Why did J. Crew file for bankruptcy? : Planet Money This month, J.Crew went bankrupt. But not before inventing a whole new way of playing hardball with lenders. | Subscribe to our weekly newsletter here.

J. Screwed

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UNIDENTIFIED REPORTER, BYLINE: This is PLANET MONEY from NPR.

AMANDA ARONCZYK, HOST:

When Rynetta Davis doesn't know what to wear, she has a backup plan.

RYNETTA DAVIS: My immediate default is a Tippi and something - a Tippi and jeans, a Tippi and a pair of slacks. Like, that is my default. You can't figure it out, Rynetta? Grab a Tippi.

MARY CHILDS, HOST:

The Tippi - it's a sweater made by J. Crew. It has a round neckline. It's a light merino wool, perfect for her job as a professor at the University of Kentucky.

DAVIS: You could wear the sweater by itself. You can also wear it under a blazer. And it just transcends the seasons. I love, love, love, like, love the Tippi.

CHILDS: J. Crew knows that its customers love the Tippi. They have a loyal following of people like Rynetta. So they figure, what if we give them the Tippi, but different? In 2014, they roll out the Tilly. They bill it as the Tippi's, quote, "shrunken cousin."

DAVIS: I was like, no, no, no, no, no, no. The Tilly was shorter, and it was cropped. And I'm like, oh, I'm not buying a cropped sweater.

ARONCZYK: The sweater was all wrong. Everyone hated it with kind of shocking vitriol. Those intensely loyal fans felt betrayed. And if that wasn't bad enough, then came the crisis of the ballet flat.

CONNIE WANG: I call it Cecegate.

CHILDS: This is Connie Wang. She covers retail and fashion for the lifestyle website Refinery29.

ARONCZYK: The Cece had been one of J. Crew's bestselling shoes, and customers started to notice at a certain point that something had gone wrong with the Cece.

WANG: So the fabrication had changed. The sourcing had changed. It was lower in quality. Everything was bad about it, and yet it was the same price.

CHILDS: Customers were like, did you think we wouldn't notice? Now they were enraged.

WANG: It was shocking. If you read comments about this, you would think that people were talking about just, like, just - I don't know - like, a hostage situation.

(SOUNDBITE OF MAXIME PINTO'S "GROOVY ROLLIN'")

CHILDS: Because in a way, the Cece wasn't just a shoe. It was a sign that the company was abandoning the people who loved it the most.

ARONCZYK: And those people suspected that something strange was afoot at J. Crew.

CHILDS: And the shoe falling apart - that was just the Tippi of the iceberg.

(SOUNDBITE OF MAXIME PINTO'S "GROOVY ROLLIN'")

CHILDS: Hello, and welcome to PLANET MONEY. I'm Mary Childs.

ARONCZYK: And I'm Amanda Aronczyk. In early May, J. Crew announced it had gone bankrupt. And, sure, part of it's because of the shutdown. It's been a really brutal time for retail. J.C. Penney, Neiman Marcus - also bankrupt.

CHILDS: But those outraged J. Crew customers were onto something. The company had made a kind of devil's bargain trying to stay in business.

ARONCZYK: Today on the show, why a beloved American brand betrayed its most loyal fans.

CHILDS: And invented a new piece of financial sorcery so brazen it got its own name. People are now terrified of getting J. Screwed.

ARONCZYK: Today, you can still buy J. Crew online and in some stores. Don't worry; Rynetta can still get her Tippi sweaters. That's because the kind of bankruptcy J. Crew is doing is called restructuring, right? It's not liquidation. In liquidation, companies generally close all the stores, sell the stuff, go home forever.

CHILDS: In restructuring, the debt the company can't pay - it gets wiped away. The company's owners and some people they borrowed from, they still lose a lot of money. Other people probably lose their jobs. But the company itself, the name J. Crew, that still has a lot of value. The company comes out healthier, ready to compete.

ARONCZYK: J. Crew's name has a lot of value partly because it's been around for decades. It was trademarked back in 1983. Here's Connie Wang again.

CHILDS: Who was Mr. J. Crew?

WANG: Wow, that's a big question. I don't believe that Mr. J. Crew was an actual person. It was a marketing term that someone came up with to rename a company that was not very successful, to evoke a very preppy kind of imagery, and I think it really achieved that. J. Crew - who is Mr. J? No one knows, but he does crew.

CHILDS: Before, it had been Popular Merchandise Inc., which is maybe the most utilitarian brand name ever, which actually fit because the clothes were practical, affordable. Changing the name to J. Crew gave it this kind of New England aura.

WANG: It became a look of the '80s that was very much in line with the other sort of catalog brands at the time, like an L.L.Bean or a Land's End. Their customer base were, you know, very preppy East Coast people who wore cable knit sweaters and boat shoes and chinos, who would monogram their tote bags.

