In July 2016, Josh Bekenstein, co-chairman of Bain Capital, tapped then-Toys R Us CEO Dave Brandon for a favor. Bekenstein asked Brandon, a former fast-food mogul from his days as head of Dominos, to call the founder of Jimmy John's, whom Bain was courting for a possible investment.
Brandon responded, "I've done this for you guys 100 times! I'm happy to reach out to him."
That is according to a lawsuit filed in New York court by a trust representing more than 100 former Toys R Us creditors, most of them suppliers. In a scathing complaint, attorneys alleged that the toy retailer's former executives and private equity owners — who they say had deep relationships with each other — bilked Toys R Us of cash ahead of its disastrous bankruptcy and then pursued an expensive plan to revamp the retailer in Chapter 11. A plan which failed and left Toys R Us suppliers with hundreds of millions of dollars in unpaid claims.
The complaint accuses former Toys R Us executives and private equity owners of "breaches of fiduciary duty, fraudulent concealment, misrepresentations, and negligence" that led to hundreds of millions of dollars in losses for suppliers and other unsecured creditors. It also examines the deep, mutually dependent relationship Toys R Us executives, especially Brandon, had with the retailer's private equity owners.
It alleges, for example, that Brandon was paid above-market salary by Bain-controlled companies he worked for, which includes Dominos as well as Toys R Us. In an email cited by the complaint, Brandon said that Bain allowed him to invest in the firm's deals and funds and waived some of the fees and requirements.
Named as defendants in the lawsuit are Brandon, former CFO Michael Short and former chief merchant Richard Barry — who today heads TRU Kids, the entity that controls the dead retailer's intellectual property. Also named are former directors of Toys R Us' board, who were also employed by the retailer's private equity owners, Bain Capital, KKR and Vornado (Bekenstein included).
"At all times, the former directors and officers of Toys R Us and members of management acted in the best interests of the company and its stakeholders," Bob Bodian of Mintz, lead counsel for the former executives and directors named in the lawsuit, said in an emailed statement. "Because none of the named defendants has any financial exposure, this lawsuit is just a misguided effort to pressure insurance carriers to pay meritless claims. We will defend against this baseless lawsuit vigorously."
'Obvious conflict of interest'
Following Toys R Us' leveraged buyout, which left it with a debt load of more than $5 billion, the company paid tens of millions of dollars in fees back to its private equity sponsors, transactions that Toys R Us documented over the years in regulatory filings.
According to the lawsuit, Toys R Us directors, who also worked for the retailer's private equity sponsors, decided whether to renew the agreement to pay the fees and negotiate their amount.
"On its face, the agreement made no sense," the complaint states. "TRU paid large fees each quarter to Bain, KKR, and Vornado — the equity owners of the company. But Bain, KKR, and Vornado were not required to provide any actual services in exchange for these fees. Moreover, TRU was already paying expensive outside consultants, such as McKinsey and AlixPartners, for business advice."
Paying those fees was "an obvious conflict of interest" for Toys R Us' board, the complaint alleges, and the decisions to pay them should have been turned over to independent directors or consultants. From the fourth quarter of 2014 through 2017 the fees cost Toys R Us roughly $17.9 million, according to the complaint. Those years include times of market share losses and operational deterioration at Toys R Us.
According to court documents, between 2005 — the year of the buyout — and 2017, Toys R Us paid $250 million to its private equity owners.
'We have to be creative'
In an email from July 15, 2017, about two months before Toys R Us filed for bankruptcy, Brandon discussed his salary and those of his fellow executives with Toys R Us' chief talent officer, Tim Grace.
In the email, cited in the creditor lawsuit, Brandon said, "About a year ago you put us all in a room and explained that our base salaries ... particularly in leadership roles [and] our annual bonus percentages were over indexed to market" and "that the combination of the two was costing [TRU] millions of dollars in out-of-market, excess compensation."
Brandon's solution, per his email: "We have to be creative and design something that works for us. Outside stats and comparisons are not going to help us."
