year after failing to reorganize at the height of the financial crisis.

The complaint over the buyout, filed as an adversary proceeding in bankruptcy court, accused the private equity buyers of engaging in a series of fraudulent transfers that separated Mervyn's from its real estate assets while they reaped $58 million in fees for the transaction.

"Mervyn's began the day of the closing with more than $1 billion of real estate, and within the blink of an eye, it was gone," the creditors said. "Mervyn's received nothing in return."

Moreover, according to the complaint, the deal increased the company's rent obligations by some $80 million annually to help the private equity firms service the debt taken on in the acquisition. For its part, Target allegedly breached its fiduciary duty to Mervyn's creditors for selling into a buyout that left the company on the verge of bankruptcy, the suit said.

The settlement also resolved claims in a separate committee adversary suit that sought to re-characterize a $30 million loan Mervyn's made to Sun Capital in 2007 as an equity contribution, according to the settlement.

Representatives for Sun Capital and Cerberus did not immediately respond to requests for comment Tuesday.

Before filing for bankruptcy, Mervyn's had 18,000 employees in locations throughout California and the Southwestern U.S. The company reported a $64 million loss on net sales of $2.5 billion for the fiscal year ending Feb. 2, 2008, according to court documents.

The committee is represented by Jay R. Indyke, Ronald R. Sussman, Cathy Hershcopf and Seth Van Aalten of Cooley LLP and Neil B. Glassman and Ashley B. Stitzer of Bayard PA.

Cerberus is represented by Schulte Roth & Zabel LLP.  Sun Capital is represented by Kirkland & Ellis LLP.

The cases are Mervyn's LLC v. Lubert-Adler and Klaff Partners LP et al., case number 1:08-ap-51402, and the Official Committee of Unsecured Creditors of Mervyn's Holdings LLC et al. v. SCSF Mervyn's (Offshore) Inc. et al., case number 1:09-ap-50887, in the U.S. Bankruptcy Court for the District of Delaware.

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