Unsecured Creditors Do Not Need to Be the Losers - 2022 ...

ABI panel at

National Conference of Bankruptcy Judges Annual Meeting

Indianapolis, October 8, 2021

Unsecured Creditors Do Not Need to Be the Losers

Moderator:

Hon. Kevin J. Carey (Ret.), Hogan Lovells US LLP, Philadelphia, PA

Presenters:

Cullen Drescher Speckhart, Cooley LLP, Washington, D.C.

Edward T. Gavin, Gavin/Solmonese LLC, Wilmington, DE

David M. Posner, Kilpatrick Townsend & Stockton LLP, New York

In re: Country Fresh Holding Company Inc., et al.

Objection of the Official Committee of Unsecured Creditors

to Emergency Motion for Entry of an Order (A) Authorizing

and Approving the Debtors’ Key Employee Incentive Plan

and (B) Granting Related Relief

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE SOUTHERN DISTRICT OF TEXAS

HOUSTON DIVISION

§

In re: § Chapter 11

§

COUNTRY FRESH HOLDING COMPANY

INC., et al.,

§

§

Case No. 21-30574 (MI)

§

Debtors.1 § (Jointly Administered)

§

OBJECTION OF THE OFFICIAL COMMITTEE OF UNSECURED

CREDITORS TO EMERGENCY MOTION FOR ENTRY OF AN

ORDER (A) AUTHORIZING AND APPROVING THE DEBTORS’ KEY

EMPLOYEE INCENTIVE PLAN AND (B) GRANTING RELATED RELIEF

TO THE HONORABLE MARVIN ISGUR, UNITED STATES BANKRUPTCY JUDGE:

The Official Committee of Unsecured Creditors (the “Committee”) of the above

captioned debtors and debtors in possession (the “Debtors”), by and through its undersigned

proposed counsel, Kilpatrick Townsend & Stockton LLP, hereby files its objection (the

“Objection”) to the Emergency Motion for Entry of an Order (A) Authorizing and Approving the

Debtors’ Key Employee Incentive Plan and (B) Granting Related Relief [Dkt. No. 275] (the

“Motion”),2 filed by the Debtors, and shows the Court as follows:

1 The Debtors in these Chapter 11 cases and the last four digits of each Debtors’ taxpayer identification

number are as follows: Country Fresh Holding Company Inc. (7822); Country Fresh Midco Corp. (0702);

Country Fresh Acquisition Corp. (5936); Country Fresh Holdings, LLC (7551); Country Fresh LLC

(1258); Country Fresh Dallas, LLC (7237); Country Fresh Carolina, LLC (8026); Country Fresh

Midwest, LLC (0065); Country Fresh Orlando, LLC (7876); Country Fresh Transportation LLC (8244)

CF Products, LLC (8404) Country Fresh Manufacturing, LLC (7839); Champlain Valley Specialty of

New York, Inc. (9030); Country Fresh Pennsylvania, LLC (7969); Sun Rich Fresh Foods (NV) Inc.

(5526); Sun Rich Fresh Foods (USA) Inc. (0429); and Sun Rich Fresh Foods (PA) Inc. (4661). The

Debtors’ principal place of business is 3200 Research Forest Drive, Suite A5, The Woodlands, TX,

77381.

2 All capitalized undefined terms used herein shall have the meanings ascribed to them in the Motion.

Case 21-30574 Document 376 Filed in TXSB on 03/23/21 Page 1 of 11

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PRELIMINARY STATEMENT

1. The Debtors propose to “incentivize” the KEIP Participants for work already

performed. Beyond vague and conclusory statements, the Motion fails to provide any evidence

that the KEIP Participants need to be incentivized beyond the payment of their already

substantial salaries ranging from or that the proposed “incentive” metrics

will truly incentivize the KEIP Participants to perform above and beyond their already existing

job responsibilities, which they will have already performed when this Motion is heard by the

Court. In fact, this Court is scheduled to hear this Motion on the same date that the Court will be

asked to approve a sale, which predicates a substantial portion of the proposed KEIP.

2. The KEIP must be viewed in the appropriate context according to the facts of this

case. Here, the proposed KEIP will further enrich these senior executives at the expense of other

creditors of the Debtors’ estates, including general unsecured creditors who may receive nothing

from these potentially administratively insolvent estates. As discussed below, the various

proposed ranges for incentive payments in the KEIP are neither very challenging nor difficult to

attain, and thus are not incentivizing. The Debtors’ argue that “properly incentivizing,

compensating and rewarding the Debtors’ key employees at this critical juncture is in the best

interests of the Debtors, the Debtors’ estates, and all parties in interest.” However, should this

Motion be approved, the KEIP Participants will be paid for work already completed. The

Debtors fail to explain (and the Committee cannot see) any reason that the KEIP is in the best

interests of the Debtors’ estates at this juncture. While the Committee understands the concept

of rewarding hard working employees for meeting challenging performance metrics during a

chapter 11 process, the KEIP, as currently proposed, does not meet the requirements of sections

503(c)(1) or 503(c)(3) of the Bankruptcy Code.


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BACKGROUND

3. On February 15, 2021 (the “Petition Date”), the Debtors filed their voluntary

petitions for relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy

Code”). The Debtors are continuing in possession of their property and operating their businesses

pursuant to sections 1107 and 1108 of the Bankruptcy Code. No trustee or examiner has been

appointed.

4. The Committee was constituted by the United States Trustee on February 25,

2021.

5. On March 12, 2021, the Debtors filed the Motion in which they seek approval of

the key employee incentive plan (the “KEIP”) for five members of their management team (the

“KEIP Participants”).

