Lawsuit Claims Hedge Fund Benefits if American Apparel Goes Bankrupt

An American Apparel class-action shareholder lawsuit filed April 29 claims that the apparel company is being held hostage by Standard General, the New York hedge fund that is a controlling stockholder, and that the hedge fund would reap enormous profits if American Apparel declares bankruptcy.

The lawsuit also claims that former and current board members breached their fiduciary duties by claiming in proxy statements that Dov Charney, the company’s founder, was an integral part of the brand. Once they were elected in June, they turned around and suspended Charney as the chief executive and removed him as the chairman of the board. Charney was terminated as the CEO in December.

American Apparel executives, in response to the lawsuit, said they were confident they would succeed on all of these meritless claims.

“Dov Charney, Dov Charney’s lawyer and other people related to Dov Charney continue to bring claims that are wrong on the facts and wrong on the law. Each of these claims is rooted is the exact same agenda. These meritless claims serve as public relations opportunities now, but they will each fail the test when put before a judge, according to an American Apparel spokesperson. "American Apparel’s new management is focused on restoring the financial health of the company and does not intend to waste time addressing each of these meritless claims in the court of public opinion. We are confident we will succeed on every one of these in the proper venue.”

An intricate financial tale is outlined in the latest lawsuit filed by shareholder and former American Apparel employee Eliana Gil Rodriguez in the Court of Chancery in Delaware. It details how Standard General was able to use American Apparel’s falling stock price to gain control of the company, the lawsuit said, even though sources close to Standard General said that is untrue.

At one time, Charney owned 43 percent of American Apparel’s stock, but a secondary stock offering of 61 million shares in March reduced his share to 27 percent.

After being suspended as CEO in June, Charney entered into an agreement with Standard General that if it acquired at least 10 percent of American Apparel’s outstanding shares, Standard General would loan Charney the funds to buy those shares from the hedge fund.

“While Charney viewed Standard General as a lucrative financing source to regain control of his company, Standard General saw an opportunity to take advantage of the former CEO and pursue a valuable investment opportunity.

“From June 26 to June 27, Standard General acquired 27.3 million shares of American Apparel common stock. After these purchases, Charney and Standard General controlled approximately 43 percent of American Apparel’s common stock,” court documents said.

In July, in a standstill agreement, Standard General agreed to invest approximately $25 million in American Apparel and was able to appoint seven of the company’s nine members who currently sit on the board of directors. This in effect gives the hedge fund de facto control of the board of directors, court documents said.

Sources close to Standard General said they only directly nominated three board members and agreed to the nomination of two others in conjunction with the old board.

While Standard General directly owns approximately 1.1 million American Apparel shares, Standard General has a security interest in Charney’s 74.5 million shares and he is required to vote his shares consistent with Standard General, the lawsuit said.

Also, if Charney defaults on his Standard General loan, which carries a 10 percent interest rate, all his stock transfers to Standard General. The loan matures on July 15, 2019.

“Instead of managing the company in such a way to maximize stockholder value, Standard General has positioned itself to make more profit based on the company’s failure instead of success,” the lawsuit said. “The company’s falling stock price allowed Standard General to purchase millions of American Apparel’s debt, such that if the company were to file for bankruptcy today, Standard General would be the company’s largest secured creditors."

A Standard General spokesperson said their debt is not secured and that "the allegations in the lawsuit are without merit," and they will prevail in this nuisance action.

Court documents reveal that in January, Irving Place Capital offered $1.30 to $1.40 per share to buy American Apparel. This represented a 103 percent premium over the stock price at that time, but the offer was turned down, legal papers said. American Apparel’s stock closed at 67 cents on April 30.

Sources close to American Apparel maintain that Irving Place Capital made an inquiry into buying the company's stock but never made a formal offer.

Rodriguez, in her class-action suit, is asking for declaratory relief from the court that includes findings that election of the last board members was illegally obtained and invalid and there should be another vote at a special stockholders’ meeting. Also that there was a “poison pill” amended to American Apparel’s bylaws that removed stockholder’s ability to call a special meeting and thwarts plans to employ directors who are open to a possible value-maximizing offer.

Named as defendants in the case are current and past American Apparel board members. They are Allan Mayer, David Danziger, Colleen Brown, Robert Greene, Alberto Chehebar, Marv Ingleman, William Mauer, David Glazek, Thomas Sullivan, Laura Lee and Joseph Magnacca. Also listed as defendants were former American Apparel Chief Financial Officer and interim Chief Executive John Luttrell and Standard General.