By Terminating Its CEO, American Apparel Unexpectedly Unravels Lending Agreement

| Zuckerman Spaeder Team

Firing a key executive can have repercussions beyond a severance dispute or a wrongful termination or discrimination claim by the executive.  American Apparel’s recent termination of its CEO, Dov Charney, provides the latest example of the wide-ranging consequences that can arise when a C-level employee is let go.  In American Apparel’s case, the consequences have included the threat of default on a $15 million loan and a resulting shareholder lawsuit.

How did this happen?  According to the New York Post, when Lion Capital LLC lent American Apparel the $15 million, the two entered into a lending agreement that said American Apparel would be in default if it fired Charney.  After American Apparel’s board told Charney it was going to fire him in 30 days, Lion Capital accelerated its demand for payment on the loan, threatening the company with bankruptcy.  American Apparel argued in an SEC filing that it wasn’t in default because Charney was still technically CEO.  However, it continued to work behind the scenes to remedy the situation.  Now, the company now appears to have struck a deal with a hedge fund to save it from Chapter 11.

One of the company’s shareholders, however, still isn’t happy.  Tammy Federman has sued it in California federal court, alleging that the board turned a “blind eye” to Charney’s alleged misconduct over the years, and that it should have worked out an arrangement to avoid default with Lion Capital before taking action against Charney.  Now, the company will not only have to battle with Charney, but with one (and possibly more) of its investors. 

“Key man” provisions like the one in Lion’s lending agreement aren’t uncommon.  For example, investment fund agreements can include provisions stating that if the managing principals leave the investment firm, the investors can terminate the investment period.  This can have a significant impact on the firm’s business.  When deciding to terminate a key employee, companies should be careful to consider whether any of their agreements include these kinds of provisions, and whether the termination of the employee will trigger them.  As the American Apparel affair has shown, bringing these “key man” provisions into play might even result in the company losing its shirt.

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