6. If approved, the proposed KEIP will potentially pay close to to five of

the Debtors’ employees, specifically, the Chief Executive Officer, the Chief Financial Officer,

the Executive Vice President of Operations, the Executive Vice President Food Safety & Quality

Assurance, and the Executive Vice President Human Resources. As senior officers of the

Debtors, the KEIP Participants are insiders within the meaning of section 101(31) of the

Bankruptcy Code.3

7. As set forth in the Motion, the proposed payment of a KEIP bonus is based upon

certain metrics. First, the Debtors propose to provide an award to KEIP Participants based upon

the Debtors’ fill rate4, which will be benchmarked at (the “Fill Rate Incentive”). If the

Debtors’ fill rate is in the aggregate through the conclusion of the Sale, the Debtors will

3 The Debtors acknowledge that all five KEIP Participants “are or may be considered ‘insiders’ under the

Bankruptcy Code.” Motion ¶ 9.

4 According to the Debtors, the fill-rate for customer orders is the basis upon which the Debtors are paid.

If the Debtors’ do not meet their fill-rate, they are penalized through a backup penalty charge or reduced

payment.


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award the KEIP Participants a bonus that is 25% of their base salary. Such an award will result

in a $445,000 payment to the KEIP Participants.

8. Second, the Debtors propose to provide an award to the KEIP Participants tied to

the total price of the sale (the “Sale Incentive”), which will award the KEIP Participants

collectively $123,550 for every additional in proceeds above the current Stalking

Horse Bid. An aggregate cap of $492,500 will apply to the Sale Incentive, limiting the total

award for each KEIP Participant, with the exception of the CEO. The CEO will receive no less

than $100,000 upon the sale of the Debtors that the Debtors’ secured lenders have allegedly

agreed to fund from their distribution should an overbid not yield sufficient proceeds. The

$492,500 cap does not apply to the CEO’s award under the Sale Incentive.

9. The Debtors propose to measure the award for the Fill Rate Incentive and Sale

Incentive at the Sale closing and will pay such awards “as soon as practical after the Sale

closing.” Motion ¶ 20.

OBJECTION

10. Section 503(c)(3) controls whether the Court should approve Debtors’ proposed

KEIP. “Section 503(c) was enacted to limit a debtor’s ability to favor powerful insiders

economically and at estate expense during a chapter 11 case.” In re Pilgrim’s Pride Corp., 401

B.R. 229, 234 (Bankr. N.D. Tex. 2009). In other words, through section 503(c)(3), Congress

sought to “eradicate the notion that executives were entitled to bonuses simply for staying with

the Company through the bankruptcy process.” In re Hawker Beechcraft, Inc., 479 B.R. 308,

312-13 (Bankr. S.D.N.Y. 2012) (internal citations omitted); see also In re Dana Corp., 358 B.R.

567, 575 (Bankr. S.D.N.Y. 2006) (discussing the legislative history of section 503(c) of the

Bankruptcy Code). To make that determination, courts often look at historical performance

under proposed performance metrics and whether the targets will be difficult to achieve. See In


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re Velo Holdings, Inc., 472 B.R. 201, 210-11 (Bankr. S.D.N.Y. 2012) (noting that the Debtors

had yet to meet the proposed incentive program targets). The goals should be more like “half

court flings at the buzzer” than “layups” or “free throws.” Hawker Beechcraft, 479 B.R. at 313 n.

7. Thus, debtors bear a burden by the preponderance of the evidence that insider bonus programs

are truly incentives and not retentive in nature. In re Residential Capital, LLC, 478 B.R. 154, 170

(Bankr. S.D.N.Y. 2012).

11. In evaluating any proposed incentive plan, the first consideration is whether it is

merely a disguised retention plan, the approval of which is governed by the strict requirements of

section 503(c)(1) of the Bankruptcy Code, rather than the more liberal provisions of section

503(c)(3) of the Bankruptcy Code. The Committee submits that, in this case, the proposed KEIP

is a disguised retention plan designed to benefit a small subset of already well-compensated

insiders for work already performed. Specifically, the KEIP Participants’ salaries range from

. Courts recognize that debtors often mischaracterize retention programs

as incentive programs to evade the heightened scrutiny of section 503(c)(1). See In re Velo

Holdings Inc., 472 B.R. at 209 (“Attempts to characterize what are essentially prohibited

retention programs as ‘incentive’ programs in order to bypass the requirements of section

503(c)(1) are looked upon with disfavor”); In re Hawker Beechcraft, Inc., 479 B.R. at 312 (“the

threshold question . . . is whether the KEIP is a true incentive plan, or instead, a disguised

retention plan.”). As such, this Court must examine the proposed KEIP and determine whether

its KEIP metrics are “designed to motivate insiders to rise to a challenge or merely report to

work.” Hawker Beechcraft, 479 B.R. at 313.

12. For a KEIP to be truly incentivizing, it should be tied to significant and

challenging metrics. See, e.g., In re Dana Corp., 358 B.R. at 583 (approval of incentive plan

where performance metrics were “difficult targets to reach and [were] clearly not ‘lay-ups’”);


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US2008 18245505 5

Hawker Beechcraft, 479 B.R. at 313-15 (rejection of a bonus plan where lowest level of

performance metrics were “well within reach”). Additional work and requirements placed on

insiders caused by the commencement of a chapter 11 case are not sufficient reasons for

increased pay. See In re Residential Capital, LLC, 478 B.R. 154, 168 (Bankr. S.D.N.Y. 2012).

(“[w]hile it is no doubt true that the requirements of these chapter 11 cases and the proposed

assets sales have altered or increased the work of insiders, such would also be true in virtually all

chapter 11 cases; section 503(c) requires more than increased responsibilities to justify increased

pay for insiders.”). Yet, this type of additional work is exactly what the Debtors seem to rely

upon in trying to justify the payment of over in KEIP incentive payments to the five

insiders.

