Byline: Vicki M. Young

NEW YORK — The intense scrutiny of the business operations of bankrupt retailers by their creditors can sometimes provide insight into certain not-so-nice corporate practices.
Pending in two federal bankruptcy courts are lawsuits by creditors in the Montgomery Ward case in Delaware and in the Crowley, Milner & Co. case in Michigan, both detailing allegations of the accounting games played by management.
The Montgomery Ward matter, filed this year against General Electric Capital Corp. and certain affiliates, involved charges that GE Capital “manipulated Ward’s financial structure and the timing of Ward’s second bankruptcy filing to benefit its own credit card and marketing businesses” and maximize for itself certain tax advantages.
The lawsuit said that creditors were “duped into extending hundreds of millions of dollars in unsecured credits to the debtors” and that GE Capital made millions in loans secured by the retailer’s real estate, creating a fiction that GE Capital was supporting Ward’s. The delay in Ward’s bankruptcy filing, the lawsuit charged, diminished by “tens of millions” the value of Ward’s estate.
In addition, the lawsuit charged that Jack Welch, former chief executive officer of GE, “arranged a GE grant of stock worth $2.5 million to [Ward’s ceo Roger] Goddu as a quid pro quo for Goddu rejecting J.C. Penney’s offer” of the ceo spot and remaining at Ward’s. Goddu was approached by Penney’s in May 2000.
In the Crowley, Milner case, which was filed in September 2000 and also involved the unsecured creditors from the Steinbach Stores Inc. bankruptcy, the lawsuit detailed a “price reduction down inventory accounting system” that allegedly “inflated the true value of the debtors’ inventory.” Since the working capital facility was asset-based, the inaccurate financial information allowed the retailers to “borrow more funds under their [facility] than otherwise would have been available.” The lawsuit was filed against Dennis Callahan, who was chairman, president and ceo, and John Dellacqua, who was chief financial officer, secretary and treasurer.
The suit charged that the scheme involved periodic inflation of the ticketed selling price of merchandise, along with point-of-sale discounts or other markdowns to reduce the actual price paid by customers. The inflated ticket prices allegedly increased the sales margin, and at the same time were used to offset the point-of-sale discounts. Because the accounting system involved the offsetting of current period markdowns against presumed future markups, it allegedly crashed when a drop in inventory purchases in the fourth quarter of 1997 left the perpetrators of the scheme unable to generate new “dollars” to offset actual markdowns.
While the shenanigans charged in the two lawsuits suggest serious violations of corporate mismanagement, experts say that among the thousands of retail operations in the U.S., those allegations are more often the exception than the rule.
Adam Rogoff, restructuring partner at the law firm of Cadwalader, Wickersham & Taft, with a specialty in retail bankruptcies, said: “Generally in the retail cases I have been involved in, I have not seen many instances of accounting improprieties being alleged.” Rogoff represents the Crowley, Milner debtors and, if the unsecured creditors are successful in their lawsuit against Callahan and Dellacqua, would be responsible for disbursing any recovery to creditors.
He noted that the number of financial players typically involved in the lending syndicates and factors that review the financial records — often on a quarterly basis — help to cut down on the irregularities that might creep up.
Ronald Sussman, bankruptcy litigation partner at Kronish Lieb Weiner & Hellman, observed that irregularities come to light more frequently when a company is liquidating because of the structure of the bankruptcy process.
“By the very nature of a successful Chapter 11, deals are being made so everybody can be happy. Conversely, in a liquidation, when all interested parties are looking at what scraps are left, it is naturally more contentious and suspicions arise,” Sussman said.
Sussman’s firm is involved in both creditor lawsuits.
In Montgomery Ward, GE Capital filed its answer this month denying charges and seeking to dismiss the lawsuit. Creditors are seeking at least $500 million in damages and an order that GE’s $1 billion in claims be subordinated behind the claims of creditors.
The defendants in Crowley, Milner were unsuccessful in having the $25 million lawsuit dismissed, and the case is still proceeding through the court system.

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