W. T. Grant's Lending Relations with Banks

Before 1973 W. T. Grant conducted its business with only minimal participation by the financial community.

Grant generally satisfied its short term cash needs through the commercial paper market. The lines of credit at money center banks were utilized to cover Grant's short term interim cash needs that resulted from the delays inherent in placing and selling commercial paper through W. T. Grant Financial Corp. [which was organized for the business of making loans to Grant and borrowed funds for that purpose]. ("Order Fixing Time and Place for Hearing to Authorize and Approve Agreement of Compromise and Settlement with Bank Claimants," in Morgan v. Grant , 4; hereafter cited as "Order Fixing Time")

This conversion also solidified the long-term relations between Grant and the banking community and deepened the latter's role in Grant's affairs. Banks' presence on nonfinancial boards can thus facilitate access to capital, as many corporations acknowledge.

By the spring of 1974 Grant's management had converted some of its short-term debt of commercial paper into long-term debt. With the help of Peterkin, who sat on both Grant's and Morgan's boards, Morgan Guaranty organized a five-year unsecured term loan of $100 million for Grant and became the agent for eight other banks ("Order Fixing Time," 4).

The sequence of events leading to Grant's difficulties actually began before December 1973, when high dividend payout rates coupled with inefficient managerial discretion caused a 78 percent decline in earnings (New York Times , 26 July 1974, 64; see also "Order Fixing Time," 6). Both Moody's and Standard and Poor's downgraded Grant's commercial paper rating from prime 1 to prime 2 and also downgraded Grant's long-term securities. This downgrading, together with Grant's declining performance, forced the retailer to resort to its bank lines of credit, which stood at more than $200 million. "As a result, Grant's overall borrowing increased sharply—by approximately $167 million—during 1973." The retailer's performance continued to decline through January 1974, when "Moody's withdrew Grant's commercial paper rating and substantially downgraded Grant's long term securities" ("Order Fixing Time," 6, 7). Grant could therefore no longer cover its short-term cash requirements through the commercial paper market and was forced to rely once again on the banks for its equity-to-debt conversion.

By March 1974 "Grant had $284 million of commercial paper outstanding of which $32 million was maturing on March 5, and

more than $100 million scheduled to mature the following week" ("Order Fixing Time," 7). Grant asked Morgan and the banks to reestablish the $100 million in credit lines that the banks withdrew when they made the $100 million loan to the ailing retailer. The banks agreed to reestablish this credit line, with Morgan Guaranty, Chase Manhattan, and First National City Bank (Citibank) each increasing their loans to Grant by $79 million. The total loans and credit lines the nine banks made were $415 million at this point.

The banks were clearly aware of their power as organized controllers of loan capital to destroy or rescue the firm, to define crisis, and to constrain managerial decision making. John P. Schroeder (executive vice president of Morgan Guaranty, and director and vice chairman of the board of both Morgan Guaranty and J. P. Morgan) testified that the banks met to discuss "what other sources besides the banks there would be for Grant. . . . [and] it was pretty apparent that the options for Grant had been reduced to banks, and banks alone" (Schroeder, in Morgan v. Grant , 18).

In June 1974 twelve of Grant's major banks met to discuss the retailer's situation (Schroeder, in Morgan v. Grant , 35). Apparently the banks recognized that they had a common problem by virtue of their involvement in Grant's lending consortium. That such a meeting (and many similar meetings throughout this case) took place attests that cooperation is standard practice among banks. Lending consortia facilitate and often necessitate such communication, and the consequent development of bank unity, because the situation they create fuses the interests of consortia members.

The new loans and credit lines did not stem the declining performance of the retailer. In July 1974 Grant was troubled by "severe cash shortages, was in default on a number of its short term notes and was running overdrafts at its lead banks." By August 1974 Morgan Guaranty, Chase Manhattan, and Citibank had each given Grant $5 million more in secured loans. Each bank was now exposed by $84 million to Grant. These loans were "secured by an assignment of certain customer accounts receivable of Grant" ("Order Fixing Time," 7). Accounts receivable are running records of customers' credits, payments, and balances due. Control of accounts receivable means control of the lifeblood of the firm, be-

cause these records provide invaluable information for corporate decisions. Furthermore, payments are made to whomever controls the accounts. Hence when the banks seized control of Grant's accounts, they were in a position to intercept any payments customers made on their bills. They were also able to control information regarding the firm's actual financial condition, thereby hindering management's ability to make defensible decisions. The banking community was able to gain control over this essential element of Grant because of their collective control of capital flows: they defined the situation as a crisis and demanded control of accounts receivable in exchange for the infusion of desperately needed capital. By extending loan capital when such an investment appeared imprudent and then seizing accounts receivable, the banks were able to delay bankruptcy to position themselves for their own maximum benefit.