A. Fill Rate Incentive

13. The Debtors have entirely failed to meet their burden with respect to the Fill Rate

Incentive. The Debtors note that during the first week of these chapter 11 cases, the Debtors met

a fill rate. The Debtors fail to provide any other historical information sufficient for this

Court, the Committee and other parties in interest to determine that the proposed fill rate

metric is an appropriate target.

14. Additionally, at the time of the hearing for approval of the Sale, the Debtors will

likely know whether they will achieve a fill rate from the Petition Date through the

closing of the Sale, as the closing is required to occur on or before April 8, 2021 consistent with

the milestone set forth in the Final Order (I) Authorizing the Debtors to Obtain Postpetition

Financing, (II) Authorizing the Debtors to Use Cash Collateral, (III) Granting Liens and

Providing Superpriority Administrative Expense Claims, (IV) Granting Adequate Protection to

Prepetition Secured Parties, (V) Modifying Automatic Stay, and (VI) Granting Related Relief

(the “Final DIP Order”) [Dkt. No. 335]. See Final DIP Order ¶ 24. Approval of the KEIP at the


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March 25, 2021 hearing cannot be said to properly incentivize the KEIP Participants, who will

already know whether or not the fill rate target is likely to be achieved. Accordingly, the

Fill Rate Incentive should be removed from the KEIP.

B. Sale Incentive

15. Under the Sale Incentive, the Debtors propose to award the KEIP Participants

collectively $123,550 for every additional in proceeds above the current Stalking

Horse Bid. An aggregate cap of $492,500 will apply to the Sale Incentive, limiting the total

award for each KEIP Participant, with the exception of the CEO. The CEO will receive no less

than $100,000 upon the sale of the Debtors assets, as the Debtors’ secured lenders have allegedly

agreed to backstop this amount from their distribution should an overbid not yield sufficient

proceeds. The $492,500 cap does not apply to the CEO’s award under the Sale Incentive.

16. The Committee objects to providing the KEIP Participants with incentive payouts

simply for entry by this Court of an order approving the sale of the Debtors’ assets (which is

expected to occur soon) and the subsequent closing of such sale. That simply is not

incentivizing. The Debtors argue that it is “critical” that they implement the KEIP

“immediately” to ensure that the KEIP Participants “continue to meet the extraordinary

challenges confronting the Debtors during these chapter 11 cases and to ensure the highest

and best value for the Sale.” Yet, the KEIP Participants will be rewarded simply because a

bidder determines in its own business judgment to increase its bid. Moreover, the Motion

was filed at a time during which the Debtors anticipated that multiple bids for portions or

substantially all of the assets would be received. In addition, many of the functions that the

Debtors allege the KEIP Participants are being asked to perform are functions that, upon

information and belief, the Debtors’ Chief Restructuring Officer is also performing. The


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Sale Incentive is not challenging when the Debtors and their management team were already

aware that a competitive auction would likely be held.

17. In sum, the APA with Stellex/CF Buyer (US) LLC and Stellex/CF Buyer (CN)

Inc. (collectively, “Stellex”) was negotiated and executed prior to the bankruptcy filings, so the

KEIP Participants should not need to be incentivized for work that has already been done

prepetition in connection with the APA. Moreover, under the KEIP, the Debtors’ CEO will

receive $100,000 for the mere closing of the proposed Sale to Stellex; hardly an incentive to

maximize value of the Debtors’ estates. Further, the proposed incentive payments that are tied to

each increase of the sale price of the Debtors’ assets appear to be readily achievable

as the Debtors are already aware of multiple bids that have been made for the Debtors’ assets.

Perhaps most importantly, at the time of the scheduled hearing on the Motion, the auction will be

over, and the Debtors will know whether the Sale Incentive targets have been achieved. Where

the KEIP Participants themselves will know exactly what their award related to the Sale

Incentive will be at the time of the Debtors’ request for approval of the proposed KEIP, such

Sale Incentives cannot possibly be designed to properly incentivize. In sum, based on the

foregoing, the Committee submits that the Sale Incentive should be totally eliminated from the

KEIP.

CONCLUSION

18. The Debtors have the burden of proving by a preponderance of the evidence that

the KEIP is an incentive plan. See In re Dana Corp., 351 B.R. 96, 100 (Bankr. S.D.N.Y. 2006).

The Debtors have failed to establish that the KEIP Participants will work above and beyond their

fulfillment of their pre-existing employment and/or fiduciary duties. See In re GT Advanced

Techs., Inc., No. 14-11916-HJB, 2015 WL 5737181, at *6 (Bankr. D.N.H. Sept. 30, 2015) (“the

Insiders seek bonus compensation for doing a job they are already obligated to do—to right the


9

ship”). Indeed, the KEIP seeks to “incentivize” the KEIP Participants for work they have

already substantially performed. In addition, the scope and cost of the KEIP is neither

reasonable nor fair as the KEIP Participants may receive over in the aggregate in

addition to the base salaries they continue to collect. The Committee submits that such KEIP

awards are inappropriate and far from fair or reasonable in a case where a portion of the KEIP

awards are all but guaranteed and where unsecured creditors may not receive any recovery.

Lastly, the Debtors have failed to prove that the various proposed targets for the Fill Rate

Incentive and Sale Incentive are truly difficult metrics to establish and thus incentivizing. In

fact, if approved, the KEIP would provide $100,000 to the CEO simply for the closing of the

Sale already contemplated by the Stalking Horse Bid. In the absence of meaningful or

challenging targets that would truly provide a benefit to these estates, the proposed KEIP payouts

cannot be characterized as a true incentive plan and should not be approved. The Debtors have

failed to meet their burden in showing that the KEIP is properly structured to actually incentivize

the KEIP Participants to meet certain difficult targets. Accordingly, this Court should find the

KEIP to be retentive and not incentive-based and therefore deny approval thereof.