Later, lawyers with Kirkland & Ellis — who were brought on before the retailer filed for Chapter 11 and would represent the company through the process —told Brandon that bonuses for top executives would be under strict rules and scrutiny once Toys R Us was in bankruptcy.
So Brandon devised a plan that would pay a cash bonus of 75% of their base salary to himself and other top execs days before Toys R Us filed for bankruptcy. He directed consulting firm Alvarez & Marshal, whose co-founder Brandon also had a relationship with, to prepare an analysis that would support the bonuses, which it did, accord to the creditors' complaint.
Brandon got $2.8 million from the plan. The lawsuit alleges the bonuses were a breach of fiduciary duty and caused Toys R Us and its creditors to lose more than $16 million.
Burned in bankruptcy
Going into bankruptcy, Toys R Us negotiated for more than $3 billion in debtor-in-possession (DIP) financing, structured as an asset-based credit facility, meaning it was backed largely by Toys R Us' inventory.
This loan was meant to help Toys R Us modernize and adapt to a new competitive environment, where Amazon, Walmart and Target had become fierce competitors in the toy category, in the online and brick and mortar worlds.
The creditor lawsuit alleges that Toys R Us executives led suppliers to believe that Toys R Us' DIP loan contained no major milestones that it would need to reach to maintain funding. In fact, as Toys R Us attorneys would detail only much later, the company had holiday targets that it needed to hit, which it missed, forcing the retailer into default in early 2018.
In the meantime, Toys R Us was buying hundreds of millions of dollars worth of inventory from toy and baby product suppliers, up until March 2018. But Toys R Us had missed its financial targets much earlier than that, after the company's abysmal holiday period in 2017.
"Commencing September 18, 2017, Brandon, Barry, and Short personally contacted key Trade Vendors through telephone calls, texts, and emails, and represented that TRU had obtained $3 billion in DIP financing that for the next 16 months gave TRU funds to pay Trade Vendors for goods or services provided on credit," according to the lawsuit.
But instead of 16 months of financing, lenders pulled Toys R Us' access to funds under the DIP the next spring, meaning Toys R Us was out of money to repay vendors, many of whom extended the retailer trade credit, about six months later. Suppliers, feeling burned by Toys R Us, objected in court to Toys R Us' plans to liquidate and distribute proceeds among its secured lenders, but ultimately settled for nickles on the dollar.
In a 2018 letter in response to a Congressional inquiry, a KKR official said that Toys R Us was a "challenged business" when the private equity group acquired it. He attributed the company's decline to a changing retail landscape and rise of e-commerce players like Amazon. He also noted that the company wrote down its entire $418 million equity investment in Toys R Us in 2017.
"To be clear, we did not want the U.S. operations to be liquidated," he said. "We wanted the company to restructure, return to health and vitality and stay in business — but the creditors had a different and prevailing view."
All told, Toys R Us' bankruptcy left $800 million in unpaid claims filed during Chapter 11 and $1.8 billion in pre-bankruptcy claims, according to the complaint.
Creditors allege that the plan to keep Toys R Us operating through bankruptcy without an arranged bankruptcy plan was reckless all along. "The directors gave no consideration-none at all-to assessing the probability that the DIP financing strategy would fail," the complaint alleges. "If the financing terminated, TRU would have no choice but to conduct an immediate liquidation. The directors never assessed the likelihood of this outcome. They adopted a 'we don't care about the risks' attitude."
Meanwhile, as Toys R Us continued to operate into the winter of 2017, rather than wind down gracefully, Brandon and his fellow executives kept drawing salaries.The retailer's private equity owners could preserve some value in their equity if the retailer "could revitalize and emerge as a successful business with a going-concern value in excess of its debt," the complaint states.
But that didn't happen. Instead, Toys R Us went into sudden liquidation, after which the story is well known. Suppliers lost millions, 30,000 employees suddenly were without jobs, and the last national dedicated toy retailer disappeared.
Clarification: Bob Bodian is the lead counsel for all defendants.