Lawsuits and losses paved road for American Apparel showdown

In a dimly-lit private dining room at the Redeye Grill in Manhattan, four board members of American Apparel and their lawyer plotted out their next 24 hours over steaks and red wine.

It was time; they had gathered there to plan the firing of the company's founder and chief executive Dov Charney, whose flamboyant leadership under mounting legal and financial setbacks had finally snapped the close bond with his handpicked board.

But executing his dismissal would require a bit of staging, a bit of role-playing among the board members, who envisioned various situations that could unfold once they approached Charney with the intention of ousting him.

The small, intimate group – two board members were absent, along with Charney – braced for a bruising, explosive fight with the man who was about to lose the company he had devoted his life to since founding it in 1998.

And there seems little doubt that strategies for dealing with the public fallout weighed on the board members' minds. Allan Mayer, a board member, was a co-author of a book on public relations called Spin: How to Turn the Power of the Press to Your Advantage.

That Tuesday night, June 17th, Mayer, who has become the board’s co-chairman since Charney’s firing, agreed to lead the showdown the following day at 4 Times Square. The board members anticipated offering an alternative to exile via termination; perhaps Charney would accept a long-term paid consulting position.

But despite all the dinnertime planning the gang of five could hardly have anticipated that the next day’s scheduled board meeting would be so contentious that it would last more than nine hours.

To the outside world, and certainly to some investors, the board’s decision to remove Charney was overdue. He had been running a company steeped in lurid intrigue for years, promoting and fostering a hypersexual playground for selling clothes.

First question

“We were well aware when we did this that the first question most people would ask was, ‘what took you so long?’” Mayer said. “We were not blind and deaf to all the allegations and the newspaper stories. But you can’t take an action this serious simply on the basis of rumours and allegations.”

Interviews with nearly a dozen current and former high-level company insiders depict a recent cascade of events that essentially forced the hand of a traditionally sympathetic board. Charney’s coarse behaviour was well known, and apparently tolerated, as evidenced by how unscathed he remained despite a parade of harassment lawsuits that trailed him for years.

But the company’s financial situation had grown precarious: interest rates on some loans had shot up to as high as 20 per cent, last year the retailer posted a loss of $106 million, and the stock price had plummeted to a low of 47 cents a share this spring from $15 in 2007.

And Charney had become more vulnerable – in a scramble for cash to shore up the retailer’s finances a stock dilution reduced his stake in the company to 27 per cent from 45 per cent.

John C Coffee jnr, an expert on corporate governance at Columbia University, suggested the board might have been patient with Charney until the company's fortunes were sagging. "The combination of being a virtual outlaw and losing money is not a combination which you can persist with for long. I think your margin for error shrinks once you begin to lose money, and you have all your constituencies concerned about the future. It's realpolitik."

Others argued that a decade’s worth of lawsuits accusing Charney of sexual harassment and discrimination should have provided the board with enough ammunition, even though he and his lawyers have steadfastly maintained that the accusations were unfounded and that he was a deep-pocketed target for litigation.

Potential liability

“It is surprising that Mr Charney was not removed earlier,” said

Gloria

Allred, a lawyer whose firm represented several women who sued him. “He was the architect of his own demise by repeatedly disregarding societal norms and by engaging in conduct that many believed constituted sexual harassment. Retaining him exposed the company to continual allegations and potential liability.”

Several outside lawyers, as well as a person with knowledge of the board’s deliberations, pointed to tactics used by Charney and his lawyers that might have helped stymie any possible moves the board considered making against him. At American Apparel all employees sign mandatory arbitration agreements, and many were also required to sign documents waiving their right to bring any claim against the company. Defendants like Charney generally fare better in arbitration than in a jury trial, legal experts say.

Arbitration hearings, unlike trials, are usually closed, and any filings are more likely to be sealed, often enabling defendants to avoid embarrassment and maintain their powerful positions.

"Employers like arbitration so much because it's a black box – nothing gets out," said Anne Golden, a New York lawyer who has represented many women in harassment and discrimination cases.

Charney and his lawyers were also vigorous in pushing for settlements, with the terms hardly ever being made public because of his insistence on nondisclosure.