RESERVATION OF RIGHTS

19. The Committee reserves any rights as to the Motion and any further amendment

to the Motion that may be filed in these cases. The Committee further reserves the right to

amend, modify, or supplement this Objection at any time.


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WHEREFORE, the Committee requests that the Court deny the Debtors’ Motion and

grant such other and further relief as is appropriate.

Dated: March 23, 2021 By: /s/ Paul M. Rosenblatt

KILPATRICK TOWNSEND & STOCKTON LLP Patrick J. Carew, Esq.

State Bar No. 24031919

2001 Ross Avenue, Suite 4400

Dallas, TX 75201

Telephone: (214) 922-7155

Facsimile: (214) 279-5178

Email: [email protected]

-and-

KILPATRICK TOWNSEND & STOCKTON LLP Todd C. Meyers, Esq. (admitted pro hac vice)

Paul M. Rosenblatt, Esq.

1100 Peachtree Street NE, Suite 2800

Atlanta, GA 30309-4528

Telephone: (404) 815-6321

Facsimile: (404) 541-3373


[email protected]

-and-

KILPATRICK TOWNSEND & STOCKTON LLP Kelly E. Moynihan, Esq. (admitted pro hac vice)

The Grace Building

1114 Avenue of the Americas

New York, NY 10036

Telephone: (212) 775-8700

Facsimile: (212) 775-8800


Proposed Counsel for the Official Committee of

Unsecured Creditors


In re: Emerge Energy Services LP, et al.

Objection of the Official Committee of Unsecured Creditors to Debtors’

Motion (I) Pursuant to 11 U.S.C. §§ 105, 361, 362, 363 and 364

Authorizing the Debtors to (A) Obtain Senior Secured Priming

Superpriority Postpetition Financing, (B) Grant Liens and Superpriority

Administrative Expense Status, (C) Use Cash Collateral of Prepetition

Secured Parties and (D) Grant Adequate Protection to Prepetition

Secured Parties; (II) Scheduling a Final Hearing Pursuant to Bankruptcy

Rules 4001(b) and 4001(c); and (III) Granting Related Relief

IMPAC - 6339100V.2 08/10/2019 10:21 PM

UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF DELAWARE

In re:

EMERGE ENERGY SERVICES LP, et al.,1

Debtors.

)

)

)

)

)

)

)

)

Chapter 11

Case No. 19-11563 (KBO)

Jointly Administered

Hearing Date: August 14, 2019 at 11:00 a.m.

Re: Docket Nos. 20 and 64

OBJECTION OF THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS TO

DEBTORS’ MOTION (I) PURSUANT TO 11 U.S.C. §§ 105, 361, 362, 363 AND 364

AUTHORIZING THE DEBTORS TO (A) OBTAIN SENIOR SECURED PRIMING

SUPERPRIORITY POSTPETITION FINANCING, (B) GRANT LIENS AND

SUPERPRIORITY ADMINISTRATIVE EXPENSE STATUS, (C) USE CASH

COLLATERAL OF PREPETITION SECURED PARTIES AND (D) GRANT

ADEQUATE PROTECTION TO PREPETITION SECURED PARTIES; (II)

SCHEDULING A FINAL HEARING PURSUANT TO BANKRUPTCY RULES 4001(b)

AND 4001(c); AND (III) GRANTING RELATED RELIEF

The Official Committee of Unsecured Creditors (the “Committee”) of the above captioned

debtors and debtors in possession (the “Debtors”), by and through its undersigned proposed

counsel, Kilpatrick Townsend & Stockton LLP and Potter Anderson & Corroon LLP, hereby files

this objection (the “Objection”) to the Debtors’ Motion (I) Pursuant to 11 U.S.C. §§ 105, 361,

362, 363, and 364 Authorizing the Debtors to (A) Obtain Senior Secured Priming Superpriority

Postpetition Financing, (B) Grant Liens and Superpriority Administrative Expenses Status, (C)

Use Cash Collateral of Prepetition Secured Parties and (D) Grant Adequate Protection to

Prepetition Secured Parties; (II) Scheduling a Final Hearing Pursuant to Bankruptcy Rules

4001(b) and 4001(c); and (III) Granting Related Relief [D.I. 20] (the “DIP Motion” and the DIP

1 The Debtors in these cases, along with the last four digits of each Debtor’s federal tax identification

number, are: Emerge Energy Services LP (2937), Emerge Energy Services GP LLC (4683), Emerge Energy

Services Operating LLC (2511), Superior Silica Sands LLC (9889), and Emerge Energy Services Finance

Corporation (9875). The Debtors’ address is 5600 Clearfork Main Street, Suite 400, Fort Worth, Texas

76109.

