Why American Apparel is going out of fashion

With 18 days to save his controversial firm from bankruptcy, style mogul Dov Charney is seeing his dream unravel.

Bright and breezy, slightly sleazy, American Apparel is one of the most recognisable brands on the high street, whichever side of the Atlantic you are on.

The Los Angeles-based retailer of monochrome wardrobe basics and fashion tchotchkes has courted scandal as assiduously as it courts its core demographic of waify teens and twentysomethings. After years of headlines about sexually charged advertising and accusations of sexual harassment on the part of the company's eccentric founder, Dov Charney, American Apparel looks like it is going down the way it came up: in a blaze of controversy.

Charney and his managers are at the centre of a new furore in the US over their hiring policies for store staff, a process that – we learned this week – has more in common with casting a runway fashion show than picking a team of till-ringers. Revelations that potential employees are required to submit "head-to-toe" photos of themselves if they even want to be considered have spawned a whole new round of tut-tutting and accusations of discrimination.

This headache is about the last thing the company wants right now, because it has precisely 18 days to avert bankruptcy. The financiers who lent the company the money for its ragweed expansion are now in the driving seat. Charney founded the company 13 years ago. Today he owns a little over half of it – but he may well not after the end of the month.

It is impossible to say if there is a straight line from the salacious gossip – usually culled from the sensational lawsuits that the company attracts – to the financial peril in which American Apparel finds itself, but this much is clear: it is no longer the hottest place to shop. An equally bright and breezy foreign interloper, Uniqlo, is expanding fast on its home turf; H&M and Zara are buzzing with bargain-hunting fashionistas, hip to styles that change in those stores faster than they ever change at an American Apparel.

Charney's cherished business model – his decision to make all the clothes at HQ in Los Angeles rather than in low-cost countries such as China, as encapsulated in his slogan "sweatshop free" – is approaching a crossroads. The slide in sales and, more recently, the failure to rebound from recession like the rest of the high street is a bitter blow. Until recently, amid all the controversies, the founder could at least point to the numbers and say he must be doing something right. What does he say now?

"Things should come together. . . We will be able to get into a positive place," he sheepishly told Wall Street analysts after the company revealed its financial precariousness last month. "I am motivated. I am working seven days a week. I hope to make everybody proud and I appreciate everybody's patience."

Less than a month after those remarks comes the new controversy over staffing policies. A New York blog that has long been a thorn in the company's side revived suggestions that head office will demand the sacking of ugly staff members. In a new twist, Gawker revealed that applicants must receive approval from executives based on a picture which, according to an internal memo, must be a "full-body head-to-toe" shot.

In other words, no uglies. It also reported claims from former employees that store managers would be required to periodically send staff photos for discussion by executives – with team members being judged on their looks and clothes.

The story produced a flurry of correspondence from former employees. One former manager was told not to hire "trashy" black girls, only "classy black girls, with nice hair, you know". An ex-staff member wrote: "Not only did they police our clothes but our eyebrows, makeup, nails and hair colour. Our store consultant also on several occasions told girls to lose weight or told them they were 'too top-heavy for crop tops'. They routinely denied applications based on looks or shoes."

American Apparel has gone only so far to deny the accusations. After all, this is a company that promotes new job openings by hosting what it describes as an "open call" at a store, as if it is a modelling audition rather than an interview. It admits that "we do screen, but not for beauty. What we look for is personal style."

Marsha Brady, creative director, told The Cut blog that American Apparel clothes were "more like art supplies than fashion, so when we're hiring, one of the things we look for is an ability to take our products, make them exciting, and show how cool they can look, which doesn't have much to do with just being pretty. . . From time to time, someone may occasionally make a photo request to offer styling tips to a store or to make sure that employees are featuring new products, but it's infrequent."

The latest revelations only bring the chain's in-store hiring policies under the same level of scrutiny as its approach to picking models for its hyper-sexual advertising campaigns, often featuring emaciated-looking girls, pictured, critics say, to leave a hint that they might be underage.

The firm's reliance on stick-thin, naturally attractive lens candy was parodied this year by the artist Holly Norris, who photographed disabled models for the work "American Able". Less satirically, the UK's Advertising Standards Authority last year banned one ad campaign that featured a semi-naked model who it said appeared to be under 16 and "stripping off for an amateur-style photo shoot".

Many of American Apparel's models are indeed amateurs plucked from the street by scouts; many of the photo shoots are conducted personally by the elaborately-moustached Charney, now 41. He has found himself subject to several lawsuits alleging sexual harassment. None has been proven in court but at least one has been settled.

It is within these lawsuits that lewd accusations have been levelled, including that he beds the models, walks round the office in his underwear and even held a board meeting in the nude. Defending himself when he was accused of referring to his models as "whores" and "sluts", he charmed the public anew by declaring: "Some of us love sluts."

Charney's rags-to-rag-trade-riches story is a familiar one in the industry: a youngster who got the entrepreneurial bug by importing T-shirts from the US as he was growing up in Montreal, he had transitioned by the early Nineties to producing his own simple range of screen-printed T-shirts. From these humble beginnings, American Apparel now employs 10,000 people and runs 285 retail stores in 20 countries.

Imperceptibly, American Apparel has shifted from being associated with sexual self-expression (it proudly stocked the gay magazine Butt and ran a Legalise Gay campaign when California voted to ban gay marriage) to being associated with allegations of sexual harassment, exploitation and discrimination. The whiff of sleaze has overshadowed other aspects of the business which drove interest in its best days, most notably its homespun "Made in America" approach. All its goods are manufactured in downtown LA by staff earning twice the minimum wage.

The fact that these achievements have been relegated is a source of frustration to Charney, as the world discovered in one further, bizarre controversy last year. American Apparel had used a picture of Woody Allen in a billboard campaign without his permission, and instead of settling when sued, the two men engaged in an extraordinary legal duel in which Charney's lawyers declared that the use of the image was protected by the laws of free speech.

He was trying to "express his frustration at being vilified by the press (much as Plaintiff was) and convey the message that media sensationalism too frequently overshadows the content of an individual's creative work. This is quintessential speech protected by the First Amendment." American Apparel paid the film director $5m to settle – but only after threatening to drag Allen's own famous sexual history into the proceedings.

If the public perception of American Apparel has shifted imperceptibly, then its financial fortunes have shifted dramatically and obviously. Charney blames a raid on his LA factory last year, in which it was discovered that 1,500 workers – almost one in three – was an illegal immigrant to the US. As a consequence of the raid, American Apparel struggled to keep the plant running.

But the financial troubles go deeper. In-store sales are still running down 10 per cent, while the rest of the high street has tiptoed out of recession, suggesting a bigger malaise among shoppers.

Worse, the company jacked up its debt levels to fund its expansion just as the slowdown hit, and its failure to get back into profit means it will almost certainly breach promises to its lenders at the end of this month. London-based investor Lion Capital bailed the company out with a loan a little over a year ago; as it totters under the weight of $91.4m (£64.6m) in debt, Lion will have to decide if it wants to turn that debt into a share of the company, or put American Apparel into bankruptcy.

This is a company that has been built on the personality and creativity of Dov Charney. If his power is waning, there are plenty of critics who will declare that this is no bad thing.

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