What can restrict a spin off?

[muscleman]

I have been thinking about SHLD and some other similar companies in this late night, and I remember famous value investors said that they could spin off a lot of wonderful assets because their debt is unencumbered.

I am a little bit confused about this. I thought there was only one case that would make the spin off unrestricted, which is the case like MBIA. They have two subs, and the structured sub's debt is non-recourse to the parent. But for SHLD, it doesn't look like the debt of the subs are non-recourse, but they still have spun off a few assets, and they are currently talking about spinning off more. Can anyone please enlighten me on this matter? If they spin off the wonderful assets in a nightmare scenario, and then the parent goes to bankruptcy, doesn't that mean fraudulent conveyance? I know that fraudulent conveyance has 1 year limit, so if they keep some assets in the parent to make it afloat for one year, it should be good?

Anyway, what can restrict a company from spinning off the wondering assets and in a nightmare scenario, protect equity shareholders?

[muscleman]

No one?

[morningstar]

Typically debt issued as investment grade has few covenants that would prohibit such transactions, which of course are mostly bad for creditors. So SHLD has a lot of freedom to spin out assets. Yes, there could be a fraudulent conveyance issue if the company ended up going bankrupt, but in addition to having to go bankrupt within a reasonably near timeframe, it would also have to be determined that the spinoff left Sears in a certain amount of financial distress. Which would be challenging to prove in a court, I think, with Sears at a 5bn market cap and Lands End just a small fraction of that value.

 

If they were worried about fraudulent conveyance, Sears could also end up using the same tactic as in the Orchard spinoff where they raised debt at the new entity to pay a dividend up to Sears, to provide some deleveraging to offset the spin.

 

High yield bonds/leveraged loans typically have covenants restricting spinoff transactions and other restricted payments to shareholders, junior creditors, etc. So that's what prevents spinoffs in a lot of cases.

[muscleman]

Typically debt issued as investment grade has few covenants that would prohibit such transactions, which of course are mostly bad for creditors. So SHLD has a lot of freedom to spin out assets. Yes, there could be a fraudulent conveyance issue if the company ended up going bankrupt, but in addition to having to go bankrupt within a reasonably near timeframe, it would also have to be determined that the spinoff left Sears in a certain amount of financial distress. Which would be challenging to prove in a court, I think, with Sears at a 5bn market cap and Lands End just a small fraction of that value.

 

If they were worried about fraudulent conveyance, Sears could also end up using the same tactic as in the Orchard spinoff where they raised debt at the new entity to pay a dividend up to Sears, to provide some deleveraging to offset the spin.

 

High yield bonds/leveraged loans typically have covenants restricting spinoff transactions and other restricted payments to shareholders, junior creditors, etc. So that's what prevents spinoffs in a lot of cases.

 

I see. So there is a lot of leeway to get by fraudulent conveyance. Could you please explain a bit more about the Orchard case? If I understand correctly, SHLD wanted OSH to carry a boat load of debt at the time of spin off, but worried if that would case fraudulent conveyance, so they didn't do that. Instead they waited for a year for the fraudulent conveyance case to become invalid, and then they let OSH borrow money and pay SHLD the dividend. Then OSH got into chp 11 but no one could claim fraudulent conveyance now?

 

In addition to SHLD, I am also looking at FIATY's potential spin off. Its CEO once mentioned that in the worst case, they can spin off Ferrari and Chrysler to shareholders, and let Fiat die. So that is a bit different from the SHLD vs OSH case, because the child is the valuable one instead of the parent. How would they avoid fraudulent conveyance in that case?

[phil_Buffett]

Typically debt issued as investment grade has few covenants that would prohibit such transactions, which of course are mostly bad for creditors. So SHLD has a lot of freedom to spin out assets. Yes, there could be a fraudulent conveyance issue if the company ended up going bankrupt, but in addition to having to go bankrupt within a reasonably near timeframe, it would also have to be determined that the spinoff left Sears in a certain amount of financial distress. Which would be challenging to prove in a court, I think, with Sears at a 5bn market cap and Lands End just a small fraction of that value.

 

If they were worried about fraudulent conveyance, Sears could also end up using the same tactic as in the Orchard spinoff where they raised debt at the new entity to pay a dividend up to Sears, to provide some deleveraging to offset the spin.

 

High yield bonds/leveraged loans typically have covenants restricting spinoff transactions and other restricted payments to shareholders, junior creditors, etc. So that's what prevents spinoffs in a lot of cases.

 

I see. So there is a lot of leeway to get by fraudulent conveyance. Could you please explain a bit more about the Orchard case? If I understand correctly, SHLD wanted OSH to carry a boat load of debt at the time of spin off, but worried if that would case fraudulent conveyance, so they didn't do that. Instead they waited for a year for the fraudulent conveyance case to become invalid, and then they let OSH borrow money and pay SHLD the dividend. Then OSH got into chp 11 but no one could claim fraudulent conveyance now?

 

In addition to SHLD, I am also looking at FIATY's potential spin off. Its CEO once mentioned that in the worst case, they can spin off Ferrari and Chrysler to shareholders, and let Fiat die. So that is a bit different from the SHLD vs OSH case, because the child is the valuable one instead of the parent. How would they avoid fraudulent conveyance in that case?

 

muscleman great Topic! iam also interesting in this question. i hold both sears and fiat, and would be interesting to hear the exact Definition.

[JAllen]

This depends on each individual issue of debt.  All loan docs must be sorted through to determine what exactly can be done, again for each issue of debt, not just each company.