Rather, in our view, Chewy presents a warning story about how a borrower can pave different baskets for a result that creditors might not have foreseen. Some law firms and leveraged finance review sites have proposed credit document revisions to protect creditors from another Chewy incident. While such proposals are well-intentioned (and may be necessary in some cases), we believe that proposals such as banning dividend and distribution baskets for distribution of equity create complications for borrowers and sponsors and, ultimately, are not accepted by sponsors and their holding companies. In the meantime, many lenders have heard about J. Crew`s actions to remove their valuable intellectual property from guarantees that insure their long-term loans and asset-based credit facilities through the intelligent (though controversial) use of transactions authorized under the negative agreements that are included in credit contracts for these credit facilities (the “baskets”). Given that the lenders probably accepted the transfers and the process barrier was crossed, the IPO was ready to trigger the IPO, leading to an IPO of Chewy on the NYSE in June 2019. At the end of the day, PetSmart`s creditors received a payment on PetSmart`s ipo revenues (approximately 15% of the term loans were repaid) and PetSmart`s credit rating was revalued (from CCC to B- from S-P and from Caa1 to B3 from Moody`s). PetSmart approached the management and guarantee agent for its credit facilities and requested confirmation of the release of the guarantee and pledge rights, but the administrator and lenders refused to cooperate. There have been disputes in which PetSmart`s lenders have, among other things, questioned the calculations used to evaluate the baskets used by PetSmart for transfers and asserted that transfers and distributions made PetSmart insolvent. PetSmart`s credit agreement and withdrawals contained an automatic release regime which in fact provided that a subsidiary, when no longer fully owned by PetSmart, would be automatically released from its security obligations and that all pledges granted on the assets of that subsidiary would be revoked. Given the transfers mentioned in the previous recital, Chewy had become a subsidiary of PetSmart that was not 100%.
As a result, PetSmart considered that it was in good faith to be able to require creditors to release Chewy from its security obligations and terminate all pawn rights to Chewy`s assets1. In recent years, secured lenders have seen their value deteriorate. The examples of J.Crew, Claire`s and finally PetSmart draw attention to the provisions allowing the removal of potentially valuable guarantees. As a result, lenders have processed the relevant provisions in the debt documentation for new transactions. PetSmart`s transfer of approximately 36.5% of Chewy is the latest example of security loss. Issuers are generally able to make these transfers with a combination of investment baskets. First, issuers use a basket that allows them to transfer the assets of subsidiaries of limited loan parties to limited non-lender subsidiaries. Sometimes this capacity is capped, as in the case of J.Crew and Hilton; in other cases, there is no limit (for example. B to Revlon).
Second, issuers use a basket that allows restricted, loan-free subsidiaries to invest in unlimited subsidiaries, effectively putting guarantees out of reach of secured lenders. Lenders respond by pushing issuers to impose conditions to impose stricter controls on the use of unlimited subsidiaries, as well as on the amount and type of assets that can be transferred.