J.C. Penney Seeks to Bar Claim It Defaulted on Bonds

By Sapna Maheshwari & Jef Feeley – Feb 5, 2013 9:49 AM ET

J.C. Penney Co. (JCP) is seeking a court order barring bondholders from claiming the retailer defaulted on debt by entering an inventory-secured credit agreement last year.

Lawyers claiming to represent more than half of the holders of J.C. Penney’s 7.4 percent bonds due in 2037 sent the company a letter saying it defaulted by signing the credit pact in January 2012 without providing proper security for investors, the retailer said in a statement. The company filed a lawsuit in Delaware Chancery Court yesterday seeking to block bondholders’ efforts to declare a default.

Investors’ claims expose J.C. Penney to “imminent, irreparable harm,” the Plano, Texas-based retailer said in the complaint. The improper default claims could put the company at risk of demands for payment on more than $2.8 billion in debt, the attorneys added in the suit.

“The law firm involved is reputable in the restructuring space,” Liz Dunn, a New York-based analyst for Macquarie Group Ltd. in New York, said in a note. “Furthermore, the restructuring attorney we consulted characterized the move as aggressive and unusual on both sides of the table.”

The situation is a “negative development and fuel for the bears on the stock,” wrote Dunn, who has the equivalent of a hold recommendation on the shares. The balance sheet will be the focus of J.C. Penney’s next earnings report, she wrote. The company has said it will end the year with $1 billion in cash and an untapped credit line of $1.75 billion.

J.C. Penney fell 2.5 percent to $18.86 at 9:37 a.m. in New York. The shares slid 44 percent in 2012, compared with a 25 percent gain for the Standard & Poor’s 500 Retailing Index.

Credit Ratings

J.C. Penney’s credit ratings have been slashed in the past year as Chief Executive Officer Ron Johnson’s turnaround plan struggles to take hold. Moody’s Investors Service rates the company B3, six levels below investment-grade, with a “negative” outlook and S&P has an equivalent grade on the company, following three straight quarters of sales declines of at least 20 percent.

Johnson, the former retail chief at Apple Inc. (AAPL), has lost customers as he transforms most of the company’s stores into collections of 100 branded shops and reduces coupons and sale events by marketing items at an “everyday low price.”

Transformation Plan

In the company’s November earnings call, Chief Financial Officer Ken Hannah said J.C. Penney’s strong balance sheet is “positioned to be able to fund the transformation.” The retailer doesn’t have a bond maturity until 2015, data compiled by Bloomberg show.

The default claims, made by lawyers at Boston-based Brown Rudnick LLP, are a ploy “to create self-interested trading opportunities in the market, and we will therefore vigorously defend the interests of J.C. Penney and all of our constituencies in all appropriate forums,” Hannah said in yesterday’s statement.

James Stoll, a Brown Rudnick lawyer representing J.C. Penney bondholders, didn’t immediately return a call for comment yesterday on the retailer’s suit over the default claims.

J.C. Penney has $325.6 million of the 7.4 percent notes outstanding, according to data compiled by Bloomberg. The debt traded yesterday at 84.25 cents on the dollar to yield 9 percent, from 96.75 cents and a 7.7 percent yield about a year ago, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Bond Restrictions

In the suit, lawyers for the retailer contend restrictions on the 7.4 percent bonds don’t mean J.C. Penney is in default by signing the credit pact because the limitations don’t “encompass liens on inventory, but instead serves only to restrict liens” on principal property.

While the credit agreement has been in force for more than a year, J.C. Penney officials have only used it “to support letters of credit, none of which have been drawn upon,” the company’s attorneys said.

J.C. Penney has publicly disclosed for about 10 years that it has various undrawn credit facilities secured by inventory with no bondholder allegations of a violation, the lawyers said.

J.C. Penney had about $2.97 billion of long-term debt and $525 million of cash as of Oct. 27, according to the company’s most recent quarterly filing. The company is scheduled to report fourth-quarter earnings on Feb. 27. Sales may decline 24 percent to $4.13 billion, according to a Bloomberg survey of 15 analysts.

The case is J.C. Penney Co. Inc. v. US Bank National Association as Indenture Trustee, 8276, Delaware Chancery Court (Wilmington).

To contact the reporters on this story: Sapna Maheshwari in New York atsapnam@bloomberg.net; Jef Feeley in Wilmington, Delaware at jfeeley@bloomberg.net

To contact the editors responsible for this story: Robin Ajello at rajello@bloomberg.net; Michael Hytha at mhytha@bloomberg.net