NEW YORK — The LF Brands saga continues.
This story first appeared in the January 20, 2004 issue of WWD. Subscribe Today.
As former employees began receiving checks for back pay last week — beginning with the lowest paid first — W. John Short, the defunct company’s former chief executive officer, filed a complaint Friday against LF Brands and its majority owner, Three Cities Research Inc. (and its affiliates), seeking in excess of $3.7 million in compensatory and consequential damages.
The complaint, filed in Supreme Court in New York County, claims that LF Brands and Three Cities Research breached a series of employment contracts with Short, who was “relieved of his duties” as LF Brands’ ceo and chairman of the executive committee in early November, more than a month before the company abruptly shut its doors and terminated all its employees on Christmas Eve without back pay, severance or health insurance.
Short is represented by Peter B. Zlotnick of law firm Mintz Levin Cohn Ferris Glovsky and Popeo here.
J. Richard Budd 3rd, chief restructuring officer at LF Brands, said as of Friday night that he hadn’t seen the complaint, and officials at Three Cities did not return a phone call Friday. Rick Darling, president of Li & Fung U.S.A., LF Brands’ sourcing agent, had not seen the suit as of Saturday.
According to the complaint, when Three Cities Research began negotiating to buy the majority of the shares of LF Brands (which at the time was publicly traded) in November 2001, it was apparent the company would incur significant losses for the financial year ending Dec. 31, 2001. That month, LF Brands was de-listed and became a private company, with Three Cities Research and its affiliates controlling more than 80 percent of the company’s shares. The company decided then it needed to initiate a search for a new ceo (replacing John Ward), and Short was hired in March 2002 to turn around LF Brands.
During the interview process, Short learned that LF Brands had experienced significant losses in 2001, was expected to post additional losses for 2002 and would fall short of the sales and profit forecasts previously provided to the company’s lender, according to the complaint. During those initial discussions with Willem de Vogel, founder and managing partner of TCR, and LF Brands’ management, it was understood that LF Brands “was likely to lose all of its capital during the 2002 year and would need a significant injection of equity capital in order to operate. The initial estimate of equity capital necessary to recapitalize the company was a minimum of $10 million,” the filing noted.
The filing said Short wouldn’t relocate his family from Arizona and risk his professional reputation in an attempt to turn around the ailing LF Brands, unless “TCR committed in advance to invest an amount equal to or at least the minimum amount of equity needed to restructure the company’s capital and to provide certain protections [to Short] if the turnaround effort failed.” De Vogel agreed that TCR would commit not less than $10 million in new equity in LF Brands if Short agreed to join the company, the filing claimed.
Short agreed to become ceo and chairman of the executive committee through March 31, 2006, at a base salary of $650,000 per year, increasing to $750,000 per year on July 1, 2003. He also received an initial signing bonus of $500,000. The filing also said he was entitled to receive an annual bonus of up to 100 percent of his annual base salary. Furthermore, the filing noted that LF Brands would sell Short 10 percent of its outstanding common equity on a fully diluted basis pursuant to a restricted shares agreement at a purchase price of $120,000. It said the company would provide him with a five-year loan to assist in the purchase of the common equity.
The filing explained that TCR “made the decision not to invest the necessary equity capital to fund the strategic plan outlined by [Short] and approved by the LF Brands’ board of directors, despite its commitment to do so. Instead, TCR eventually loaned money to the company, adding debt and interest expense to the already overburdened company’s financial difficulties.”
The filing noted that, by TCR investing $8 million as debt instead of equity at a time when de Vogel knew LF Brands “was technically insolvent,” TCR knew LF Brands’ secured creditors would have priority over LF Brands’ equity holders, including Short, to recover their investments in a liquidation or bankruptcy. The filing added that, if Short knew de Vogel’s commitment to invest $10 million in equity in LF Brands would never be acted on, he never would have joined the firm. He also would never have invested $120,000 to acquire a 10 percent equity stake in the firm in March 2002, according to the filing.
The claim stated that, by early September 2002, LF Brands had “a negative net worth, no access to trade credit, auditors unwilling to certify the ‘going concern’ status of the business, more stringent lending criteria from CIT under the Facility and more losses forthcoming with no commitment from TCR or any other financial source to fund its operating needs.”
Additionally, the filing noted that, in late 2002, TCR decided not to provide further funding to the company, forcing it to look to outside investors. According to the complaint, LF Brands received bridge financing in the form of a $3 million standby letter of credit issued in favor of CIT and expiring Dec. 31, 2003, in order to enable the company to make critical payments for part of its already-late fall 2003 product. This additional debt brought the total TCR group investment to $11 million, the filing noted.
Eventually, LF Brands arranged “yet another high-interest loan from LF International, to support a portion of its cash needs.” LFI is a subsidiary of Li & Fung Ltd., the Hong Kong-based global supply chain management company. According to the filing, Short negotiated the sourcing agreement with Li & Fung. During the spring and summer of 2003, a dispute arose with Li & Fung Trading relating to the procurement and manufacturing of some of the company’s products. LF Brands had claims against L & F Trading for about $2.9 million, according to the complaint.
At the time L & F Trading entered into the sourcing deal with LF Brands in July 2002, the filing claimed that L & F Trading accumulated a substantial unsecured collateral position with respect to the flow of the firm’s inventory pipeline in the range of $10 million to $15 million.
Around July 28, 2003, LFI said it would participate in a private placement of subordinated debt and common stock of LF Brands. The reasons, according to the filing, were “to obtain collateral for its unsecured $10 million to $15 million pipeline inventory that Li & Fung had found itself financing; to resolve a supply chain management performance failure by dispute, and to continue its exclusive global sourcing arrangement with LF Brands.” The filing noted that LFI “ultimately purchased the entire $5 million debt as a secured participation in the CIT facility.” In addition, LFI was expected to receive warrants equal to 40 percent of the common stock of LF Brands, and when the transaction was consummated, the filing said, it resulted in LFI receiving warrants equal to 20 percent of LF Brands’ outstanding stock.
One component of the LFI transaction was that TCR agreed to vest LFI with certain powers to appoint and dismiss non-TCR directors, and the right to veto any of the corporate actions of LF Brands, such as mergers or acquisitions or declarations of bankruptcy. In addition, LFI obtained the right to dismiss the ceo and the chief financial officer of the company without the consent of any party, according to the filing.
The filing claimed that the LFI loan gave it “effective operating control” of the company and “staved off a bankruptcy filing that would likely have resulted in significant financial losses to certain LFI affiliates. As a result of this change in control, LFI induced TCR and the company to remove [Short] as the company’s ceo and chairman of the executive committee, and he was forced to resign from LF Brands’ board of directors.”
LF Brands has not yet filed for either liquidation or bankruptcy under Chapter 7 or Chapter 11, despite sources saying since the beginning of the year that the company was expected to do so shortly.
The complaint states that Short hasn’t been paid any of the severance or other amounts to which he believes he was entitled under the various agreements he had with the parties.