For example, his lawyers offered $1.3 million to settle a claim for sexual harassment and wrongful termination brought by Mary Nelson, a former sales manager. The settlement deal fell apart when Nelson and her lawyer rejected various provisions, including nondisclosure of the $1.3 million and permission for the company and Charney to publicise that an arbitrator had found them blameless.

A person familiar with the board’s deliberations said that a profusion of settlements – and the fact that many of the people who sued Charney had also waived their right to claims against the company – resulted in very little in the way of established legal fact.

That all changed this spring. According to a person with knowledge of the board’s deliberations, in March board members received an update on the company’s legal proceedings that contained an unusual tidbit: a ruling.

An arbitrator had found Charney guilty of defamation for failing to stop the publication of naked photographs of a former employee Irene Morales who had sued him for sexual harassment. But the arbitrator ruled against her on the original harassment claims, according to the person familiar with the proceedings. Morales was eventually awarded about $700,000.

With this information in hand, the board called its outside counsel, Jones Day, and taking care not to tip off Charney or anybody who would feel compelled to inform him, the board began to investigate, often by discreetly calling employees.

In May new information emerged about another long-running lawsuit brought by Michael Bumblis, a former American Apparel store manager in Malibu, California, who said Charney called him a homophobic slur and assaulted him by choking him and rubbing dirt in his face because Charney was displeased at the store's condition.

Mayer has said the decision to fire Charney was based on his conduct, not the company’s performance, which has improved.

In a letter to the company, Patricia L Glaser, Charney's lawyer, said the board was trying to fire him for "activities that occurred long ago (if at all) and about which the board and the company have had knowledge for years".

Company losses

Yet even though first-quarter earnings showed a narrowing of company losses, to $5.5 million, down from $46.5 million a year before, the retailer’s circle of support continued to shrink. For years Charney’s reputation made lenders skittish about working with his company, and some refused outright. Many observers have questioned how the business could possibly generate enough cash to sustain its interest payments with the rates so high.

Yet another layer of anxiety inside the company stemmed from Charney’s management style.

Current and former executives described him as relentlessly controlling and pointed to a power vacuum growing in the retailer's upper ranks. Analysts said the company had developed a reputation as a place where talented people did not want to work. And during the past year Charney forced out important company executives, including general counsel Glenn A Weinman. A company with about 10,000 employees was left with one lawyer in the US.

In late February Mayer and another member of the board, Robert Greene, took Charney out to dinner in Los Angeles to discuss their concerns about the churning turnover and the lack of stability in American Apparel's upper echelons.

In a lengthy statement Glaser defended her client’s stewardship of American Apparel and said his firing was illegal.

She pointed to a recent regulatory filing with the Securities and Exchange Commission that called him the "principal driving force behind our core concepts, designs and growth strategy".

“A few hours before publicly announcing Mr Charney’s termination and launching its attack on him in the press, the board privately urged Mr Charney to continue to serve the company under a multi-year, multi-million dollar services contract,” Glaser said.

“If the board genuinely believed Mr. Charney was the irresponsible and ineffective leader as it has attempted to portray him, it would not have considered, let alone pressed, for him to stay on with the company whether as a consultant or otherwise.”

Creative force

People with knowledge of the company’s operations have said that even if the board had possessed sufficient evidence to fire Charney years ago, it did not have the appetite to remove the company’s driving creative force.

Few if any board members had experience in retailing or major public companies, things that helped enable Charney to keep them at a distance and to keep board meetings infrequent.

Charney has said he intends to fight to regain his position. Analysts say his options include linking up with investors to buy a large stake in the company that would supplement his 27 per cent.

So far it is not clear who might become Charney’s knight – and at least one prime candidate has turned him down.

Johannes Minho Roth, chief executive of FiveT Capital, which owns about 13 per cent of American Apparel according to regulatory filings, said he thought Charney had done a good job of improving the company's performance in recent months, cutting costs and managing distribution problems.

Yet when Charney telephoned seeking his support in the past week, Roth turned him down.

“It’s very difficult for us to support Dov at this point,” Roth said, adding that he did not know all the facts behind the ousting.

“What if he did something crazy or criminal, which, of course, he says he didn’t – but what if he did?” Roth said. “As long as we don’t know we can’t support him.”