Case 19-11563-KBO Doc 162 Filed 08/10/19 Page 1 of 22

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1911563190810000000000001

Docket #0162 Date Filed: 08/10/2019

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financing facility contemplated therein, the “DIP Facility”).2 In support of this Objection, the

Committee respectfully states as follows:

PRELIMINARY STATEMENT3

1. The DIP Lenders, who are one in the same as the Prepetition Secured Parties, are

seeking to provide a DIP Facility consisting of new-money and roll-up loans as a means to

effectuate their pre-negotiated Restructuring Support Agreement (the “RSA”), which will turn over

substantially all of the reorganized Debtors’ equity to the Prepetition Secured Parties. Pursuant to

the proposed Plan and attendant RSA, even if the Prepetition Secured Parties are determined to be

oversecured, the Prepetition Secured Parties are slated to receive, among other things, 95% of the

reorganized Debtors’ equity (and possibly 100% of the equity) and broad sweeping releases, all

within eighty-five (85) days of the Petition Date. Unsecured creditors, in contrast, are slated to

share in 5% of the reorganized Debtors’ equity and out-of-the-money warrants, but only if such

creditors vote in favor of the Plan. While objections to the Plan contemplated by the RSA are for

another day, the Debtors’ overall strategy for these cases—which is undoubtedly driven by the

DIP Lenders/Prepetition Secured Parties—is to run roughshod over unsecured creditors at

lightning speed leaving existing management and the lenders with virtually all of the potentially

significant upside to the business while unsecured creditors owed as much as $300 million or more

(when rejection damages are added to the pot) are left with at most a few pockets full of sand.

2. As discussed herein, the DIP Facility is inextricably tied to the RSA in that they

each contain, among other things, value-destructive cross-defaults. For example, if the Debtors

2 Capitalized terms used herein but not otherwise defined herein shall have the meaning ascribed to them

in the DIP Motion.

3 Capitalized terms used but not otherwise defined in the Preliminary Statement shall have the meanings

ascribed to them below.


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attempt to exercise the fiduciary out under the RSA, such action would trigger an event of default

under the RSA which, in turn, triggers a default under the DIP Facility. With this structure in

place, approval of the DIP Facility would render the restructuring set forth in the RSA and the

related Plan a fait accompli.

3. As if that were not enough, the Prepetition Secured Parties will also use the DIP

Facility to, among other things, (a) effectuate a “creeping” roll-up of as much as $66.7 million in

prepetition debt; (b) relend such rolled-up amounts to the Debtors with the same protections that

are afforded to new-money DIP loans; (c) encumber all previously unencumbered property on

account of both the new-money loans and the Roll-Up Loans, including (i) the assets of Emerge

Services Finance Corporation (“ESFC”), a Debtor that was not subject to any of the Prepetition

Debt or the Prepetition Liens; and (ii) assets encumbered by the Prepetition Secured Parties’

Prepetition Liens that are subsequently avoided; (d) eliminate the risk of a cram-down by way

of the proposed Roll-Up Loans; (e) receive payment of all professional fees without any cap; (f)

receive payment of excessive DIP fees for minimal new money loans; (g) lock these cases into

overly restrictive milestones; and (h) obtain sections 506(c) and 552(b) and marshaling waivers.

All of this relief, if granted, would be overreaching, unnecessary and unduly prejudicial to

unsecured creditors. Indeed, unless the one-sided Interim Order (and presumably Final Order) is

modified to address the issues and objections raised herein, entry of the Final Order may deprive

unsecured creditors of substantial unencumbered value less than one month after the

commencement of these chapter 11 cases.

4. Adding insult to injury, the Interim Order (and presumably the proposed Final

Order) also inappropriately restricts the Committee’s ability to discharge its fiduciary duties by,

among other things, providing an inadequate Challenge Period during which the Committee must


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not only investigate the Prepetition Secured Parties’ liens and claims but also causes of action or

claims against such parties (which parties appear to have hand-picked a special committee that

makes all restructuring-related decisions for the Debtor)4; and (b) seek and obtain standing to

commence a challenge5. These restrictions prevent the Committee from validating the Prepetition

Secured Parties’ position that they have enforceable and valid liens on substantially all of the

Debtors’ assets and asserting any claims or causes of action against the Prepetition Secured Parties.

5. Prior to filing the Objection, the Committee engaged in negotiations with the

Debtors and the Prepetition Secured Parties in an attempt to resolve the Committees issues with

the Final Order. While such negotiations hopefully remain ongoing, the parties were not able to

agree to the form of a Final Order, which necessitated the filing of this Objection.

6. For the reasons set forth herein, the Court should condition approval of the DIP

Motion on a final basis upon the Debtors substantially revising the Final Order and DIP Credit

Agreement so as to address the serious concerns discussed in this Objection including: (a) the

overreaching liens and superpriority claims in connection with the Roll-Up Loans; (b) the proposed

encumbrance of avoidance proceeds, claims under the Debtors’ D&O insurance policies,

commercial tort claims, and any proceeds or property of the foregoing; (c) the cross-defaults

between the RSA and DIP Facility; (d) the truncated Challenge Period and related terms; (e) the

4 Prior to the Petition Date, the board of directors of Emerge Energy Services GP LLC (which is wholly

owned by the Debtors’ ultimate equity owner, Insight Equity) delegated the powers to approve and

implement the terms of the proposed restructuring to a special restructuring committee of the board created

pursuant to the RSA (the “Special Restructuring Committee”). The Special Restructuring Committee

consists of two members that were appointed by the Debtors from a slate of candidates acceptable to the

Noteholders, who are one in the same with the DIP Lenders. See Declaration of Bryan M. Gaston,

Restructuring Officer of the Debtors, in Support of Chapter 11 Petitions and First Day Pleadings [D.I. 14]

(the “First Day Declaration”) at ¶ 33. 5 The Committee’s professional fee budget related to all challenge efforts is limited to $35,000.


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restrictive case milestones; (f) the proposed section 506(c), 552(b), and marshaling waivers; and

(g) the excessive DIP Fees.

BACKGROUND

7. On July 15, 2019 (the “Petition Date”), the Debtors commenced voluntary cases

under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”). The Debtors

continue to operate their businesses and manage their properties as debtors in possession pursuant

to sections 1107(a) and 1108 of the Bankruptcy Code.