The banks then escalated their constraining influence to control the hiring and firing of Grant's top personnel. In the spring of 1974 Grant's directors discussed "relieving Mr. Mayer of his duties" because of the firm's declining profitability. Peterkin testified to the banks' activism and intervention in Grant's decision-making processes, stating that he had personally discussed Mayer's ouster with several outside board members beyond the confines of formal board meetings (Peterkin, in Morgan v. Grant , 36, 38–39). As the pressure mounted, Mayer resigned as chief executive officer in June 1974. The banks then pressured Grant to name a permanent chief executive. Schroeder testified that Morgan Guaranty, Chase Manhattan, and Citibank "made it known as loudly and as vocally as possible that the absence of a new chief executive officer was impeding [their] efforts to line up the bank group." All "three major committee banks acting in concert . . . provided the communication" to Grant that their "disposition to proceed will be sharply influenced by" the selection of a permanent chief executive (Schroeder, in Morgan v. Grant , 50, 51–52).

In September 1974 James G. Kendrick was brought in from Zeller's, Ltd. (Grant's Canadian subsidiary) as president, chairman, and chief executive officer after the banks (represented by the outside directors who forced Grant's reorganization) strongly implied that Kendrick would cooperate with the banking community. Rodman suggested that Kendrick was named on a "request from

Citibank": The banks "hit the gong pretty hard with that request. Kendrick was named" (Rodman, in Morgan v. Grant , 77, 78). Indeed, one former senior executive noted that "the company joke was you got to be a director by how fast you could say yes. And the outside directors looked to Staley and . . . Peterkin for guidance" (Business Week , 19 July 1976, 61). Rodman asserted that the banks "wanted it [Kendrick's appointment] done before they went further on the accommodation of Grant with the extension of the credit" (Rodman, in Morgan v. Grant , 78). In fact the announcement of Kendrick's selection was speeded up because Citibank refused to go along with the loan agreement until Kendrick was named. Citibank knew Peterkin "was involved in the selection of the new chief executive officer and called him directly" (Schroeder, in Morgan v. Grant , 109–110). That Citibank could freely call Peterkin of Morgan Guaranty to press for a speedy announcement of Kendrick's appointment demonstrates the ease of interbank communication and, more important, the extent to which banks now controlled Grant's strategic decision making and operations.

When Kendrick took the top position at Grant, Peterkin sent him a letter to "encourage" his efforts and to let him know that "we [at Morgan were] going to do all we could to help him in his new work." "We at Morgan expect, in fact demand total credibility," Peterkin wrote, referring to the banks' anger at Grant management's previous secretiveness and lack of cooperation. Peterkin also hinted at the banks' power over the retailer, thanks to their loans to the firm and the substantial holdings of Grant stock in some of their trust funds: "At Morgan Guaranty failure is unacceptable. We are going to seek a way to get the job done. We, the banks, have a far greater investment in Grant than any other element of the Grant ownership" (Peterkin, in Morgan v. Grant , 3, 4, 6). Peterkin's letter was a veiled threat to Kendrick that failure to cooperate with the banks' demand for information and cooperation would lead to his downfall, as it had to Mayer's. Schroeder testified that the banks were "pleased" that Kendrick had taken over Mayer's job (Schroeder, in Morgan v. Grant , 52). This episode suggests the banks' ability to affect personnel decisions in the firm as well as their satisfaction that Kendrick would cooperate.

When Kendrick grasped the full extent of Grant's financial problems, he went public with the bad news. By September 1974

Grant, Grant Financial, and Morgan Guaranty (as agent for itself and 143 other banks) entered into a loan and guaranty agreement. Under this agreement the unsecured loans as well as the secured loans advanced to Grant Financial were extended to 2 June 1975. The agreement also increased the commitments for loans made to Grant Financial, raising total bank loans and advances to $700 million.

Of the 143 banks involved in loans to Grant at the time of its demise, 14 supplied over 83 percent of the $600 million in short-term loans and all of the $100 million in long-term loans (see Table 1). As collateral for the guaranty, the banks were granted security interests in Grant's accounts receivable and 6,399,300 common shares (51.3 percent) of Zeller's, Ltd. ("Order Fixing Time," 8–9).

Notably, when Grant's managers had earlier proposed to sell their receivables, the banks were opposed. Indeed, Schroeder testified that "the banks . . . require[d] bank approval of any such receivable sale." Although Schroeder insisted that Grant "never formally asked for approval," he agreed "it was understood that the banks' approval would be required before any such sale could take place." Grant's management understood that "there wouldn't be any loan agreement if such a sale went through" (Schroeder, in Morgan v. Grant , 70). That Grant deferred the sale of its receivables until after the loan agreement was made (whereupon the banks seized control of the accounts receivable) attests to the banks' constraining power to press management to delay decisions until the banks were in a more favorable position.

