When Citigroup Inc. bought Sears, Roebuck and Co.'s $29 billion credit card portfolio last year, the companies cast the deal very much as a partnership rather than a takeover.

Now it looks like the partnership has picked up some baggage: a lawsuit by some of Sears' former unsecured bondholders.

In a filing last month to the chancery division of the Circuit Court of Cook County, Ill., 21 claimants, including J.P. Morgan Chase & Co., American International Group, and the U.S. Steel and Carnegie Pension Fund, said Sears violated its debt agreement when it invoked a redemption clause after the sale.

The plaintiffs say that redemption cost them about $80 million - the difference between the price at which Sears called the bonds and the bond's market value.

In a preemptive complaint filed in February, Sears, of Hoffman Estates, Ill., said that as a result of the sale, its receivables had declined enough over the stipulated three-month period to initiate the redemption.

There is more than the $80 million at stake for Sears. The suit covers only a portion of its bonds redeemed on the grounds of the Citi deal. In its claim, Sears said it had redeemed over $617 million of bonds, saving over $400 million of interest payments.

The former bondholders, which held around $255 million of debt, say the sale did not trigger Sears' right of redemption. To bolster their case, they have laid heavy emphasis on the partnership aspect of the deal. They say the two companies' proud characterization of their agreement as a "long-term marketing and servicing alliance" underscores the fact that Sears is still very much in the card business and therefore had no right to redeem the bonds.

Chris Brathwaite, a Sears spokesman, said it had said for months after announcing the deal that it would redeem its debts.

The former bondholders are "asserting that the redemption violated the terms of the contract," he said. "But we strongly believe that those assertions are entirely without merit and are nothing more than an opportunistic attempt by those financial institutions to seize value that appropriately belongs to the company's stockholders."

In an amended complaint filed March 12, Sears referred to the investors' written objections to the redemption, including a January letter in which JPMorgan Chase called the redemption "improper, unauthorized, or in violation of law." The bank also wrote that its acceptance of the redemption was "under protest," and that it reserved the right to seek damages.

In the suit, lawyers for the former bondholders quote Citi's literature at length to demonstrate what they call Sears' sale of its receivables (for a $3 billion premium) but not of its entire card business, which it continues to administer with the New York banking company.

The lawyers quote a remark Citi officials made when the deal was announced in July: "This is an intimate partnership which both our successes are heavily bound

up with."

According to the companies' "Program Agreement," Sears and Citi will "jointly develop" business and marketing plans and will "jointly own" all cardholder and transaction data. An "executive committee" with three representatives from each of the companies is in charge of the program.

"The actual credit is provided by Citi, but these are still the same Sears cards issued in Sears stores to the same Sears customers used for the same purposes," said David Wollmuth of Wollmuth Maher & Deutsch LLP in New York, which is representing the former bondholders. Sears is violating a contract's implicit "covenant of good faith and fair dealing" by defining the Citi sale as the diminishing of its receivables over time, especially when Sears continues to have a hand in the business.

The plaintiffs are not claiming that Citi bears any responsibility to cover the lost profits.

Though Sears may have breached its contracts, Citi "did nothing wrong here that I am aware of," Wollmuth said.

Wollmuth argues that because Sears' credit facility generated so much of the retailer's revenue (over 60% of its profits in the three years before the Citi deal), the sale of those receivables constituted the divestiture of "substantially all" of its assets, so Sears ought to have required Citi to assume the bond agreements.

"If Sears wanted to do this transaction, they should have had Citi assume its debt obligations," Wollmuth said. "Not only did Citi not assume it, but Citi agreed that Sears would retire it, and Sears wanted to do so as cheaply as it could."

Copyright 2004 Thomson Media Inc. All Rights Reserved.

http://www.thomsonmedia.com http://www.asreport.com

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.