$50M HHGregg suit attacks insiders for accepting customer deposits to very end

Gregf Andrews for www.theindianalawyer.com

A lawsuit quietly wending its way through a Marion County court zings former HHGregg CEO Bob Riesbeck and three other insiders of the failed chain, alleging they allowed it to continue accepting customers’ deposits on merchandise long after its tailspin cast doubt on whether it had the financial wherewithal or inventory to fulfill the orders.

The suit, which was filed by unsecured creditors of the appliance and electronics chain and seeks more than $50 million in damages, charges the defendants’ behavior violated the state’s consumer protection laws and constituted a breach of their fiduciary duties to the company.

The deposits represented the upfront payment for merchandise — either by cash or credit card — which was supposed to be followed by the swift delivery to shoppers’ homes. The approach is standard in the retail industry but can turn problematic when a company rapidly loses liquidity, leaving it short of cash just as nervous suppliers begin to restrict shipments.

The continued acceptance of the deposits — which HHGregg was able to treat like interest-free loans — saddled the company “with tens of millions of dollars in unwarranted and unnecessary liabilities and recklessly caused the permanent destruction of the company’s value as a going concern,” according to the complaint.

The financial baggage scared away suitors that otherwise might have bought all or part of the company, according to the suit, which uses internal company documents to provide a blow-by-blow account of the chain’s final months, as executives evolved from viewing financial struggles as temporary to concluding there was no way out.

Indianapolis-based HHGregg racked up more than $270 million in losses from 2014 until the spring of 2017, when it filed for bankruptcy and shut down, ending 62 years in business. The chain — done in by overexpansion and a collapse in sales of consumer electronics — at its peak operated 228 stores and employed more than 5,000 workers.

Fighting for cash

Creditors filed the suit in an attempt to put a dent in their losses by accessing one of HHGregg’s only remaining large assets — its directors’ and officers’ liability insurance coverage. Court records don’t reveal the amount of HHGregg’s D&O coverage, though an attorney for the company has said it’s in the tens of millions of dollars.

The case was filed by the committee of unsecured creditors, a group appointed as part of HHGregg’s Indianapolis bankruptcy case. It filed the 41-page suit last July, though its existence has not been previously reported. The defendants are Riesbeck, Chief Financial Officer Kevin Kovacs, Vice President Lance Peterson and longtime board member Benjamin Geiger.

Attorneys at the Indianapolis law firm Bose McKinney & Evans LLP representing the defendants asked Indiana Commercial Court Judge Heather Welch to dismiss the case without a full-blown trial, but in January she declined.

She seemed unsympathetic to defendants’ argument that they merely were continuing to operate the business as normal when they accepted the customer deposits, calling that an “overly-simple characterization.”

Riesbeck and Jim Moloy, a partner at Bose McKinney & Evans representing the insiders, declined to comment. But in a response to the suit filed Feb. 13, Bose McKinney & Evans argued that the board is protected by the Indiana business judgment rule — which offers broad leeway to directors who act in good faith — and that executives were obligated to follow the board’s direction and did so.

In another filing, the attorneys called the suit “farfetched” and “incredible,” asserting that had HHGregg stopped accepting deposits by October 2016, as the suit suggests it should have, that would been tantamount to shutting down the company.

“The board cannot be faulted for their desire to see HHGregg continue or their hope that the 2016 Christmas season would return HHGregg to profitability,” the filing said.

Further, the attorneys argued, “The premise of the committee’s claims — that consumers made deposits and never received either their merchandise or refunds — is false. Virtually, all of HHGregg’s customers were eventually made whole.”

But Adam Cole, a partner representing the plaintiffs with Chipman Brown Cicero & Cole LLP in New York City, disagreed. He said that, in the bankruptcy case, thousands of customers still are owed about $1 million for undelivered merchandise.

He said the big losers were HHGregg and its lenders, which had to provide refunds once the company landed in bankruptcy, as well as the credit card companies, which reversed charges when deliveries did not occur. The provider of HHGregg’s private-label credit card, Synchrony Bank, provided more than $13 million in customer refunds, and Discover, Visa and Mastercard provided millions more, according to the lawsuit.

