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A sign for a Target store is seen in the Chicago suburb of Evanston, Illinois, in this file photo taken February 10, 2015.

JIM YOUNG/REUTERS

In a surprise move, Target Canada now owes $1.9-billion to a property company it created, making it the insolvent chain's biggest creditor and threatening to significantly dilute the recovery of others.

Granted bankruptcy protection on Jan. 15, Target Canada has ended an agreement with the property company it had set up for its failed store operations here, which triggered the $1.9 billion intercompany claim, according to court filings.

Suppliers, however, plan to fight the new claim at a court hearing on Thursday, noting it could dash their hopes to recover an estimated $400-million in the retailer's wind-down process.

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They also point out that Target Canada had agreed to subordinate to other unsecured creditors another $3.1-billion owed to an affiliate of parent company Target Corp. – but hasn't done so for its latest $1.9-billion of debt.

"It's a big issue," Melvyn Solmon, lawyer at Solmon Rothbart Goodman LLP who represents a baby goods supplier, said in an interview. "It would probably turn the suppliers' claims into pennies."

The battle over the $1.9-billion claim steps up the tensions between Target Canada and its creditors as they try to regain as much as they can in the wake of Target Corp.'s disastrous first foray outside its U.S. home market.

Still, in a filing on Wednesday, Target Canada's lawyers refute suppliers' contention that the $1.9-billion claim changes the landscape of the bankruptcy protection proceedings. The retailer's initial filing for court protection from creditors called out that there would be a payment, the lawyers say. "We have now simply provided further disclosure," said Tracy Sandler, partner at Osler Hoskin & Harcourt LLP, which represents Target Canada, in a court document.

She said the retailer intends to seek court approval of a claims process "at an appropriate stage" in the process and, as part of that, the court-appointed monitor will outline the nature and amount of inter-company claims.

Target Canada was granted court protection from its creditors after less than two years of operating in this country, with the intention of closing all of its 133 stores by mid-May. It leaves stakeholders ranging from suppliers to landlords racing to nab their fair share of proceeds.

The $1.9-billion Target Canada claim surfaced in the retailer's latest batch of court filings, in which it also disclosed a deal with two of its biggest landlords to sell back to them 11 of their best store leases for an undisclosed "premium" price, the documents say.

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The winding down of Target's property company agreement is "a key step in implementing the orderly wind down" of Target Canada, Mark Wong, its general counsel, said in a sworn statement.

The property company oversaw renovations and other improvements to the Target Canada stores, which it subleased. Target paid it rent and other amounts for store enhancements.

But the ending of the property company agreement is now necessary to pave the way for Target Canada to disclaim, assign or surrender leases, Mr. Wong said. It will also allow Target Canada "to maximize the value of its lease portfolio for the benefit of its stakeholders," he said. The retailer has set Thursday as the deadline for initial bids for its leases.

He said the deal to sell 11 leases back to the two landlords, Oxford Properties Corp. and Ivanhoe Cambridge Inc., requires Target Canada to terminate the property firm's subleases. As a result, it has ended its property company agreements which crystallized an early termination payment and led to the $1.9-billion claim, the filings say.

But the claim has raised concerns among creditors. "Any unsecured creditor would be unhappy to discover that there is a large new claim diluting the creditor pool," David Ullmann, an insolvency lawyer at Minden Gross LLP who acts for some of Target's landlords, said in an interview.

Still, it's too early to know how the $1.9-billion claim will play out because the retailer has yet to finalize a claims process or restructuring plan, Mr. Ullmann said.

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Lawyers for Target Canada and the court-appointed monitor could not be reached on Tuesday.

The law firm Blaney McMurtry LLP, which represents some suppliers, warned in a blog on Tuesday that the $1.9-billion debt "radically changes the landscape of this insolvency." The intercompany claim "is the primary, and by far the largest, debt" of Target Canada, since it had subordinated its $3.1-billion claim, its blog said.

The real question is whether Justice Geoffrey Morawetz of Ontario Superior Court "will allow this debt to rank with all other unsecured debt without it being subordinated in the same manner as the debt owed" to the U.S. parent company, the blog said.

Darius Goldman, a lawyer at Katten Muchin Rosenman LLP in New York which represents investment firms that purchase distressed supplier claims, said Target Canada should have to show how it calculated its $1.9-billion claim.

"It takes $1.9-billion of recoveries that otherwise would go to creditors and it shifts it to a Target affiliate," Mr. Goldman said in an interview. "Target should show the calculations supporting this claim to give creditors proper assurance this is not a contrived debt."

Editor's note: A previous version of this story incorrectly said Target Canada is owed $1.9-billion by a property company it created. In fact, Target Canada owes the money to the property company, which is a creditor of Target Canada. The article also misspelled the surname of Minden Gross LLP lawyer David Ullmann.

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