Chapter 11 Debtor Toys “R” Us Creditors’ Case Approaches Tipping Point Moving to Trial
written by : Mazurkraemer Law Clerk Andrew Del Zotto- Villanova School of Law, Class of 2023
Toys “R” Us Creditors march toward trial in their adversary proceeding against former officers and managers The case will shed light on significant issues that arise given desperate attempts of distressed businesses as they slide into bankruptcy.
In September 2017, Toys "R" Us, Inc. and its affiliated entities (collectively, "TRU" or the “Debtors”) filed voluntary Chapter 11 petitions for relief in the United States Bankruptcy Court for the Eastern District of Virginia (“Bankruptcy Court”). The cases were jointly administered. At the time of the bankruptcy filing, the Debtors conducted the business of selling toys, childcare items, and related products on a global scale both online and in brick and mortar stores.
In March of 2018, the Bankruptcy Court entered an Order authorizing the Debtors to wind down U.S. operations and U.S. store closings and establishing administrative claims procedures. In connection with the wind-down, in July of 2018, the Debtors entered into a settlement agreement that resolved issues relating to the liquidation of U.S. assets. The settlement provided for the creation of a liquidation trust (“Trust”) for the benefit of the Debtors’ creditors.
In 2020, The Trust filed an adversary proceeding against the Debtors’ former officers and managers (“Defendants”) asserting a breach of fiduciary duties by:
Obtaining Debtor-in-Possession (DIP) financing at the start of the bankruptcy proceeding;
Authorizing retention payments to 114 company executives before the commencement of the bankruptcy proceeding; and
Authorizing the payment of $18 million of advisory fees to the Debtors’ private equity shareholders from the fourth quarter of 2014 through the first quarter of 2017.
The Trust further alleges that in an attempt to persuade its vendors to continue shipping goods and providing services to TRU on credit after the bankruptcy, Defendants misrepresented facts concerning the retailer’s ability to make payments. The Trust claims the total amount due to vendors totals more than $600 million. See TRU Creditor Litigation Trust v. Raether, et al, 20-03038, U.S. Bankruptcy Court for the Eastern District of Virginia (Richmond).
On June 28, 2022, Virginia U.S. Bankruptcy Judge Keith Phillips made a decision that for all but one issue (breach of fiduciary duty for DIP financing – summary judgment granted), the parties are going to jury trial.
Where Will the Case Go from Here?
Several legal questions are poised to be decided at trial. At the heart of the issue is a claim of breach of the former Toys “R” Us executives’ fiduciary duties. So, did the executives fulfill breach their duties when dishing out bonuses? While the answer to that question is unknown, the trial will almost assuredly address the actions of key Toys “R” Us executives at the time when bankruptcy was, at least according to the creditors, imminent. During this time, bonuses were paid to 114 Toys “R” Us executives and managers, the largest totaling $2.8 million to former CEO David Brandon.
Brandon, in the failed request for summary judgement, noted: “So long as a company is not insolvent, its Board members owe a fiduciary duty to the company and its owners, and can take actions that benefit the owners to the detriment of the company.” This comment raises another key question to be answered at trial: was Toys “R” Us already insolvent when it paid nearly $18 million to its private-equity backers – Bain Capital, KKR & Co., and Vornado Realty Trust – in the years immediately leading up to its bankruptcy declaration? The Trust argues that “TRU had been insolvent since at least 2014” and “the officers and directors of TRU each had a fiduciary duty to protect the value of TRU for TRU's creditors, and not merely to focus on advancing the interests of the majority equity holders-Bain, KKR, and Vornado.” Since Judge Phillips made it clear that solvency is a question of fact, this question will need to be answered by the jury at trial.
The final major legal issue looming stems from the creditors’ allegation that Toys “R” Us spent about $600 million on goods and services while well-aware of the company’s dire financial health. The relevant legal question is whether Toys “R” Us brass adequately disclosed to vendors that the company's finances were in such poor shape that store closures and large-scale shutdowns were coming. Surely, at the very least, creditors’ will be pursuing damages to recoup the losses from Toys “R” Us’ unpaid bills.
Sources:
TRU Creditor Litigation Trust v. Raether, et al, 20-03038, U.S. Bankruptcy Court for the Eastern District of Virginia (Richmond).
“Former Toys ‘R’ Us Executives Face Trial Over Botched Bankruptcy,” Jeremy Hill and Eliza Ronalds-Hannon, June 28, 2022. https://www.bloomberg.com/news/articles/2022-06-28/former-toys-r-us-execs-to-stand-trial-over-botched-bankruptcy
“Toys R Us creditors' lawsuit proceeds,” Richard Collings, June 29, 2022.
https://www.axios.com/pro/retail-deals/2022/06/29/toys-r-us-creditors-lawsuit-proceeds