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Executive Summary

REVCO REORGANIZATION PLAN FILING DATE EXTENDED to Aug. 31 by Akron, Ohio federal bankruptcy court on July 24. The Twinsburg, Ohio-based drug store chain, which has been under Chapter 11 protection since July 1988, previously had an extension that was set to expire on July 31. Under the new extension, Judge Harold White gave Revco until Nov. 30 to obtain acceptance of its reorganization plan. The extension was granted in the wake of a July 16 preliminary report from court-appointed special examiner Barry Zaretsky. The report indicates that the December 1986 management-led $1.25 bil. buyout left the drug chain with insufficient capital to continue as a going concern and that creditors may have grounds to sue former shareholders and others responsible for fraud. "At this point," the report states, "the examiner has preliminarily concluded that viable causes of action exist against a broad panoply of defendants under both fraudulent conveyance and other legal theories." The fraudulent conveyance complaints, if legally viable, could lead to the creditors' recovery of millions of dollars both against the Revco management group that led the buyout as well as others involved in the deal, such as investment bankers, the report concludes. A fraudulent conveyance is any transaction "made either (a) with actual fraudulent intent, or (b) without fair consideration if the debtor is rendered insolvent or is left with unreasonably small capital." Under the criteria, the Revco management group -- Sidney Dworkin, his son Mark Dworkin and then-Revco President William Edwards -- could be liable for $8-$12 mil. received from stock redemptions following their post-buyout ouster, Zaretsky says. The redemption, "commonly referred to as the 'Dworkin Unwind,'" according to Zaretsky's report, involved the "upstreaming" of Revco assets so that ANAC could redeem the Dworkins' and Edwards' stock and prepayment of severance compensation. "In addition to the possibility that Revco received no benefit for its payments," Zaretsky writes that: "The assets distributed to the Dworkins by [the holding company] ANAC may well have been disproportionate to the value of the stock." Others involved in the buyout together were paid some $73.2 mil. in fees and expenses at the close of the deal. Salomon Brothers was the biggest recipient, getting $38.8 mil. in fees and expenses; Wells Fargo was next with a payout of $17.3 mil. Even without the fraudulent conveyance complaint, Zaretsky's preliminary analysis " suggests that these [other] causes of action alone could return millions of dollars" to plaintiffs. Other actions would include breach of duty and contract and negligence. At the time of the leveraged buyout, $800 mil. of the debt incurred was in the form of junk bonds. D.S. Partners, the management group leading the buyout, invested only $18.9 mil. in cash in the deal. "Viewed in a macroeconomic sense," the report states, Revco "did not receive 'fair consideration' for the transfers and obligations incurred in that it served essentially as a conduit for the funds which went directly to the shareholders." Zaretsky pointed out that Revco "in particular" obtained "no meaningful benefit from incurring obligations to the banks...or the holders of the subordinated notes...or from encumbering its assets as security for the banks and certain pre-LBO debt." Acknowledging that he has not fully reviewed the financial status of Revco immediately after the buyout, Zaretsky nonetheless concluded preliminarily that "certain indicia of insolvency are present." Moreover, his report states that "projections used to support the analysis" of the leveraged buyout "may not have been properly prepared." Despite the preliminary indications that Revco was basically insolvent immediately after the leveraged buyout, Zaretsky recommends that no litigation be commenced immediately in the hope that the threat of legal action will spur the creation of a voluntary reorganization plan. Zaretsky is a Brooklyn Law School professor and bankruptcy and commercial law expert, and his recommendations on the use of fraudulent conveyance as a grounds for lawsuits are being closely followed by other companies involved in heavily leveraged deals. Revco had trouble meeting its payments immediately after the leveraged buyout was completed. When the chain filed for protection from its creditors under Chapter 11 in mid-1988, it was the largest, and perhaps most spectacular, failure to date of a junk bond-financed leveraged buyout and was seen by some industry observers as a harbinger of the end of the high-yield, unsecured debt mechanism's heyday as a takeover tool.

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