The Playhut sale[1] is emblematic of the financial crisis faced by companies caught up in the “retailpocalypse.” The events that unfolded throughout the Playhut sale reveal the extraordinary measures some professionals are taking to preserve stakeholder value under dire circumstances.
Founded in 1992, Playhut produced innovative play structures and enjoyed huge success. Playhut grew, obtained a significant share of the toy structures market, and formed relationships with major retailers. It sold products in North and South America, Europe, Asia and Australia. Playhut produced more than 25 years of sustained success before eventually falling victim to the massive collapse and liquidation of Toys “R” Us. The Toys “R” Us collapse, among other factors, pushed Playhut into bankruptcy. On May 24, 2018, Playhut filed a voluntary chapter 11 petition in the U.S. Bankruptcy Court for the Central District of California. Immediately after filing its bankruptcy petition, Playhut filed an emergency motion for cash-collateral funding and other financial protections, although it did not have a clear strategy on how it was going to move forward.
In early July 2018, Playhut was operating on short-term stipulations and orders governing its allowable cash-collateral usage. The cash collateral and financing approved for Playhut was critical: Playhut needed to make sure it could fulfill its upcoming Black Friday orders to Walmart and Canadian Tire. At the time, Playhut was awaiting a final, mid-July hearing on the Interim Financing Order. Playhut was extremely aware that the financing that might or might not be approved at that hearing, and that it was essential to the business’s future viability.
Playhut’s already vulnerable situation was compounded by mismanagement and misrepresentations by Playhut’s CEO. The CEO’s misrepresentations, Disney’s “surprise” drawdown of its $900,000 letter of credit, and growing uncertainty around key licensing agreements significantly eroded creditors’ confidence. Initially, Preferred Bank consented to Playhut’s use of cash collateral based on the CEO’s representations regarding Playhut’s critical licensing agreements and royalty payments. A combination of the CEO’s misrepresentations and the drawdown of the letter of credit eventually caused Preferred Bank to withdraw its consent for the cash collateral. This further jeopardized Playhut’s restructuring efforts.
The instability of Playhut’s CEO and the decrease in creditor confidence prompted the emergency appointment of James Wong as chief restructuring officer (CRO) on July 12, 2018. In conjunction with Wong’s appointment, professionals negotiated a stipulation that going forward, Playhut’s CEO would no longer have any financial control over Playhut’s operations or restructuring efforts, or the financial operation of the bankruptcy estate.
Soon after the CRO’s appointment, an evaluation of the sale process began and discussions with potential buyers ensued. The CRO quickly realized that operations were deteriorating and determined that a “fast-track” sale process was the only answer. It was the CRO’s hope that this “fast-track” sale process would salvage the remaining value of Playhut, future business opportunities for vendors and employee jobs. The CRO expressed his intention to have a closing date of no later than Sept. 25, 2018. This expedited schedule required professionals to obtain DIP financing and line up qualified Chinese factories to jump-start production ahead of the imminent Black Friday deadlines.
Throughout the Playhut sale, professionals were required to overcome multiple obstacles. Some of these obstacles resulted directly from the CEO’s mismanagement, misrepresentation and wrongdoing. For example, the CEO was aware of Disney’s “surprise” drawdown on the letter of credit one week prior to the reveal, but did not disclose this relevant information to the interested parties. Professionals were then required to resolve the resulting apprehension among creditors in order to move forward with reorganization efforts. Additionally, professionals had to confront obstructionist tactics by the CEO. The CEO attempted to undermine the CRO’s authority almost immediately after the CRO assumed his duties. The CEO contacted Playhut’s suppliers suggesting that the CRO had forfeited the duties of his new role. This untruthful and manipulative attempt created even more concern and anxiety among Playhut’s suppliers. Additionally, the CEO paid himself unauthorized insider compensation and attempted to install his girlfriend on the payroll as a non-insider.
