Toys ‘R’ Us Creditors’ Lawsuit Accuses Directors, Private-Equity Owners of Fraud

By | March 16, 2020

Toys “R” Us Inc. creditors filed a lawsuit accusing the defunct retailer’s executives and private-equity owners of fraud and breach of fiduciary trust.

Former Chief Executive Officer David Brandon and other directors misrepresented the toy seller’s ability to repay creditors after it filed for bankruptcy in 2017 while collecting millions in bonuses and advising fees, according to the complaint filed in New York Supreme Court. The case is being brought by a trust created for creditors, including toymakers.

Toys “R” Us liquidated in 2018, leaving those vendors and workers scrambling for funds too limited to meet all claims. That’s prompted years of recrimination against onetime owners KKR & Co., Bain Capital, and Vornado Realty Trust, who bought the company in 2005 in a deal that critics said left the retailer unable to make investments to remain competitive.

A lawyer representing Toys’ former executives and directors called the lawsuit “baseless” and said the group would defend against it “vigorously.”

“At all times, the former directors and officers of Toys “R” Us and members of management acted in the best interests of the company and its stakeholders. Because none of the named defendants has any financial exposure, this lawsuit is just a misguided effort to pressure insurance carriers to pay meritless claims,” Bob Bodian of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo P.C. said in an emailed statement.

No Hope

The suit claims that the company’s stewards didn’t disclose that Toys had to meet certain milestones it had no hope of achieving when it took on a $3.1 billion bankruptcy loan, and that it misrepresented the company’s financial situation to avoid losing that funding.

“The DIP financing strategy was not only a foolish gamble, it was a very expensive gamble,” the complaint says, claiming that it cost Toys more than $700 million in financing fees, interest, professional fees, and additional operating losses that were borne not by Bain, KKR, and Vornado, but trade creditors and employees.

Managers assured suppliers that Toys wouldn’t default and that they could continue shipping on credit right up until the company announced its liquidation, resulting in more than $600 million in losses to vendors, the suit says.

“The directors gave no consideration — none at all — to assessing the probability that the DIP financing strategy would fail,” the creditors say, and refused to consider alternatives such as selling parts of the company. Nor did executives make needed cost cuts, even as sales withered and the company’s chances for recovery narrowed.

Unusually Contentious

The situation has been unusually contentious, according to Greg Dovel, one of the lawyers who brought the case, which he said came months after negotiations among the parties stalled. Dovel said in an interview that he spoke with more than 100 parties while preparing the litigation.

“We talked to a lot of trade creditors in gathering evidence,” he said. “Years later, they still have a great deal of anger over this. They really want their day in court.”

The suit also asserts that Brandon and other executives awarded themselves $16 million in bonuses on the eve of the company’s bankruptcy filing, while KKR, Bain and Vornado collected more than $250 million in advising fees from the time of their acquisition, including after the company became insolvent in 2014.

Executives on an earnings conference call in December 2017, “failed to mention the disastrous holiday results,” and Brandon spoke of the company’s plan to emerge from bankruptcy and its “bright future,” according to court papers. The company also misrepresented its situation when it met manufacturers at a major industry trade show that February — though at that point they knew a significant lender group was in favor of a liquidation, creditors said in court documents. Instead, Brandon told attendees at a roundtable that the company would emerge from bankruptcy.

The company didn’t stop ordering goods until March 14, the day before it announced it was liquidating.

After the company’s collapse left 33,000 workers without severance, its owners came under intense pressure from former employees and high-profile politicians like former presidential candidates Elizabeth Warren and Cory Booker to create a fund to pay severance. KKR and Bain created a $20 million fund in late 2018.

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