Situation Overview
2
In 2017, with consumer preference shifting from brick-and-mortar stores to e-commerce,
a struggling PetSmart, Inc. (the “Company”) purchased online-pet supply retailer
Chewy.com (“Chewy”) for $3 billion.
• The Company purchased Chewy for $3 billion, $1 billion of which was funded from proceeds of the Company’s
private equity sponsor BC Partners (the “Sponsor”) equity contribution, and the remainder of which was funded
through a combination of new-issue senior secured and unsecured debt.
• Given that some investors believed that Chewy’s value was increasing exponentially, market participants soon
speculated that the Company would spinoff Chewy to benefit the Sponsor or effectuate a J. Crew-like transaction.
How did they do it? J. Crew & The Original Trap Door
• In June of 2018, as the market had predicted, PetSmart announced that it had spun-off 20% of Chewy’s equity by
way of a dividend to the Sponsor and transferred 16.5% of Chewy’s equity to a newly-formed “Unrestricted
Subsidiary” of the Company.
• Given that Chewy was no longer a wholly-owned subsidiary, PetSmart requested that agent under the Company’s
term loan credit agreement release the liens on Chewy’s assets and its guarantee of the term loans, though Chewy
would still be a “Restricted Subsidiary” under the loan documents and, therefore, continue to be subject to the credit
agreement and indenture covenants.
Locked into billions of dollars in secured debt instruments that, by their terms, required all subsidiaries to
provide guarantees and grant a security interest in their assets, how did the Company manage to spin out its
most valuable subsidiary and release its guarantee of the Company’s debt?
20% Chewy
equity
(dividend)
Step One: The Chewy Dividend & Investment
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In June of 2018, the Company transferred a total of 36.5% of its equity interests in Chewy through
a combination of a dividend to the Sponsor and an investment in an unrestricted subsidiary that
utilized the existing restricted payment and investment baskets under its debt documents.
• The Company transferred 20% of Chewy’s equity through a dividend
to the Sponsor and 16.5% of Chewy’s equity as an investment in a
new, unrestricted subsidiary of the Company (“Unrestricted
PetSmart”).
• Under the Company’s debt documents, spinning off Chewy’s equity
through a dividend required capacity under the restricted payments
baskets equal to at least the fair market value (“FMV”) of equity being
spun off, and transferring Chewy’s equity to an unrestricted
subsidiary required capacity under the restricted payments and/or
investment baskets equal to at least the FMV of equity being
transferred.
‒ By valuing Chewy at $4.54 billion, the Company was able to
comply with the investments and restricted payment baskets
under the Company’s existing debt documents. In addition to the
dollar baskets that were used, the Company determined that it
could make restricted payments up to $1 billion by relying on an
“Available Amount” basket that allowed the Company to make
distributions up to the amount of post-closing equity
contributions it had received from the Sponsor.
Sponsor
The Company
Unrestricted
PetSmart
Chewy
16.5% Chewy
equity
(investment)
Step Two: Guarantee & Lien Releases
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Under the Company’s existing secured debt documents, any subsidiary that ceased to be a
wholly-owned subsidiary was released from its lien and guarantee obligations under the
Company’s debt documents.
• After the dividend and investment transactions, Chewy was no
longer a wholly-owned subsidiary of the Company.
‒ Under fairly standard boilerplate provisions in the credit
agreement concerning administrative agent action, to the
extent that a restricted subsidiary ceased to be a wholly-
owned subsidiary of the Company pursuant to transactions
authorized under the credit agreement, the agent was required
to release the liens on the restricted subsidiary’s assets and it
guarantee of the term loans.
‒ Under the note indentures, Chewy’s liens and guarantee are
released automatically upon any release of its liens and
guarantees under the credit agreement.
• As a non-guarantor restricted subsidiary, Chewy was still subject to
the covenants in the debt documents, but the term loan lenders and
noteholders no longer had a direct claim against Chewy or a security
interest in any of Chewy’s assets and their interest in Chewy was
now structurally junior to Chewy’s liabilities and limited to the value of
the Company’s equity in Chewy.
Sponsor
PetSmart
Inc.
Unrestricted
PetSmart
Chewy
20%
63.5%
16.5%
Post-Transaction Structure
Post-Transaction Term Loan Litigation
and Aftermath
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Immediately following the Company’s announcement of the transaction, Citibank, the
agent under the credit agreement, refused the Company’s instruction to provide
documentation evidencing the release of Chewy’s guarantee and termination of the lien on
Chewy’s assets.
• On June 26, 2018, the Company filed a lawsuit against Citibank for breach of contract and requested a declaratory
judgment blessing the transactions and requiring the agent to provide the documentation evidencing the release of
Chewy’s guarantee under the credit agreement and termination of the lien on Chewy’s assets.