CHILDS: And that's what it was for decades, just this preppy brand, affordable for almost-rich people, ideal for mom to wear to the country club, but distinctly not cool.

ARONCZYK: Until 2008.

WANG: I credit J. Crew's success to Michelle Obama.

ARONCZYK: That fall, there was a recession and a presidential campaign. So there's all this scrutiny on the candidates. And it became public that then-vice-presidential-candidate Sarah Palin had a $150,000 budget for her clothes. Around the same time, Michelle Obama went on "The Tonight Show With Jay Leno."

WANG: Michelle Obama wore a pencil skirt, a cardigan and a blouse. It sounds like a very, very boring combination 10 years later, but at the time, the color was really, really cool.

CHILDS: So she's onstage in this all-yellow get-up, chatting with Jay Leno. And he's like, how much did your clothes cost?

(SOUNDBITE OF TV SHOW, "THE TONIGHT SHOW WITH JAY LENO")

JAY LENO: I want to ask you about your wardrobe. I'm guessing about 60 grand...

(LAUGHTER)

LENO: ...60,000, 70,000 for that outfit.

MICHELLE OBAMA: Actually, this is a J. Crew ensemble. Thank you.

LENO: Really? Wow. You know what's amazing?

OBAMA: (Unintelligible).

LENO: I have no idea what that means, but OK.

OBAMA: Yeah, right.

(LAUGHTER)

OBAMA: We - ladies, we know J. Crew.

LENO: That's very good.

(CHEERING)

OBAMA: You can get some good stuff online.

WANG: And then to find out that she got her outfit at the mall (laughter) at a brand that we hadn't thought about for a long time, like, we thought about this as a parent's brand, that really captured people's attention.

CHILDS: So suddenly, there's this huge spotlight on J. Crew. And as luck would have it, J. Crew had someone in-house who was randomly exactly what America wanted right at that exact moment, their creative director, Jenna Lyons. A lot of people just found her fascinating.

WANG: She had, like, slicked back hair and big chunky glasses that were, quote-unquote, like, "unsexy." And yet, she was, like, 20 feet tall, really willowy. She was just this mixture of things that were unexpected. She's an icon.

ARONCZYK: This icon working for some normal mall brand, like if Beyonce was writing jingles for Home Depot.

WANG: Then it turns out that Jenna Lyons had been working at J. Crew for a long, long time. She wasn't just this, like, flash in the pan sort of celebrity designer. She had a Cinderella story, really. She started out as an assistant, worked her way up. And now that she's at the head of this, like, major fashion company, everyone just - there's a reason to root for her. She's the underdog.

CHILDS: Jenna Lyons had this sort of magical way of combining expensive things with really cheap things or things you already owned with just a smidge of very fashionable extras so you could be thrifty but still cool. Jenna dressed that way, and that became the J. Crew look, which then became fashion trends. You want to wear all blue like Jenna Lyons? You have a blue shirt and blue pants, probably. There, you're fashion. You thought you could never wear that floral button-down with those plaid pants? Jenna says you can.

ARONCZYK: And this was important to a lot of people at a time when they didn't have much money. People outside the country club set became obsessed with Jenna Lyons and J. Crew. Their stars rose together. J. Crew had its first runway show, and Jenna became the kind of celebrity who gets invited on "Oprah."

WANG: It was a total pop culture phenomenon.

CHILDS: They had turned this regular mall store into a successful brand. The name J. Crew now meant cutting-edge fashion, which was great for business. So, OK, fat and growing margins, plus insanely loyal customers buying Tippis, free endorsements from the Obamas - it could hardly get better. In fact, it could almost only get worse.

ARONCZYK: After the break, how J. Crew borrowed against that good name and then pulled a fast one.

In 2010, J. Crew was still a public company, so its shares were trading on the stock market, and they were going up, so they got a call from two private equity firms. One of these firms was an old friend. In fact, they'd owned J. Crew years before.

CHILDS: Private equity firms are basically just companies that pool money from rich people and institutions and then use that money to buy other companies and make them more profitable by rethinking how they work. And at the time, private equity was everywhere, looking for companies to buy.

ARONCZYK: These firms bought Neiman Marcus, Burlington Coat Factory, Payless Shoes and J. Crew. It was a windfall for everyone who held the stock.

CHILDS: So now these two firms are basically running J. Crew. The CEO of J. Crew has these new bosses. And one big thing - when private equity buys a company, they often do it by borrowing money that the company, in this case J. Crew, is on the hook to pay back on a strict schedule. This is, like, private equity's favorite move.