8. On July 17, 2019, the Court entered its Interim Order (I) Authorizing Debtors (A)

to Obtain Postpetition Financing Pursuant to 11 U.S.C. §§ 105, 361, 362, 363, and 364 and (B)

to Utilize Cash Collateral Pursuant to 11 U.S.C. § 363, (II) Granting Adequate Protection to

Prepetition Secured Parties Pursuant to 11 U.S.C. §§ 361, 362, 363, 364 and 507(b) and (III)

Scheduling Final Hearing Pursuant to Bankruptcy Rules 4001(b) and (c) (the “Interim Order”)

[D.I. 64].

9. On July 30, 2019, pursuant to Section 1102 of the Bankruptcy Code, the United

States Trustee for the District of Delaware appointed the Committee [D.I. 111]. The Committee

consists of the following five members: (i) Trinity Industries Leasing Company; (i) The

Andersons, Inc. an Ohio Corporation; (iii) Iron Mountain Trap Rock Co.; (iv) Greenbrier Leasing

Company, LLC; and (v) BMT Consulting Group, LLC.

10. On July 30, 2019, the Committee selected Kilpatrick Townsend & Stockton LLP

and Potter Anderson & Corroon LLP as its proposed co-counsel. On August 2, 2019, the

Committee selected Province, Inc. as its proposed financial advisor and Miller Buckfire as its

proposed investment banker.

11. The objection deadline for the DIP Motion was originally August 7, 2019 at 4:00


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p.m. (ET). The Debtors agreed to extend the objection deadline for the Committee to August 1,

2019 at 11:59 p.m. (ET). A hearing to approve the DIP Motion on a final basis is scheduled for

August 14, 2019 at 11:00 a.m. (ET).

OBJECTION

12. Courts routinely recognize that “[d]ebtors in possession generally enjoy little

negotiating power with a proposed lender, particularly when the lender has a prepetition lien on

cash collateral.” In re Defender Drug Stores, Inc., 145 B.R. 312, 317 (9th Cir. BAP 1992). As a

result, courts are hesitant to approve financing terms that are considered harmful to an estate and

its creditors. See, e.g., In re Ames Dep’t Stores, Inc., 115 B.R. 34, 40 (Bankr. S.D.N.Y. 1990)

(noting that “the court’s discretion under section 364 is to be utilized on grounds that permit

reasonable business judgment to be exercised so long as the financing agreement does not contain

terms that leverage the bankruptcy process and powers or its purpose is not so much to benefit the

estate as it is to benefit a party-in-interest”). Thus, while certain favorable terms may be permitted

as a reasonable exercise of the debtor’s business judgment, bankruptcy courts have not approved

financing arrangements that convert the bankruptcy process from one designed to benefit all

creditors to one designed for the sole (or primary) benefit of the lender. See, e.g., Ames, 115 B.R.

at 38; (citing In re Tenney Vill. Co., 104 B.R. 562, 568 (Bankr. D.N.H. 1989)) (holding that the

terms of a postpetition financing facility must not “pervert the reorganizational process from one

designed to accommodate all classes of creditors . . . to one specially crafted for the benefit” of

one creditor).

13. The Interim Order, and presumably the Final Order, includes a number of

provisions that (a) prejudice the rights and powers that the Bankruptcy Code confers on the Court,

the Debtors, and the Committee, (b) unjustifiably benefits the DIP Lenders/Prepetition Secured


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Parties at the expense of the Debtors’ unsecured creditors, and (c) are likely to give the DIP

Lenders/Prepetition Secured Parties undue control over these cases.

I. The Liens and Claims on Account of the Roll-Up Loans Are Unwarranted and

Overreaching

14. The Committee recognizes that roll-ups are approved by courts in certain situations

based upon the unique facts and circumstances of a case. Here, however, the DIP liens and

superpriority claims related to the Roll-Up Loans are overreaching and detrimental to all creditors,

save the DIP Lenders/Prepetition Secured Parties. As discussed above, the DIP Facility

contemplates a “creeping roll-up” of the Prepetition Revolving Credit Obligations from cash

proceeds from the sale of any Prepetition Collateral or the proceeds from receivables. Such rolled

up amounts will then be deemed borrowed by the Debtors on a dollar-for-dollar basis under the

DIP Facility. Despite the Roll-Up Loans being characterized as DIP borrowings, the economic

reality of the Roll-Up Loans is that they are tantamount to the consensual use of cash collateral.

Notwithstanding this important distinction, the DIP Lenders are requesting that the Roll-Up Loans

be afforded the same DIP liens and superpriority claims as if they were new money financing, but

they are not.

15. If the DIP liens and superpriority claims on account of the Roll-Up Loans are

approved as currently proposed, the Roll-Up Loans will encumber all of the Debtors’

unencumbered assets, namely (a) assets of the Debtor obligors under the Prepetition Secured Debt

that were previously unencumbered; (b) encumbered assets that become unencumbered as a result

of a successful Challenge by the Committee (or any other party); and (c) the assets of ESFC, a

Debtor that was not previously subject to any of the Prepetition Debt or the Prepetition Liens.

Such a result would essentially guarantee that unsecured creditors will not see a penny on account

of the Debtors’ unencumbered assets.


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16. Given that these cases were clearly commenced for the benefit of the Prepetition

Secured Parties/DIP Secured Parties, the DIP Lenders’ efforts to scoop up all of the Debtors’

unencumbered assets on account of the Roll-Up Loans is overreaching and inconsistent with the

protections afforded to the use of cash collateral, which is all that is being provided by the so-

called Roll-Up Loans. Accordingly, the Committee objects to the DIP Lenders being granted any

DIP liens or superpriority claims on account of the Roll-Up Loans on any unencumbered assets

except to secure a superpriority adequate protection claim for diminution in value, if any, provided

that the Debtors are required to marshal encumbered assets before unencumbered assets. These

superpriority adequate protection claims and the new money portion of the DIP Facility are the

only claims that can properly be secured by any unencumbered assets.

