Department store operator Mervyn's has sued three private equity firms and Target Corp., alleging that the leveraged buyout of the chain from Target was a fraudulent deal that stripped Mervyn's of valuable real estate and doomed it to bankruptcy.
The retailer said the private investors financed the 2004 takeover with $800 million borrowed against Mervyn's real estate, then leased the properties back to Mervyn's at "substantially increased rates."
Cerberus Capital Management, Sun Capital Management and Lubert-Adler have taken $400 million out of the company since acquiring it in 2004, leaving it struggling to pay creditors, Mervyn's said in papers filed Tuesday with the U.S. Bankruptcy Court in Wilmington, Del.
The result "ultimately led Mervyn's to bankruptcy and is a fraudulent transfer that cannot withstand scrutiny," attorneys for the company said.
Hayward, Calif.-based Mervyn's is battling to stay alive in Chapter 11 by closing underperforming stores and persuading vendors to help it keep its shelves stocked with goods.
If it succeeds, the lawsuit could mean more money for creditors, including banks owed about $329 million. Defendants are the private equity giants, banks that financed the transactions and Target, which sold Mervyn's to Cerberus, Sun and Lubert-Adler.
"Target emphatically disagrees with the claims against Target in this lawsuit," said Target Corp. spokeswoman Hadley Barrows. "Our 2004 sale of Mervyn's was an arm's-length transaction that was the result of a competitive bidding process."
Cerberus spokesman Peter Duda said the suit lacks merit.
A spokesman for Sun Capital Partners declined to comment on the suit, which seeks the return of $58 million in transaction fees and other damages as well as a court order allowing Mervyn's to reclaim its real estate. Other named defendants declined to comment or couldn't be reached.
Mervyn's lawsuit tackles a favored technique of the last wave of leveraged buyouts, which have begun washing up in bankruptcy. Acquirers took advantage of the high value of real estate to finance the purchase of retailers such as Mervyn's in transactions that separated the real estate from the underlying business.
"The amputation of the real estate legs from the body of the retail operations ... was all done in a split-second series of concurrent transfers orchestrated by" the private equity firms, Mervyn's attorneys said.
According to Mervyn's, it received only $8.3 million out of the deals that deprived it of its real estate, while the private equity firms, lawyers and investment bankers split $58 million in fees. Mervyn's lawyers say the real estate was worth about $1.68 billion.
Mervyn's real estate wound up in the hands of bankruptcy-proof companies so that creditors of the retailer could never reach the assets, the company alleges. According to the lawsuit, those behind the deal knew at the time this would leave Mervyn's without sufficient assets to survive.
In stage two of the real estate-based leveraged buyout, acquirers lock in a stream of cash flow through advantageous leases to the acquired companies. Mervyn's says its $172 million annual occupancy expense is $80 million higher than it would have been had the private equity firms not acquired it from Target and started charging rent.
Target sold Mervyn's to the three private-equity firms after closing the chain's Minnesota stores.
Staff writer Jackie Crosby contributed to this report.