The CRO came to the realization that there was even more wrongdoing committed by the CEO and chose to investigate further. The CRO investigated Playhut’s office in China and determined that it was, in part, a front for paying the CEO’s relatives, who did not perform any meaningful work for the company. The CEO attempted to hold the estate “hostage” by not revealing Playhut’s online bank account passwords, and used the accounts to pay his personal expenses. The CRO discovered that the CEO had moved certain inventory “off the books” and into the inventory of an affiliated company. To add to Playhut’s existing challenges, the financial controller and senior accountant resigned shortly after the petition date. Fortunately, upon his appointment, the CRO convinced both to return to the company and assist with the complex accounting issues.
In addition, professionals confronted inadequate financing, production delays and the evaporation of new orders. While this was occurring, the team also had to combat a hard money lender’s last-minute efforts to block a sale. As operations ground to a halt, the debtor and committee professionals raced against the clock, working together to solve these challenges while simultaneously engaging in due diligence with prospective acquirers.
Against the complicated backdrop of halted operations, CEO challenges, financing issues, and Playhut’s continued frantic search for a stalking-horse buyer, the CRO suffered a heart attack and was hospitalized on the weekend of Sept. 6. The CRO had emergency surgery that weekend and was back at work by Monday. The CRO filed his declaration with the court the next week, outlining a plan for the Playhut sale process moving forward.
By now, Playhut was nearly dead and the company faced a Catch-22. On the one hand, customers and licensors were waiting to negotiate with whoever might emerge as a buyer, which effectively suspended Playhut’s operations. On the other hand, potential acquirers were reluctant to bid without licenses and future orders in place. The window for securing licenses and new orders in the toy industry was closing at the end of September: The Sept. 30 deadline to register for the Toy Association’s “Fall Toy Preview” conference created an impending, market-driven deadline.
Given these realities, Playhut’s lender would not consent to the use of cash collateral beyond Sept. 20. Out of time, the debtor and the unsecured creditors’ committee — lacking a stalking-horse bid — filed a “Hail Mary” joint bid procedures motion on Sept. 13 in the hope of closing a sale by the CRO’s intended date of Sept. 25. Judge Julia Brand had many questions, to which the CRO responded under oath during lengthy oral testimony. Ultimately, convinced of a dire emergency, the court approved a Sept. 27 auction date with a sale hearing the next day.
The auction began on the morning of Sept. 27 with four qualified bids for Playhut’s surplus inventory. After entertaining the bids for surplus inventory, the debtor then addressed the two qualified bids for substantially all of Playhut’s assets, including its intellectual property, as a going concern. Basic Fun and Explore also submitted bids, although they differed in the method of payment and the inclusion or exclusion of Playhut’s surplus inventory. After a full day of negotiations and an analysis of both bids, the team of professionals and the parties involved concluded that Basic Fun was the highest and best bid. Basic Fun ultimately acquired Playhut for an all-cash bid of $1.15 million, including Playhut’s surplus inventory, and absorbed all 25 of its employees. Incidentally, the CEO attempted to resell Playhut’s domain name after the asset sale was approved by the court.
Because of the team’s tremendous effort over this incredibly short, yet complicated, period, Playhut’s key vendors secured future orders from the buyer, and Playhut was able to avoid liquidation. While the Playhut sale is certainly not the largest § 363 sale the Playhut professionals had worked on, Playhut had all the twists and turns of an “ER” episode. The professional team exemplified industry excellence in the skill, dedication, collaboration and sheer grit that they brought to bear to overcome crisis after crisis and save this patient from the brink of death.
The team was comprised of Mette H. Kurth at Fox Rothschild LLP, Robert Goe at Goe & Forsythe, LLP, James Wong at Armory Consulting Co., Randye B. Soref and Jerry Switzer at Polsinelli, and Michael Fletcher at Frandzel Robins Bloom & Csato, L.C. The team worked congenially and collaboratively throughout the entire sale process. Each team member showed extraordinary commitment to working at all hours through a complex, yet expeditious, due-diligence process.