II. The DIP Liens and Superpriority Claims and Adequate Protection Liens and

Claims on Account of the New Money Loans Should Not Encumber Avoidance

Proceeds, Commercial Tort Claims, Claims Under the Debtors’ D&O

Insurance Policies, or Proceeds or Property of the Foregoing

17. The Committee objects to the DIP Lenders being granted any DIP liens and

superpriority claims or adequate protection liens and claims on avoidance proceeds, commercial

tort claims, claims under the Debtors’ D&O Insurance Policies, and proceeds or property of the

foregoing, even to secure the new money and superpriority diminution in value claims.

18. With respect to the proposed liens and claims on avoidance proceeds, such relief is

fundamentally at odds with the unique purposes served by avoidance actions. Avoidance actions

are distinct creatures of bankruptcy law designed to benefit, and ensure equality of distribution

among, general unsecured creditors. See Official Comm. of Unsecured Creditors of Cybergenics

Corp. v. Chinery (In re Cybergenics Corp.), 226 F.3d 237, 244 (3d Cir. 2000), rev’d en banc, 330

F.3d 548 (3d Cir. 2003) (identifying underlying intent of avoidance powers to recover valuable

assets for estate’s benefit); In re Tribune Co., 464 B.R. 126, 171 (Bankr. D. Del. 2011) (noting


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“that case law permits all unsecured creditors to benefit from avoidance action recoveries”). The

Debtors have not provided any justification for the extraordinary grant of liens on avoidance

proceeds, or for the potential payment of superpriority claims with the proceeds of avoidance

actions. To the contrary, there is no legal basis for this Court to grant the DIP Lenders a lien on

avoidance proceeds. Accordingly, avoidance proceeds should be wholly excluded from the DIP

Collateral and reserved for the benefit of the Debtors’ unsecured creditors. With respect to any

DIP liens and superpriority claims or adequate protection liens and claims against the Debtors’

D&O insurance policies and commercial tort claims, those assets were likely unencumbered

prepetition and they should continue to remain unencumbered postpetition for the benefit of

unsecured creditors who, under the existing Plan, may receive no recovery whatsoever.

III. The Cross-Default Provisions in the DIP Facility and RSA Give the DIP

Secured Parties Undue Control Over These Cases

19. The fiduciary out is illusory because, should the Debtors determine that an

alternative restructuring proposal is in the best interest of the estates and terminate the RSA, the

DIP Lenders may (a) declare an event of default under the DIP Facility immediately, without

notice, application or motion, hearing before or order of the Court, (b) declare all obligations under

the DIP Facility immediately due and payable, (c) immediately terminate and restrict any right of

the Debtors to use cash collateral; and (d) upon five days’ written notice, exercise all rights and

remedies, including foreclosure upon the DIP Collateral, without further notice or order from the

Court. See DIP Credit Agreement §§ 10.7(c) and 11.1(a), Interim Order at ¶ 14(d). Accordingly,

any termination of the RSA and as a result, the DIP Facility—even if consistent with the exercise

of the Debtors’ fiduciary duties—would result in dire consequences for these estates and its

stakeholders.

20. Furthermore, although the RSA does not contain a “no-shop” provision, the


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existence of the cross-defaults and tight case milestones effectively creates a restrictive “no-shop”

provision. Indeed, the First Day Declaration makes no mention of the Debtors looking outside of

their own capital structure with regard to an in-court restructuring of the Debtors’ balance sheet

and business operations. Rather, the First Day Declaration provides that the Debtors and their

restructuring advisors engaged with only Insight Equity (the Debtors’ ultimate equity owner) and

the Prepetition Secured Parties. See First Day Declaration at ¶ 32. Why now, with a cross-default

looming over any exercise of the Debtors’ fiduciary out, would the Debtors “shop” for

restructuring alternatives, if they have not apparently done so to date? Furthermore, even if the

Debtors were to exercise their fiduciary out, they are still liable for the breach of the RSA: “no

termination of this Agreement shall relieve any Party from liability for its breach or non-

performance of its obligations hereunder prior to the date of such termination.” RSA at ¶ 6(e).

Therefore, approval of the Final Order in its current form would be tantamount to (a) approving

the assumption of the RSA without compliance with the provisions of section 365 of the

Bankruptcy Code; and (b) confirming a plan of reorganization without compliance with the

provisions of section 1129 of the Bankruptcy Code.

21. For the foregoing reasons, this Court should deny the DIP Motion to the extent that

the DIP Facility provides cross-defaults with the RSA and effectively nullifies the Debtors’

fiduciary out, improperly granting control of these cases to the Prepetition Secured Parties/DIP

Secured Parties. At a minimum, in the event a DIP default is triggered as a result of the Debtors

exercising their fiduciary out, the DIP Lenders’ exercise of remedies should not extend beyond the

ability to terminate lending. For the DIP Lenders to be able to exercise “all remedies”, including

the ability to foreclose, is inappropriate and value-destructive.