Rodman told the court that the banks' procurement of Grant's receivables "was prejudicial to the rights of other creditors" because "it set them [the banks] up with a claim to those assets. The accounts receivable were the single largest assets of Grant, with apparent priority over the other creditors." Rodman suggested that the banks procured these receivables "by virtue of their control and domination," since "it was up to Grant's best interest to cooperate . . . with the banks." Grant had to cooperate because the banks had the power to "force Grant into a very awkward situation" by calling in their demand notes (Rodman, in Morgan v. Grant , 75–76, 76–77, 76). Indeed, Grant executives Harry Pierson and Robert A. Luckett complained later that "the banks were running the company" (Schroeder, in Morgan v. Grant , 350).

The banks appear to have dominated Grant by virtue of their ability to advance or deny loans and thus to force the retailer to accept terms that were not in its interest. According to a Citibank document, "Bankers voiced the opinion that Grant died when [the banks] . . . took collateral and started a chain which made it [Grant] unrehabilitatable" (Schroeder, in Morgan v. Grant , 183). These struggles underscore a general pattern of bank intervention in Grant's decision making.

Not all the banks in Grant's consortium readily agreed with the lead banks' strategy of increasing Grant's lines of credit. Schroeder testified that he worked closely with John Sundman (director and financial vice president of Grant in 1974) between June and August 1974: "Our mission was to put together banks into a cohesive, committed operating group, and it was a very difficult mission" (Schroeder, in Morgan v. Grant , 30–31). One incident that illustrates the resistance of the small banks was the struggle with the Toms River Bank in central New Jersey.

To settle its account with Grant and discontinue involvement, Toms River Bank filed suit to recover its loans. Schroeder testified that "we [Morgan] had to have that suit dropped in order to proceed [with Toms River Bank's increased line of credit]. . . . The notion here was that no one of the banks was going to buy out any other bank." Bankers at Toms River hoped their suit would make them "difficult enough and provide a difficult enough scene so that we [Morgan Guaranty], in fact, would buy them out. But they didn't realize that our position was really quite adamant." Schroeder noted that if Toms River's suit was successful, the action would have forced Grant into bankruptcy (apparently before Morgan Guaranty was ready to precipitate Grant's bankruptcy). The lead banks began to apply pressure on Toms River: "The sound and furor within our sort of agent bank circles . . . about this Toms River Bank was very real. We sent a delegation down there to try to dissuade them. . . . We approached the management of that bank from a number of sources" (Schroeder, in Morgan v. Grant, 57, 58, 59).

One of those sources was the head of the Philadelphia Federal Reserve District, who "was . . . in touch with the management of the Toms River Bank, expressing . . . his great concern over" Toms River's suit. Schroeder acknowledged that such a communication from the Federal Reserve "would certainly be taken with greater seriousness by any bank manager." He told the court that at this request, the New York Federal Reserve District "authorized us [Morgan Guaranty] as the agent bank to mention the fact that we had a meeting with the Fed to the [recalcitrant] banks." A Continental Illinois Bank document indicated that "Morgan [Guaranty] was authorized . . . to report to Federal Reserve authorities such banks as refused to participate." Schroeder told the court that Morgan made telephone calls to Toms River to remind bankers there of Morgan's authorization to report recalcitrant banks to the Washington, D.C., Federal Reserve and to try to convince them to join the major banks in increasing Grant's credit line to $6 million (Schroeder, in Morgan v. Grant, 59, 60). The mounting pressure was apparently too great for the small New Jersey bank to resist. Toms River capitulated, withdrew its suit, and joined the other banks in a cohesive strategy toward Grant.

Schroeder testified that such communication between banks is a

standard operating procedure (Schroeder, in Morgan v. Grant, 63). By facilitating the modification of dissident viewpoints among banks, it creates a coalescence of policy within the banking community as a whole and produces a unified force confronting non-financial corporations. The structure of the lending consortium was the key factor here in the achievement of bank unity. Grant would have been forced to default on its loans without bank support in restructuring its debts. Therefore, since the large banks insisted that all members of the consortium participate in that restructuring arrangement, the small banks were constrained to remain in the consortium to recover their money.^[1]

The formation of coalitions was evident in both the structure of Grant's lending consortium and the establishment of an advisory committee. In November 1974 Grant's three lead banks formed the advisory committee (later called the steering committee) "to give [Grant's management] . . . a forum for discussing with [the banks] . . . ideas that would have . . . consequences [for], or . . . need input from the banking group" (Schroeder, in Morgan v. Grant, 185). Grant was clearly aware of the power of the banks and was trying to line up the banks' approval before making any policy decision that might anger them.

