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American Apparel Now Risks Credit Default by Firing CEO Charney

Stocks in this article: APP

NEW YORK (TheStreet) -- American Apparel's (APP) controversial founder Dov Charney was ousted as chairman on Wednesday, but the company's debt situation may provide more troubles ahead.

Its June 18, SEC filing states that the suspension of Dov Charney as CEO "may be deemed to have triggered an event of default under the Credit Agreement, dated as of May 22, 2013."  

Management has remained mum on the specifics of its credit agreements, but has admitted it is working with creditors to amend its covenants. Within these covenants, there must be language that states, if positions of top management are changed, that would constitute an "event" that breaches contract. This is similar to if the company were to unexpectedly raise more debt without telling lenders, which would increase the debt-to-equity ratio and over leverage the company. American Apparel is in the process of getting this part of the covenant amended, but if it is unable to do so, it will default.

The U.S. clothing retailer is known for its over-the-top advertising campaigns, however, the board seems to have had enough with Charney's risque conduct.

In the past, Charney has been fairly open with his sleazy behavior. His exhibitionism has included engaging in a sex act with an employee during an interview with Jane magazine. He was also featured in a company add titled "in bed with the boss."

After a recent investigation into unspecified misconduct, the board finally decided it had seen enough and suspended its current chief executive and chairman for a contractual 30-day waiting period, then plans to fire him.

"We take no joy in this, but the board felt it was the right thing to do," Allan Mayer, who has been on the board since 2007, said in a public statement. Mayer was reportedly named co-chair in the process.

American Apparel's stock accelerated higher on the Charney news, nearly 25% above Tuesday's close. The penny stock closed at 68 cents, up 4 cents (or 6.47%) Thursday.

Although the company is taking a step in the right direction by firing the CEO, it may still have financial troubles ahead that could adversely affect its share price.

American Apparel reported a net loss of $106.3 million in 2013. Now management changes may have triggered a default.

In April, the New York Stock Exchange warned that the retailer would be delisted if it didn't sort out its "financial impairment."

Alongside falling sales, a heavy debt-load, which required a $13.4 million interest payment on April 15, has caused the company financial instability.

John Luttrell, the company's chief financial officer and interim chief executive, was out of the office and could not be reached for comment on American Apparel's debt situation.

It is assumed, however, that if the retailer cannot get its lenders to waiver the default terms, the company's share price will plunge even farther into penny-stock territory.

The ousting of its CEO is progress, but the remaining risks that lie behind the surface of American Apparel continue to make it an unattractive investment.

Note: This article contains one or more stocks with a market cap under $2 billion. Such small-cap stocks tend to be volatile.

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At the time of publication, the author had no position in any of the funds mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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