Trapdoor (finance)

A trapdoor maneuver in financial restructuring refers to a technique that moves collateral into unrestricted subsidiaries and out of reach of existing creditors, particularly the movement of intellectual property.{{Cite news |last=Al-Muslim |first=Aisha |date=2020-08-26 |title=Distressed Borrowers Sneak Collateral Through 'Trapdoors' |url=https://www.wsj.com/articles/distressed-borrowers-sneak-collateral-through-trapdoors-11598465255 |access-date=2024-12-15 |work=Wall Street Journal |language=en-US |issn=0099-9660}} By transferring assets to a new subsidiary and licensing it back to the parent, new debt can be raised on the collateral stripped from the original creditors.{{Cite web |title=The J.Crew "trap door" and its implications for the future of leveraged finance {{!}} Insights {{!}} Torys LLP |url=https://www.torys.com/en/our-latest-thinking/publications/2019/05/the-j-crew-trap-door-and-its-implications-for-the-future-of-leveraged-finance |access-date=2024-12-15 |website=www.torys.com |language=en}}

The maneuver takes advantage of weak covenants in existing debt agreements. Companies first identify investment capacity in their existing covenants and then utilize this capacity to transfer collateral into a restricted, non-loan-party subsidiary. From there, the collateral is moved to an unrestricted subsidiary, making the collateral inaccessible to existing lenders.{{Cite web |title=J. Crew, Nine West, and the Complexities of Financial Distress |url=https://www.yalelawjournal.org/forum/j-crew-nine-west-and-the-complexities-of-financial-distress |access-date=2024-12-15 |website=www.yalelawjournal.org}}

The trapdoor was pioneered by retailer J.Crew in its 2016 restructuring to move US$ 250 million of trademarks to the Cayman Islands, where it was beyond the legal reach of existing lenders.{{Cite web |title=A "Trap Door" Intact: Fixing the J.Crew Blocker |url=https://www.orrick.com/en/Insights/2020/07/A-Trap-Door-Intact-Fixing-the-J-Crew-Blocker |access-date=2024-12-15 |website=www.orrick.com |language=en}} The new subsidiary was then used to raise US$300 million of incremental debt from Blackstone.

Since then, other companies in distress have also used the financial maneuver, including Travelport, Revlon, Neiman Marcus, Party City, and Cirque du Soleil.{{Cite web |date=2024-08-11 |title=Hedge Funds Smell Blood as Lenders Turn on Each Other |url=https://www.envoy.cirrus.bloomberg.com/news/features/2024-08-11/hedge-funds-are-capitalizing-on-rampant-creditor-on-creditor-violence |access-date=2024-12-15 |website=Bloomberg.com |language=en}} As of 2024, European companies have also begun using the maneuver in debt-management.{{Cite news |last=Fox |first=Sabrina |date=2024-04-16 |title=Comment est-ce qu'on dit "J Screwed"? |url=https://www.ft.com/content/9d07e82d-0dbd-40b5-a1ec-749edd308357 |access-date=2024-12-15 |work=Financial Times}}