ARONCZYK: Because of that transaction, J. Crew now has over a billion dollars in debt. And it's due in a few years, which also means they have bigger monthly interest payments. Now they have to grow or die. And for a few years, that was totally doable. They had Jenna Lyons. They'd rolled out this great luxury collection at crazy prices. They had the little sister brand Madewell, which was doing great.

CHILDS: So they're like, things are going so great, why don't we try to make even more money, expand our margins? Private equity loves expanding margins. We could sell both sweaters, the Tippi and the Tilly. And another fun way to make some extra cash is to use cheaper materials in our signature ballet flat. And maybe instead of stitching a shoe together, we could just glue it and then sell that shoe for the same price or even more.

ARONCZYK: Except that customers noticed. They could tell the Cece flat was getting worse and that their cashmere sweaters were now falling apart. And meanwhile, the fashion world kind of moved on without them. Instead of setting trends, J. Crew was totally missing them. And their sales started to drop.

CHILDS: And, sure, in the fickle world of fashion, that happens. But normally, a brand misses a trend, and it's whatever. People kind of forget about that brand for a minute, and life goes on. But because J. Crew had strived so hard, they had alienated their core fans, people who wanted to buy basic things. Those fans noticed that J. Crew was selling all these ridiculous products, like a floor-length sequin skirt for $2,500. Like, why? Their formerly loyal customers were like, how dare you? We are not here for cutting-edge fashion. We are here for the practical button-downs and the Tippis.

ARONCZYK: Here's fashion writer Connie Wang again.

WANG: That is a hard change that J. Crew really underwent in a very short amount of time. Whereas before, they were an affordable brand that was regarded by cool people as designer level, it became a designer brand with designer price points that most people regarded as average. And that's not a good place to be.

CHILDS: But that should be survivable.

WANG: They were only not very, quote-unquote, "cool" for five years or so.

CHILDS: That's, like, a very normal dry spell for fashion, right?

WANG: That's a very normal dry spell. There is a philosophy in fashion that if you do something well, you kind of stick to your guns because you expect the trends to kind of come back to you. The danger, of course, is if you're not resilient enough to sort of weather a down dip in when people are not so interested in your brand. You know, do you have enough resources to kind of survive until your brand's cool again?

CHILDS: So all J. Crew had to do was hunker down for a few years, hope enough superfans like Rynetta bought enough Tippis and wait for matching sweater sets to be cool again.

ARONCZYK: Except that they couldn't really wait. By 2016, they were only a few years into being uncool, but they still owed over a billion dollars. And in a few years, they were going to have to pay that back.

CHILDS: But at that point, no one was going to lend them new money at a reasonable rate, which caused a lot of anxiety. So debt analysts like Valerie Potenza started getting all these phone calls.

VALERIE POTENZA: People asking us, you know, how is the company going to be able to repay this debt, how they're going to be able to do that?

ARONCZYK: Valerie works for Xtract Research. She writes reports that help investors understand these super long documents written by lawyers when a company wants to borrow lots of money.

CHILDS: Meanwhile, J. Crew is rooting around, looking for stuff that they can borrow against. By now, they've mostly promised all their stuff, but maybe they forgot something. So what do they have lying around? They have clothes. They have shoes. And they have a bunch of Tilly sweaters that no one wanted.

ARONCZYK: And, of course, they have their good name, a brand that they've been building for years, J. Crew.

POTENZA: The J. Crew name is the trademark for its U.S. business, which is obviously valuable. It needs it in order to sell its clothes, right?

CHILDS: That name was worth a lot of money, hundreds of millions of dollars.

ARONCZYK: And, in fact, several years earlier, J. Crew had borrowed money and said to the lenders, if we don't pay this money back, you can take our name, our trademark. J. Crew - it's yours. Just like when I got a mortgage for my house, I told the bank, if I don't pay you back, you can take the house.

CHILDS: So the trademark - it's already promised. Huge bummer. But at this point, J. Crew is getting kind of desperate. They start going through all their old documents, rereading all the promises they'd ever made. And they're like, hang on a second. This promise wasn't totally binding because if you pair the fine print in this document with the fine print in that document and you line it up just so...

ARONCZYK: Suddenly, it clicks together and they've discovered a magical hidden escape hatch, a way for the rights to the name, the trademark. They're just going to fall out of that earlier promise.

CHILDS: So they make a new little company in the Cayman Islands, a company that exists only on paper. They call it J. Crew Cayman Limited. And they give the trademark to this new paper company. So now J. Crew, the retailer, doesn't own the trademark. J. Crew Cayman Limited owns it. So then J. Crew Cayman Limited creates another new company that also exists only on paper.

