Revlon, Inc. (NYSE: REV), the cosmetics giant controlled by Ron Perelman, reported a 52.2% drop in year-over-year EBITDA for the third quarter. This is causing some investors to ask if Perelman may find it advantageous to push Revlon’s valuable intellectual property assets beyond the reach of creditors using the same technique that J.Crew and other issuers have used. In this report, the Debtwire legal analyst team discusses the investment capacity and debt and lien capacity available under Revlon’s debt agreements to answer the question—can Revlon “pull a J.Crew?”
In a J.Crew-style transaction, one of Revlon’s non-guarantor subsidiaries would use IP assets received from transferee guarantor subsidiaries and use them to secure structurally senior priming debt with a new lender—say, for instance, Perelman’s holding company, MacAndrews & Forbes. The non-guarantor subsidiary could make payments on the new priming debt with fees generated from licensing the transferred brand assets back to Revlon. Using this type of structure, Perelman’s holding company would have a claim on any transferred assets ahead of Revlon’s existing secured creditors.
Revlon’s debt agreements provide substantial debt and investment capacity for a J.Crew-style asset transfer and subsequent priming debt transaction. Specifically, there are no limitations on asset transfers to Foreign Subsidiaries, and Foreign Subsidiaries are permitted to incur at least USD 485.1m of secured debt. Revlon could also use available investment capacity to move at least USD 384.3m of assets to an Unrestricted Subsidiary, which would not be subject to debt or lien restrictions.
But “pulling a J. Crew” could be risky business. J.Crew faced intense litigation from debt holders who argued that J.Crew’s tactics failed the leverage test and blew other covenants, among other arguments. However, we believe that with proper transaction structuring, Revlon could avoid the problems that J.Crew faced in litigation.
Revlon’s Capital Structure
How to “Pull a J. Crew”
Transfers to Unrestricted Subsidiaries
All of Revlon’s debt agreements have similar Unrestricted Subsidiary regimes.  As is typical, a transfer of assets to an Unrestricted Subsidiary (either a new or existing one) requires investment capacity. Below we summarize the requirements to transfer assets to an Unrestricted Subsidiary (subject to our discussion below regarding moving assets through the “trap door” in the credit agreements):
- Designation of a Restricted Subsidiary as an Unrestricted Subsidiary constitutes an investment and therefore requires investment capacity equal to the fair market value of the assets held by the subsidiary so designated. Investment capacity could also be used to transfer assets to an existing Unrestricted Subsidiary. In the credit agreements, the designation of an Unrestricted Subsidiary also requires the absence of any pro forma Default or Event of Default.
- Any transfer of assets from Revlon or its Restricted Subsidiaries to an Unrestricted Subsidiary must also comply with the asset sale covenants, which govern both asset sales and asset transfers. This test is easily satisfied for Revlon because, as is typical, the asset sale covenants exempt transfers that constitute permitted investments.
Unrestricted Subsidiaries are not subject to any (or at least most) of debt agreement’s restrictive covenants, and therefore Unrestricted Subs can issue any amount of secured debt the market will bear. Because an Unrestricted Subsidiary is not required to guarantee Revlon’s debt, any new debt at an Unrestricted Subsidiary would be structurally senior to debt issued by Revlon, meaning that lenders to an Unrestricted Subsidiary would have first dibs on any assets held by that subsidiary before the holders of Revlon’s existing debt.
Investment Capacity in the Credit Agreements: The Trap Door
Similar to J.Crew, the investment covenants in Revlon’s credit agreements contain “trap-door” provisions that increase investment capacity beyond the obvious dollar-cap baskets. While the trap door in both J.Crew and Revlon necessitate two step transactions to increase investment capacity, the trap door mechanics in Revlon are a bit different from J.Crew’s. Revlon’s trap door is more like a black hole.
In Revlon, the ABL and Term Loan credit agreements put no limit on the transfer of assets to a Foreign Subsidiary or an Unrestricted Subsidiary (though there do exist limitations on transfers of cash). This means that unlike the Notes, under the credit agreements there is no need to tally dollar cap investment baskets when the transfer of IP assets (or any non-cash asset) is the subject of interest: all asset transfers are permitted using the trap door.
Specifically, the trap-door provisions in the credit agreements’ investment covenants (namely, sections 7.7(j) and 7.7(z)(ii) read together) allow the Company and its Restricted Guarantor Subsidiaries to transfer an unlimited amount of assets to Restricted, Non-guarantor Subsidiaries (such as Foreign Subsidiaries). Restricted, non-guarantor subsidiaries are themselves permitted to make unlimited investments in any non-guarantor subsidiary, including Foreign Subsidiaries and Unrestricted Subsidiaries. To take advantage of this trap-door, then, the Company could simply use a two-step transaction to first transfer any amount of assets first from a guarantor into a Foreign Subsidiary, and second, from the Foreign Subsidiary into an Unrestricted Subsidiary. Fortunately, Company’s notes indentures do not contain trap door provisions.
Investment Capacity in the Indentures
The 2021 Notes are the most limiting instrument in Revlon’s capital structure with respect to investment capacity, and therefore control Revlon’s maximum investment capacity. Assuming no prior usage, the 2021 Notes have approximately USD 384.3m of readily identifiable investment capacity in the following baskets:
- General Restricted Payment Basket: USD 20m
- Unrestricted Subsidiary Basket: Greater of USD 20m / 1.5% total assets (USD 47.52m at 3Q17)
- General Investment Basket: Greater of USD 125m / 10% total assets (USD 316.8m at 3Q17)
If Revlon can meet a 2.0x fixed charge coverage ratio (“FCCR”) test,  additional capacity may also exist in the 2021 Notes CNI-based builder basket which is backdated to November 2009, although we note CNI has recently been negative. There is also a basket for investments in a “Permitted Business,” broadly defined to include any related business, for the greater of USD 75m / 6% of total assets (USD 190.1mm at 3Q17) which could arguably be used to “invest” in an Unrestricted Subsidiary whose only business activity is licensing intellectual property. We believe, however, that reliance on the Permitted Business basket would increase litigation risk.