When HHGregg sought bankruptcy protection in March 2017, it had $50 million in unfilled customer deposits, in addition to $56 million borrowed under its line of credit, court records show.

A financial adviser for HHGregg found that, as of that month, the number of unfilled deposits was 69,882. And despite the chain’s boasts of rapid delivery, 61 percent of those deposits had aged at least 30 days and 42 percent had aged at least 90 days, the suit says.

But attorneys for the HHGregg insiders said the level of deposits the company held when it filed for bankruptcy was entirely consistent with historical averages and did not represent a spike.

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“Clearly, it was not the customer deposits, in isolation, that prevented a going concern sale of HHGregg,” the attorneys wrote, adding that what killed the company “was its inability to adapt to changing consumer preferences and remain profitable in an exceedingly competitive environment.”

Searching for buyer

The company in February 2017 enlisted investment bankers to find potential investors that would provide a capital infusion or buy all or part of the chain, but suitors “determined the value of HHGregg as a going concern was virtually zero due to the crushing weight of customer deposits,” according to the lawsuit.

The suit says one of the suitors was an investment group assembled by former HHGregg Executive Vice President Gregg Throgmartin, whose family founded the company.

In mid-February, the Throgmartin group said it “could operate the company, reestablish supplier relationships, provide equity, and form a new banking relationship,” the suit says.

But its tone shifted as it learned more about the customer deposits, and a month later it notified HHGregg it was pulling out, according to the suit.

“Gentleman — we have worked extremely hard to make the math make sense, but after the last report regarding customer deposits we see no way to have a go forward business. We are formally stepping out of the process and wish you luck.”

Throgmartin, who is executive chairman and CEO of suburban Los Angeles-based Skin Laundry, a chain of stores offering walk-in laser facials, did not respond to requests for comment.

The suit says HHGregg management gave thought to the propriety of continuing to accept customer deposits as liquidity problems grew. It quotes Riesbeck at one point acknowledging an “ethical dilemma of putting consumers’ cash at risk” and potential “expos[ure] from a D&O perspective or with [the] Attorney General,” the state official charged with enforcing consumer protection laws.

Paying off debt

The plaintiffs seek damages based only on alleged breaches of fiduciary duty, but they also highlight a variety of other actions by company officials they consider misleading.

For example, they note that, as steep losses began piling up, the company went to extraordinary lengths to pay off its credit line at the end of every quarter so it could report to investors that it was debt-free.

The company had a $300 million credit line with Wells Fargo, and before 2016 that balance rarely climbed above $35 million, according to the suit. Even after it ballooned to $80 million in January 2016, the company managed to find the cash to pay it off as of March 31 and June 30.

But by September of that year, the no-debt streak was in jeopardy. To keep it going, management negotiated a barter transaction with the Connecticut-based advertising agency Icon International under which it agreed to buy a block of HHGregg’s inventory at or below cost for $3.5 million in cash. As part of the deal, HHGregg committed to buying more than $40 million in advertising services in the coming year.

As Dec. 31 approached, Riesbeck and Kovacs looked for new ways to raise cash and explored providing $10 million in gift cards to Icon in return for an infusion. HHGregg wasn’t able to work out a deal, and the company ended the quarter with $30 million in debt.

Meanwhile, because the credit line was collateralized by inventory and inventory was falling, the amount the company could borrow was plummeting. As of Dec. 31, its borrowing limit was just $94 million.

In February 2017, as HHGregg’s problems deepened, Riesbeck threatened to quit unless his salary was increased from $700,000 to $1.75 million, according to the suit, which says he also sought raises for other top executives.

According to the suit, on March 2, the board’s compensation committee denied the request, “primarily due to their belief that this management team caused the company to be filing Chapter 11.”

In a filing, attorneys for the insiders deny the lawsuit’s description of the salary discussion. The filing says HHGregg’s outside attorneys advised company officials that they should develop a key employee retention plan. Such plans are common in bankruptcy cases and typically include compensation increases to discourage top executives from leaving while a company is going through the reorganization process.•