ARONCZYK: J. Crew Brand Holdings in Delaware. And J. Crew Cayman Limited gives the trademark to the company in Delaware. And now, through this convoluted legal funnel, this new company within a company within a company - J. Crew Brand Holdings of Delaware - can borrow money using the trademark as collateral.

CHILDS: So J. Crew went to their old lenders, and they're like, OK, remember how we said if anything went wrong and we couldn't pay our debts you could just take our trademark, that name J. Crew? So you can't do that. The rights to the trademark are on vacation in Delaware. If we don't pay you back, you can still have these old dresses that we found upstairs and some statement necklaces, but you just can't have that name.

ARONCZYK: Valerie says she and her team came up with a nickname for this trick. They called it the trap door.

POTENZA: It was this two-step transfer, but it's kind of become shorthand, you know, for a play where a company, you know, moves assets away from one group of lenders to benefit another.

CHILDS: This little loophole does exist for legitimate reasons. Businesses need to be able to create new businesses, little subsidiaries. But the way they used it was creative, kind of elegant at best, illegal at worst. It seemed a lot like theft.

ARONCZYK: And, in fact, the angry lenders - they sued. But Valerie says the trap door - turns out it's legal. It's right there in the documents.

POTENZA: People don't necessarily read things, or they don't read them that in-depth, or, you know, we tell them things and they don't always listen, or often they don't listen. So when people start - don't start paying attention until things go south or till, you know, something happens like this, and then they scramble to figure out, you know, how things were done.

CHILDS: And then they call you, and you're like, that was literally in my report.

POTENZA: Right. Yeah, yeah. We - or read the report. It's on the first page, you know.

CHILDS: It was brazen, but anyone who was so horrified or shocked kind of just hadn't thought creatively enough about lining up all these loopholes, hadn't thought like a company desperate to raise money.

ARONCZYK: Some of J. Crew's lenders felt cheated, like they'd just lost hundreds of millions of dollars.

CHILDS: And it became this bond market horror story, like a trap door can appear out of nowhere, and your stuff can just fall through it. It's like, what? So promises mean nothing anymore? Contracts are meaningless? Those lenders had gotten J. Screwed.

POTENZA: We got people asking us or, you know, can I get J. - as you said, J. Screwed. I don't use - you know, really use that. You know, can we get J. Crewed here? Can the company take assets away from the lenders who think they've got a good claim on them and move them away, use them to do something to our detriment? And that's really what it's become shorthand for.

ARONCZYK: And did this ultimately help the company?

POTENZA: Well, it - I guess it bought them some time, so they chugged along.

CHILDS: It bought J. Crew, like, a year or so, which isn't great. But a year, I mean, it's pretty inspiring to other overindebted companies on the brink of bankruptcy. It gave them hope and a road map.

ARONCZYK: So if you find yourself painted into a corner with too much debt, just look around. Maybe you'll find a trap door to sneak out your most valuable sort-of-already-promised-elsewhere thing. PetSmart used the trap door - not bankrupt. Claire's and Neiman Marcus - they used it, too, but it didn't save them. It just bought them some more time. They are both bankrupt now.

CHILDS: And this might become even more popular. Like every other nonessential business, retailers have had to shut their stores because of the pandemic, and shoppers are not feeling super spendy with so many people newly unemployed and those with jobs unsure when they'll ever get back to a physical office or, like, a party. Dressing up for Zoom is just less compelling.

(SOUNDBITE OF MATTHEW ALEXANDER HOLLAND'S "BOURBON STREET BLUES")

ARONCZYK: As for J. Crew, it's now working its way through the bankruptcy process. It won't be owned by private equity firms anymore. They've handed over the keys to the shop.

CHILDS: We did call J. Crew to ask for an interview - didn't happen. But the company is still around. They're still selling stuff online. A few weeks ago, I went to the website, and I saw the Tippi for $17 - 80% off. And I love a good discount, but I just - I didn't buy it.

(SOUNDBITE OF MATTHEW ALEXANDER HOLLAND'S "BOURBON STREET BLUES")

ARONCZYK: Do you have a hidden magic trick of financial engineering? You can email us at planetmoney@npr.org. We're on Facebook, Twitter and Instagram at @planetmoney.

CHILDS: We also have a newsletter. This week, we look at the future of cities after the pandemic.

(SOUNDBITE OF MATTHEW ALEXANDER HOLLAND'S "BOURBON STREET BLUES")

CHILDS: Today's show was produced by Alexi Horowitz-Ghazi and James Sneed. Alex Goldmark is our supervising producer, and Bryant Urstadt edits the show. I'm Mary Childs.

ARONCZYK: And I'm Amanda Aronczyk. This is NPR. Thanks for listening.

(SOUNDBITE OF MATTHEW ALEXANDER HOLLAND'S "BOURBON STREET BLUES")

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