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Tuesday, February 12, 2013

The JC Penney Lawsuit

A couple of weeks ago, an ad hoc group of bondholders, acting through the indenture trustee, sent a notice of default to J.C. Penney, claiming that the company had breached the indenture by giving its working capital bank lenders a lien on inventory without complying with the equal and ratable clause of the indenture and giving the bonds a share of the lien (even though it appears this practice had been employed annually for several years without prior complaint).

JCP then sued the indenture trustee in Delaware Chancery fora  declaratory judgment that it was not in default.

I read the papers and didn't think it was all that interesting (or meritorious) a suit.  It's a simple contract interpretation and the language is also very simple. Basically, the indenture gives the bondholders a equal and ratable lien on Principal Property which is defined to be anything that is "part of" a store.  So the case depends on whether you interpret "part of" in just the physical sense (in ch case inventory is not physically part of a store, it's eminently severable from the physical store) or in the concptual sense (there is no "store" without inventory).  I imagine the court declines to answer the question from the document itself and takes testimony, which I expect will show that (1) Principal Property is generally used and understood in the stricter physical sense and not the looser conceptual sense, and (2) retailers jealously guard their inventory against liens, because trade creditors place enormous weight on the inventory being free from liens before they will extend terms, and the only time you would grant a lien on it would be to the lender financing your inventory, never to your old money bondholders.

I was wondering why bondholders would bring what looks ultimately like a weak suit and figured it was something desperate and time-sensitive, such as maybe they had CDS that was going to run off soon and they were trying to force a credit event to collect before the CDS expired.  But Zero Hedge, master conspiracy spotters, had a much more interesting explanation.  Based on the facts that Bill Ackman has a big bet on J.C. Penney, that Carl Icahn and Ackman are famously at war with each other, that the suit was filed just a few days after the two went after each other on CNBC, that a big slug of the bonds traded right around the time of the suit, and the suit is brought by a law firm that has worked for Icahn often in the past, Tyler Durden posits that Icahn is behind the suit.

Now that makes sense. It's not about the merit of the lawsuit.  It's personal.  And it's a lot more interesting to watch now.