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American Apparel Is In a Race For Survival

NEW YORK (The Deal) -- American Apparel's (APP - Get Report) founder Dov Charney is looking for a comeback as the board adopts an unusual poison pill trying to keep him at bay, while it negotiates with its lenders.

But its days may be numbered as an independent company, sources say, because pressed on all sides, a sale may be the best way out.

The shareholder rights plan was passed by the board Saturday, after Charney said in a securities filing on Friday that he had formed a pact with New York-based Standard General LP, for the event driven firm to buy 10% of the retailer's shares, and then loan Charney the money to buy that stake from the firm.

Charney, however, didn't waste a moment. In a regulatory filing Tuesday, he claimed that Standard General had already completed its share purchase Friday, meaning that Charney was now almost a 43% stake holder.

He also said, that, in his role as CEO, he was calling a special meeting of shareholders for Sept. 25 to enlarge the board and consider other proposals including the election of dissident nominees.

The drama unfolded after the board suspended Charney as CEO on June 18 over what it said was "alleged misconduct" including violating the company's sexual harassment policies and misusing corporate assets. Charney's attorney has denied the charges. After a 30-day cure period, he would be out as chief executive.

But whatever the problems with keeping Charney on, moving against him had its risks, as it could trigger default provisions in a $10 million loan advanced by Lion Capital.

Thus, the showdown between a board determined to rid itself of its troublesome founder and said founder.

The poison pill was aimed squarely at Charney and his backer. It had the standard 15% trigger threshold, but it also said that if Charney attempted to add even 1% to his current stake, the pill would go into effect.

And the event that meant he had increased his stake would be merely finalizing his share buy-and-sell agreement with Standard or even entering into a financing arrangement with the firm.

Standard, no patsy apparently, would get 10% on its loan in return for its troubles. The loan, which is due in 2019, would be backed both by the stake Charney already owns in the retailer and the shares he would acquire from Standard.

Standard did not respond to a request for comment.

American Apparel's new poison pill, as is typical, wouldn't affect a takeover proposal acceptable to a majority of shareholders. The company had said in the past that it wasn't seeking to sell. Peter J. Solomon Co. was hired as an adviser, though supposedly with the strict mandate only to assist the retailer with its capital needs. Nevertheless, sources said, that refinancing process could eventually lead to a sale, indeed, one industry observer said, a sale may be the company's best option if a buyer can be found.

And the board may not have much leisure time to weigh its options. Though the company said Monday it was in continuing negotiations with Lion Capital over the $10 million loan, it declined to comment further on the situation. Lion Capital declined to comment.

One of the big problems with American Apparel defaulting on the Lion Capital loan is that it could trigger a cross-default on almost $30 million drawn on a $50 million credit facility provided by Capital One Financial Corp.

When exactly the company will be in default on the $10 million loan, if it's not already, is debatable because either the board's suspending Charney as CEO has already acted as a default, or that time will come when the cure period is up.

Either way, the pressure is on and lenders are likely using the situation to demand better terms, a source said.

Besides the loan and credit facility, American Apparel has $206 million outstanding in secured first-lien 13% notes due April 15, 2020. Those aren't involved in the default over Charney's ousting; though if the Lion Capital loan exceeded $10 million, there could also be a problem under the covenants attached to those notes.

It is likely to no one's benefit, at this stage, however, to put the company in a position where it has to file for bankruptcy. A bankruptcy would likely wipe out stockholders, including Charney, one source said.

Lenders would not necessarily have the best chance for recovery under a bankruptcy filing in the near-term, as well, and even though they would have an influential voice in bankruptcy proceedings, they wouldn't necessarily have the final say, the source added.

And the company's board and management, as well, could lose control of the company's fate during bankruptcy proceedings. Especially when there's no plan going into reorganization proceedings, the typical outcome for retailers is liquidation.

But American Apparel is in such an unusual and messy position, sources have said, complicated by Charney's continued involvement and his past, that attracting new lenders or obtaining fresh capital at this stage will also be difficult.

An industry expert on bankruptcies said in a situation such as American Apparel's, where little makes sense and in which one of the key actors is not acting rationally, it's hard to have confidence in the company's survival.

When reached on Monday, Charney declined to comment.

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