Further constraining influences were mobilized on 1 April 1975, when Grant, Grant Financial, and Morgan (as agent for all 143 banks in the consortium) entered into the loan extension agreement.

This agreement provided (1) for payment of outstanding loans made by 116 banks, in the aggregate principal amount of $56,509,610; and (2) for the extension of the maturity date to March 31, 1976, of outstanding loans made by the Bank Claimants in the aggregate principal amount of $540,916,978. ("Order Fixing Time," 9)

By extending lines of credit and loans totaling $700 million to Grant, and by entering into the loan extension agreement, the banks strengthened their constraining influence on Grant's poli-

cies. Since Grant now depended heavily on the banking community for survival, its management was not free to make decisions that might antagonize the banks. A covenant of the loan extension agreement stipulated bank participation and intervention into Grant's decision-making processes, including personnel and resource allocation. The agreement called for "bank approval of the changes in . . . voting control of the stock" (Schroeder, in Morgan v. Grant, 307). The banks also now demanded that Grant replace Kendrick with someone with expertise in merchandising who would be able to forcefully change, retain, and/or dismiss personnel and policies as necessary. Peterkin headed the search committee, which brought in Robert A. Anderson, a former vice president of Sears Roebuck and Co. (Peterkin, in Morgan v. Grant, 27). The process by which a search committee headed by a bank representative selected Anderson as Grant's chief executive illustrates how Grant's management acted to satisfy the banks.

Although the banks selected Anderson, he quickly had "substantial and loud disagreements with respect to Grant's inability to get merchandise." He threatened to resign, complaining that the banks were not meeting Peterkin's promise of bank support. Chase Manhattan Bank issued a memo on 16 June 1975 that stated, "I believe our only hope is a very senior level meeting with Anderson to try to convince him to stay within our ground rules." Schroeder told the court that Anderson "was not cooperating with the banks [and] . . . he was later told he was expected to. . . . He had 27 banks that were working their heads off to help him and [I told him] that he might just cooperate with them a little better" (Schroeder, in Morgan v. Grant, 321, 325–326).

The struggles between the banks and Grant's management continued against the backdrop of power plays by the major banks against the minor banks. On 2 June 1975 the major banks "convinced the 117 smaller banks to accept a 40% payment" of their loans to Grant, thus reducing the number of banks involved in Grant's indebtedness (Schroeder, in Morgan v. Grant, 312). This action, under which the minor banks recouped only a small portion of their loans to Grant, also precluded them from gaining access to Grant's assets when the major banks later declared the firm insolvent and forced it into bankruptcy.

The banks responded collectively to Anderson's "noncoopera-

tion" when he told them in September 1975 that Grant would need them to help put "more cash . . . into the company" (Kendrick, in Morgan v. Grant, 736). After exending so much support to the firm, the banks suddenly told Grant that they would not provide any more money to enable the retailer to reorganize. Instead, the banks entered into a subordination agreement in August 1975 to persuade vendors and suppliers to continue to ship goods to Grant. Under this agreement the banks "agreed to subordinate $300 million of Grant's indebtedness to them to certain trade obligations of Grant" ("Order Fixing Time," 10). But according to Anderson the subordination came too late to rescue Grant from bankruptcy, and Kendrick testified that both he and Anderson had requested the subordination as early as April or May 1975 (Kendrick, in Morgan v. Grant, 764–766).

Grant filed for Chapter XI bankruptcy on 2 October 1975. At that time the banks "set off approximately $94,523,110 of Grant's funds on deposit with them. . . . $90,300,000 of the set-off funds was subsequently advanced to Grant as a debtor-in-possession" ("Order Fixing Time," 10). By this action the banks essentially lent Grant its own money.

The banking community initially responded to Grant's cash flow shortage and deleterious patterns of managerial decision making by concurring that Grant's approach to business needed to be restructured and by agreeing that the firm should be allowed the opportunity to reorganize under Chapter XI bankruptcy proceedings. This approach is by and large reserved for firms that seem able to reemerge from reorganization as healthy, competitive businesses. The agreement by the banking community to allow Grant to file for reorganization protection indicated that at this point the banks did not define Grant's predicament as a crisis (that is, as permanently damaging to Grant's business trajectory). Rather, they defined it as a problematic situation that was expected to respond positively to reorganization efforts. A creditors' committee (composed of six banks and five trade creditors) was formed ostensibly to aid the firm in its reorganization attempts. Yet the question remains, Why did Grant's banks continue to extend increasing amounts of loans and lines of credit to a firm whose cash flow situation was clearly desperate?