American Apparel Control War Escalates as Charney Adds Stake

Jul 02, 2014 4:15 pm ET

(Updates with closing share price in fifth paragraph.)

July 2 (Bloomberg) -- Two weeks after an unceremonious ouster from American Apparel Inc., Dov Charney has a fighting chance of wresting back control of the clothing retailer he founded 16 years ago -- even as his opponents show no signs of backing down.

Charney’s fellow board members suspended him as chief executive officer last month for a litany of alleged misdeeds said to range from misuse of company funds to retaliating against a former employee that sued him for sexual assault. The company has enlisted a firm that specializes in investigations to help it dig up more dirt on Charney, and it’s making hay over the founder’s request that American Apparel return a computer containing his personal photos.

Since being canned, Charney has refused to walk away from the company and is now within arm’s reach of making his return a reality. Helped by a loan from a hedge fund, he increased his stake to 43 percent of the retailer’s shares, just shy of the majority he needs to reshape the board with handpicked directors who could reinstate him. He’s now poised to take his appeal directly to the shareholders and would need the support of just more than 7 percent of the base to get his way.

“His chances of succeeding look pretty good,” said David Rosewater, a partner for Schulte Roth & Zabel LLP in New York who has worked on consent solicitations in the past. “It is not a very high bar to get to a majority of the outstanding.”

The shares have rallied since Charney’s ouster on June 18, surging 36 percent through yesterday. Much of the gain came on June 27 when American Apparel rallied 30 percent as Charney boosted his stake. The stock fell 4.6 percent to 83 cents at the close today in New York.

Retailer’s Survival

The drama is the latest saga in a succession of ups and downs since the Los Angeles-based chain started trading publicly in 2007. It rapidly opened stores in the middle of last decade when it became a hip place to shop for basics like T-shirts, peaking with a 41 percent sales gain in 2008. By 2009, the chain faced what would become one of several cash shortfalls that it’s survived by borrowing money, selling shares and convincing lenders to amend credit agreements

The company found some solid ground in the first half of last year with sales rebounding until a malfunctioning distribution center stalled the turnaround. The company had to raise capital again, this time by selling stock to the public.

That recent patch of turbulence, combined with Charney’s controversial history and the board’s investigation, culminated last month in his suspension and a plan to fire him within 30 days. The 45-year-old has been sued for sexual harassment multiple times with all the cases either being dismissed or going to private arbitration.

FTI Role

The board is using FTI Consulting Inc. to intensify its investigation of Charney, according to a person familiar with the situation who asked not to be named because the matter is private. FTI is a global advisory firm that works on issues ranging from business reputation to investigations.

Charney’s lawyer recently sent a letter to American Apparel asking it to hand over a server on company property that contained Charney’s personal photos without accessing any of them, according a person familiar with the situation. The company is assessing if it has the legal right to access the server, the person said. Another person said the request stems from a legal agreement between Charney and the company that set up a server for him to safely store his photos, some of which were used by the company, and to only be accessed by him.

Charney last week returned fire by buying 27.4 million shares, boosting his stake in American Apparel to 74.6 million shares, according to regulatory filings. The purchase was funded by a loan Charney got from Standard General LP last week.

Charney, an American Apparel spokesman and Nicole Madison, a spokeswoman for FTI, declined to comment.

Board Expansion

The founder’s increased holdings may help him expand the board so that a majority of the directors would be his own nominees and could give him back the CEO job. After the company blocked his attempt to execute that plan through a special meeting, Charney is now resorting to a tactic called a consent solicitation, which would allow him to add his directors if he can win approval from holders of more than half of the shares.

In response to Charney’s attempts to regain control, the board last week adopted a one-year takeover defense plan, a so- called poison pill, that would dilute the shares if Charney adds 1 percent more to his current stake in the company. Charney’s most recent share purchases didn’t trigger the plan because they preceded its adoption.

Holdings Enlarged

Board members enlarged their holdings yesterday, with Co- Chairmen David Danziger and Allan Mayer and directors Robert Greene, William Mauer and Marvin Ingelman each acquiring 11,494 shares from American Apparel, according to regulatory filings. Combined they now own about 750,000 shares, which is less that 0.5 percent of the outstanding shares.

If Charney’s consent solicitation is approved by the U.S. Securities and Exchange Commission, shareholders would have as long as 60 days to mail in their votes on the plan.

The company’s directors also are trying to negotiate a settlement with Lion Capital LLP, a creditor to the retailer, that would prevent a chain reaction of defaults that would dry up the company’s access to capital.

Lion had a stipulation in its loan agreement with American Apparel that said a change in CEO could trigger a default and allow it to demand payment. Lion, which has loaned the retailer money in the past, isn’t granting a waiver and is asking to be paid, according to a person familiar with the situation. Shona Prendergast, a spokeswoman for Lion Capital, has declined to comment.

Default Risk

That decision threatens to trigger a default on a $50 million credit line with Capital One Financial Corp., under which $30 million is drawn, because of cross-default provisions in the agreements. A default also means American Apparel would lose access to $20 million available under that pact.

Capital One is holding its own talks with the company’s management and working to get Lion back on board with granting a waiver, according to one of the people.

“Charney is not going to back down easy, so there’s going to be a lot more twists and turns,” said Damien Park, a managing partner at Hedge Fund Solutions LLC in Philadelphia, which researches and consults on activist investing. “This thing is going to be a roller coaster.”