In Depth November 26, 2008, 5:00PM EST

How Private Equity Strangled Mervyns

(page 4 of 5)

Browse Issues

Story Tools

Creditors soon approached Goodman with an odd idea: On behalf of Mervyns he should sue the private equity owners who had seemingly run the company into the ground. As the CEO, they reminded him, it was his fiduciary responsibility to preserve as much of the company's value as possible. Normally creditors do the litigating in such situations, but the four-year statute of limitations to bring suit against the buyout was about to expire, and they couldn't get organized in time to file a complaint of their own. Goodman was being asked to sue the very people who had hired him five months earlier.

On Sept. 2, Goodman announced in a memo to staff that the company was planning to file suit. In the memo he alleged that the buyout firms had used financial engineering to acquire Mervyns' "considerable real estate holdings, and then leased back properties to the company at substantially increased rates," moves that helped force the company into Chapter 11. The complaint, filed in Delaware bankruptcy court, alleges that Mervyns' private equity owners deliberately rendered the company insolvent.

About 1,000 employees at headquarters were summoned to separate rooms at 10 a.m. on Oct. 7. Most were told they had been selected to "take the company to a higher level." At least 100 were told they had to be out of the building by noon. They would be paid for the day, but that was it—no severance. "There were a lot of people in tears," recalls 19-year vet Steve Sunyog. He says the treatment "was a slap in the face." Loretta Robinson, a former merchandise coordinator with 32 years at the company, was fortunate to find another job at an office-furnishings store. But the new job is a 50-mile commute and pays less. She says she's borrowing money from her parents and adding ham and beans to pots of soup to stretch them further. "I need every dime," she says.

At the time of the firings, Goodman was furiously shopping Mervyns to potential buyers. But there was a deal-breaker: the new rent payments. Mervyns' landlords wouldn't agree to lower them enough to attract a buyer. Absent cheaper rents, no suitor thought the chain could survive the recession.

Soon rumors began to circulate that no deal would transpire. Executives started packing up their things and walking out. As fears of liquidation spread, "there was mass panic," says Zialcita, 37, the former manager. Employees lined up to hand in their resignations on the belief that it would give them a better chance of getting paid for unused vacation days. "There weren't enough hands in human resources to handle all of the people," says a former executive.

Their worst fears were realized days later when Sun and Lubert-Adler, unable to dig themselves out of their mess, decided that liquidation was the only option. Says Sun Capital Partners in a written statement to BusinessWeek: "When it was acquired, Mervyns was struggling. Significant improvements were achieved, but financial headwinds and the challenging retail environment proved insurmountable." (Lubert-Adler didn't return phone calls or e-mails seeking comment.)

The move rippled through Mervyns' supplier network. Ben Coons, CEO of Advanced Wireless in Lakeville, Minn., is out a major customer and as much as $30,000 for unpaid services: "That's about a third of the biweekly payroll. That stings."

Goodman, for one, has landed on his feet, starting a new job as CEO of mall-based specialty retailer Charlotte Russe (CHIC) in November. But most of the thousands thrown out of work are faring much worse. A bankruptcy court recently ruled that some creditors must be paid before employees, meaning many former workers may not receive vacation pay.

"THERE IS NO MONEY"

Those people are scrambling. Former communications analyst Jeff Rainey, a 28-year veteran, says he feels "powerless" and may have to file for bankruptcy.