• In response to the Company’s lawsuit, an ad hoc group of term loan lenders formed and directed Wilmington Trust,
the successor agent following Citibank’s resignation as agent, to bring various counterclaims against the Company
on the grounds that, among other things:
‒ the Company did not have sufficient investment and restricted payment capacity under the indentures to
effectuate the transaction and therefore breached the indentures, which resulted in a cross default and Event of
Default under the credit agreement;
‒ the transaction violated the “Affiliate Transactions” covenant in the credit agreement requiring that transactions
with Affiliates be “on terms substantially as favorable to [PetSmart] as would be obtainable by [PetSmart] at the
time in a comparable arm’s-length transaction with a Person other than an Affiliate”; and
‒ the dividend of Chewy equity to the Sponsor constituted a fraudulent transfer because the Company was
insolvent (or rendered insolvent as a result of) the transaction.
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• In April of 2019, the Company and Wilmington Trust settled the litigation over the Chewy transaction.
• In connection with the settlement, the credit agreement was amended to provide lender parties a 50
bps consent fee, increase the interest rate by 125 bps, tighten covenants, and require a $250 million
par paydown within 12 months of the amendment effective date.
• In exchange for, and in connection with, the amendment (which was signed by over 90% of the
lenders), Wilmington Trust delivered the documentation required to evidence the release and
termination of the applicable guarantees and security interests as a result of the Chewy transactions
and each lender acknowledged and agreed that the Chewy transactions were permitted under the
credit agreement, ratified the transactions and provided customary releases with respect to the
transactions to the Company and Sponsor.
• In June of 2019, the Company took Chewy public and sold 40.9 million shares at a price of $22.0
per share for gross proceeds of $900 million. The Company used approximately $221 million of
proceeds to purchase first lien notes and approximately $679 million of proceeds to purchase the
term loans
Post-Transaction Term Loan Litigation
and Aftermath (cont’d)
Key Takeaways
7
The tactics employed by the Company and its Sponsor to carve out Chewy from the collateral and
guarantee package of the term loan and notes to and dividend equity in Chewy to the Sponsor
raise a number of key points for lenders to consider when assessing potential alternative
transactions that can be effectuated under debt documents and the related risk of value leakage.
• The Company and Sponsor identified and utilized a creative strategy by capitalizing on investment and debt capacity
and certain boilerplate provisions in the debt documents to effectuate the dividend of Chewy equity and unrestricted
subsidiary investment transactions.
• The Company relied on a sizable “Available Amount” basket to materially increase the Company’s restricted payment
capacity to distribute a sizeable minority equity interest in Chewy to both the Sponsor and an unrestricted subsidiary.
• However, even if the Company transferred a single share of Chewy equity to the Sponsor, an unrestricted subsidiary
or other third party, under the applicable loan documents the agent would have been required to release the Chewy
guarantee and security interest.
• By transferring Chewy’s shares to an unrestricted subsidiary, which is not subject to the debt documents and the
claims of the lenders, the Company could freely monetize the value of such equity, either by raising debt secured by
these shares, effectuating a dividend of the Company’s equity interests in the unrestricted subsidiary to the Sponsor
or selling the equity to a third party without any restrictions on the use of proceeds from the sale
• Though lenders initially challenged the transaction, they ultimately consented to it in exchange for a paydown of the
term loans and other economic and non-economic concessions from the Company
Considerations for Lenders
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PetSmart reminds us of the potential value of
certain protections against leakage, including:
• Where possible require all subsidiaries (and not
just wholly-owned subsidiaries) to be guarantors.
• Where guarantors are limited to wholly-owned
subsidiaries consider (x) including restrictions on
the formation, or creation or designation of non-
wholly owned subsidiaries in the future (y)
provide that the company may not engage in a
transaction in which a wholly-owned subsidiary
becomes non-wholly-owned to the extent the
intent of such transaction is to reduce the
collateral and/or guarantee or (z) provide that
collateral and guarantees will not be released if a
guarantor goes from wholly owned to non-wholly
owned.
• Require the borrower to certify that the
transaction giving rise to such release was
permitted under credit agreement.
LEAKAGE RISKS
• Lenders should be careful to include “PetSmart” protections in
their debt documentation, either by not only requiring all
subsidiaries to be guarantors but by also stating that
guarantees (and the liens securing such guarantees) will not
released just because a wholly-owned subsidiary becomes a
non-wholly owned subsidiary, particularly in cases where the
other equity continues to be held by affiliates within the
broader capital structure (e.g., the Sponsor).
• Similar to the J. Crew transaction, the Company and
Sponsor used a newly formed unrestricted subsidiary to
consummate the PetSmart transaction, but importantly, such
step was not necessary to effectuate the release of the liens
and guarantee. The transfer of a single share of Chewy’s
equity to a non-Company party was the only necessary
step.
