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American Apparel's Next Step Is Likely The Courthouse

Stocks in this article: APP

NEW YORK (TheStreet) -Ousted American Apparel (APP) CEO Dov Charney disclosed Tuesday that he now owns a 43% stake, which could mean the next step for the company is the courthouse, according to an expert.

Shares were sinking 5.3% to 85 cents on Tuesday as the boardroom saga at the T-shirt and basics retailer took another right turn.

According to a new Securities and Exchange Commission filing, Charney owns 74.5 million shares, or 43% of American Apparel's outstanding stock, as of June 27. Charney, who previously owned approximately 27%, was able to amass a more significant stake through a partnership with Standard General, a New York-based hedge fund.

Charney disclosed in an SEC filing last week that he had entered into a partnership with Standard General in which the firm would acquire at least 10% of shares of American Apparel. Standard General would loan Charney the money to buy the shares from the firm. The loan terms include: an interest rate at "10% per annum;" a maturity date of July 15, 2019; and that Charney and Standard General "will agree to vote their shares only as agreed between them," the filing said.

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American Apparel retaliated on Saturday, adopting a one-year shareholder rights plan, or so-called poison pill, that is triggered if any one shareholder attempts to purchase more than 15% of the company's shares. Additionally, if any shareholder that already owns more than 15% of the stock, i.e. Charney, acquires an additional 1% of stock, the pill is triggered as well. Poison pills dilute voting rights and are a backstop against hostile takeovers.

"The rights plan is designed to limit the ability of any person or group, including Dov Charney, to seize control of the company without appropriately compensating all American Apparel stockholders," American Apparel said in a press release.

According to Tuesday's filing, Charney was obligated to purchase the shares and claims to be beneficial owner of the shares. The total purchase price of the 27.4 million shares was $19.6 million. Charney also disclosed in the new filing he had sent a letter to the board calling for a special meeting of stockholders for Sept. 25 of this year. Charney is looking to amend the company's bylaws to boost the number of directors to 15, among other things.

Now that Charney essentially owns a 43% stake and is trying to get a majority vote, according to the New York Post, it would seem as if he is trying to take over the company.

The back and forth that's going on at American Apparel essentially means one thing now -- the board and Charney are likely heading to court.

"This is most definitely going to end up in Delaware court," said Gary Hewitt, head of research at GMI Ratings, a leading corporate governance and data provider. American Apparel is incorporated in Delaware.

One of the issues that will likely end up in litigation is the specific timing of the most recent share purchases by Charney via Standard General, versus when the poison pill was implemented, Hewitt stated. The question becomes did Charney beneficially own the shares purchased by Standard General before the pill was implemented?

It would seem so, since Charney's most recent filing uses the date June 27 - one day before the company implemented the poison pill. However the filing wasn't on the SEC's website until a few days later.

Even if Charney's 43% stake is deemed beneficial, acquiring even just 1% more will trigger the poison pill, Hewitt said. With the addition of the poison pill, American Apparel's board has fortified itself enough that it would be a "time-consuming process to take control of the company," according to Hewitt.

American Apparel already held its annual shareholder meeting back in April. Additionally, the company has what's called a "classified" board, meaning all directors are not re-elected every year. More recently, the board has taken away shareholders right to call a meeting and made it harder for shareholders to act by written consent, according to Hewitt.

Shares have soared since June 18, gaining 40%, the day before the Los Angeles-based company announced that it had "terminated" Charney, 45, who founded the company in 1997.

The longer the fight between Charney and American Apparel's board goes on for, the more likely that the only option for the company would be to find a buyer. American Apparel is facing a potential liquidity crisis as the deadline (a deadline of July 4 according to media reports) nears for its to repay its $10 million loan to Lion Capital, following the removal of Charney.

An American Apparel spokeswoman declined to comment.

--Written by Laurie Kulikowski in New York.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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