The 2024 Notes have significantly greater investment capacity, with at least USD 550m in general baskets or baskets designated specifically for Unrestricted Subsidiaries. Additional amounts may be available in the 2024 Notes buildup basket (based on CNI and building from late 2016, with a USD 250m starter amount minus recent net losses), unused amounts in the annual USD 40m carryforward RP basket and the USD 250m basket for investments in a Related Business.
Transfers to Foreign Subsidiaries
All of Revlon’s debt agreements permit unlimited non-cash asset investments by and among Revlon and its Restricted Subsidiaries, which includes most (if not all) Foreign Subsidiaries. The credit agreements place conditions on cash contributions to Foreign Subsidiaries, but, unusually, do not limit non-cash investments. Unlimited investment in Restricted Subsidiaries (whether guarantors or not) is a typical permission in indentures, and is permitted in Revlon.
Like Unrestricted Subsidiaries, any debt at a Foreign Subsidiary would be structurally senior to debt issued by Revlon and its subsidiary guarantors because Foreign Subsidiaries do not guarantee Revlon’s debt. Unlike Unrestricted Subsidiaries, however, Foreign Subsidiaries are subject to the debt covenants in Revlon’s credit documents, which limitations are discussed in more detail below.
Once assets have been transferred to a non-guarantor subsidiary, those assets can be used as credit support for debt that is structurally senior to Revlon’s existing debt.
Structurally Senior Debt at Unrestricted Subsidiaries
As discussed above, the amount of debt that an Unrestricted Subsidiary can incur is not limited by any debt or lien covenants. We estimate that Revlon has at least USD 384.3m of investment capacity to transfer assets to an Unrestricted Subsidiary, so it is safe to assume that transactions could be structured to have an Unrestricted Subsidiary incur a like amount of debt. All such debt would prime the debt held by Revlon’s existing creditors.
Structurally Senior Debt at Foreign Subsidiaries
We estimate Revlon has at least USD 485.1m of secured debt capacity for Foreign Subsidiaries. Like for investment capacity, the 2021 Notes are the most restrictive instrument for debt at Foreign Subsidiaries and therefore sets Revlon’s upper limit. The available baskets for debt in the 2021 Notes are as follows:
- General Basket: USD 200m
- Foreign Subsidiary Basket: USD 110m / 9% total assets (USD 285.1m at 3Q17)
If satisfied, additional debt under a 2.0x FCCR test could be incurred by Foreign Subsidiaries up to a maximum of USD 175m. Foreign Subsidiaries are not subject to the lien covenant in the 2021 Notes (or any of Revlon’s debt agreements), so any such debt can be secured.
We estimate that the credit agreements and the 2024 Notes all have at least USD 550m of capacity for secured Foreign Subsidiary debt.
Revlon Could Avoid J.Crew’s Litigation Quagmire
J.Crew’s lenders challenged its IP transfer and priming debt transaction on three main grounds. First, they argued that the company failed the leverage test required to designate Unrestricted Subsidiaries. Second, lenders asserted the transfer of a partial, 72.04% interest, rather than a complete 100% interest, in the J.Crew trademark violated several provisions in the term loan and security agreements. Third, they asserted that the terms of the IP licensing agreement between J.Crew and the Unrestricted Subsidiary violated the affiliate transactions covenant.
If Revlon engaged in a J.Crew-style transaction, it could likely avoid all of these issues. First, Revlon is not required to satisfy a leverage test to designate unrestricted subsidiaries. Second, unlike J.Crew, Revlon’s investment capacity is such that it should be able to transfer 100% of at least one (and likely more) of its marks to a non-guarantor, thereby avoiding the problems involved in the transfer of partial interests. Lastly, knowing that any IP transactions might receive close scrutiny, Revlon could be careful to draft licensing agreements with terms that comply with its affiliate transactions covenants.
So having learned J.Crew’s lessons well, and with sufficient debt and investment capacity, we believe Revlon could move essentially all of its valuable intellectual property outside the reach of its existing creditors, who in such event would need to start thinking creatively to avoid structural priming.
by Brian Darsow
Brian Darsow is a member of Debtwire’s legal analyst team. Brian previously worked as a corporate finance and securities attorney at Paul, Weiss, Rifkind, Wharton & Garrison LLP and Dorsey & Whitney LLP. He joined Acuris in 2016.
Any opinion, analysis, or information provided in this article is not intended, nor should be construed, as legal advice, including, but not limited to, investment advice as defined by the Investment Company Act of 1940. Debtwire does not provide any legal advice, and subscribers should consult with their own legal counsel for matters requiring legal advice.
 The credit agreements and the 2024 Notes all contain standard concepts of what constitutes an “Unrestricted Subsidiary.” The 2021 Notes use a related, but not identical, concept of “Non-Recourse Subsidiaries.” For the purposes of this report, the concepts are interchangeable.
 We estimate that Revlon’s FCCR was approximately 1.63x at 9/30/17, based on LTM Adj. EBITDA of USD 300m and interest expense of USD 184m.