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III. The Proposed Adequate Protection Package is Unwarranted

22. The Interim Order provides an overly generous adequate protection to the

Prepetition Secured Parties in the form of (a) all accrued and unpaid interest and fees at the default

rate, as provided under the Prepetition Revolving Credit Agreement; and (b) all reasonable and

documented fees, out-of-pocket expenses, and disbursements incurred by the Prepetition Secured

Parties, without any cap. See Interim DIP Order at ¶ 18(d). However, it is not clear that the

Prepetition Secured Parties are oversecured, a necessary predicate for the payment of postpetition

interest. See In re Residential Capital, LLC, 508 B.R. 851, 853 (Bankr. S.D.N.Y. 2014) (“The

Bankruptcy Code entitles oversecured creditors to postpetition interest[.]”) (emphasis added). In

fact, the Dunayer Declaration states that, “Houlihan has concluded, however, that the going-

concern value of the Debtors’ assets fall significantly short of the total outstanding obligations

under the Prepetition Facilities.” See Declaration of Adam Dunayer in Support of Motion (I)

Pursuant to 11 U.S.C. §§ 105, 361, 362, 363, and 364 Authorizing the Debtors to (A) Obtain Senior

Secured Priming Superpriority Postpetition Financing, (B) Grant Liens and Superpriority

Administrative Expenses Status, (C) Use Cash Collateral of Prepetition Secured Parties and (D)

Grant Adequate Protection to Prepetition Secured Parties; (II) Scheduling a Final Hearing

Pursuant to Bankruptcy Rules 4001(b) and 4001(c); and (III) Granting Related Relief at ¶ 9 [D.I.

21] (the “Dunayer Declaration”)6.

23. For these reasons, the Committee requests that the Final Order exclude any payment

of postpetition interest to the Prepetition Secured Parties until a final determination is made as to

(a) the value of the Debtors’ assets; and (b) the validity of the Prepetition Liens. At a minimum,

6 By the filing of this Objection, the Committee is not agreeing with the value conclusion contained in the

Dunayer Declaration and expressly reserves the right to contest same.


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the Committee requests that the default rate not be utilized in calculating the postpetition interest

payments and that the Final Order make clear that any adequate protection payments be subject to

recharacterization as payments on principal in the event the Prepetition Lenders are undersecured.

IV. The Challenge Period and Related Terms Constrain the Committee’s Ability

to Appropriately Discharge its Fiduciary Duties

24. The DIP Facility contains substantial constraints on the ability of the Committee to

discharge its fiduciary duties. Specifically, the terms of the Interim Order limit the time during

which the Committee may investigate a litany of liens and claims related to the Prepetition Secured

Parties, file a motion to obtain standing, obtain the requisite standing, and commence a challenge

to (60) calendar days after the appointment of the Committee (the “Challenge Period”)7. This

timeframe is unacceptable and unworkable because the Challenge Period applies not only to the

liens and claims of the Prepetition Secured Parties (the “Prepetition Lien Matters”), but also any

claims or causes of action that may be asserted against the Prepetition Secured Parties (i.e., lender

liability claims and claims related to a valuation of the Debtors’ assets) (the “Prepetition Claim

and CoA Matters”). Given that the Interim Order (and presumably the Final Order) includes a

broad sweeping plan-like release of the Prepetition Secured Parties, the Committee, the only estate

fiduciary who has not granted such a release, must have a reasonable amount of time to investigate

whether such a release is appropriate or whether there are viable claims or causes of action against

such parties.8 See Interim Order at ¶ 7.

7 The Committee was appointed on July 30, 2019. Sixty (60) calendar days from the appointment of the

Committee is September 28, 2019. See Interim Order at ¶ 26. 8 The Committee also objects to the proposed investigation budget, which is currently set at $35,000.

Interim Order at ¶ 27. This provision clearly seeks to shield the Prepetition Secured Parties, who are also

the DIP Secured Parties, by unduly limiting the resources available to the Committee to investigate potential

claims against such parties. Therefore, the Committee requests that an additional $40,000 be made

available to the Committee for its analysis of Prepetition Lien Matters and that no cap be placed on the

Committee’s investigation into the Prepetition Claim and CoA Matters


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25. The Committee also objects to the requirement that it obtain standing prior to the

expiration of the Challenge Period if it wishes to pursue a challenge. See Interim Order at ¶ 26.

The process by which the Committee may obtain standing to pursue such a cause of action will

likely take a reasonable amount of time. As such, and given the proposed case milestones and thin

investigation budget for the Committee, the Committee should not be required to expend the time

and expense necessary to obtain standing prior to commencing a challenge. Indeed, courts have

previously approved financing agreements that grant standing to creditors’ committees without the

need for a standing motion. See, e.g., In re Phoenix Payment Sys., Inc., No. 14-11848 (Bankr. D.

Del. Sept. 3, 2014); In re Am. Safety Razor, LLC, No. 10-12351 (Bankr. D. Del. Aug. 27, 2010) at

¶ 6; see also In re Quebecor World (USA) Inc., No. 08-10152 (Bankr. S.D.N.Y. Apr. 1, 2008) ¶

21; In re Dana Corp., Case No. 06-10354 (Bankr. S.D.N.Y. Mar. 29, 2006) ¶ 25.9

26. In light of the complexity of these cases and the speed at which they are progressing,

the Committee requests that the Final Order be revised such that: (a) the Challenge Period for the

Prepetition Lien Matters be 90 days from the appointment of the Committee; (b) the Challenge

Period for the Prepetition Claim and CoA Matters be through and until the later of (i) 90 days from

the appointment of the Committee; and (ii) the hearing to confirm a chapter 11 plan; (c) the

investigation budget be increased to $75,000 for Prepetition Lien Matters only and that no cap be

placed on the Committee’s investigation into the Prepetition Claim and CoA Matters; and (d) the

Committee be granted automatic standing to commence a Challenge or, alternatively, that upon

the filing of a standing motion, the Challenge Period be automatically tolled until three (3) business

days after this Court rules on such motion.

9 In the event the Committee is required to obtain standing, the Challenge Period should be automatically

tolled upon the filing of a standing motion until three (3) business days after this Court rules on such motion.


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V. The DIP Milestones Must by Extended by at Least Thirty (30) Days

27. Pursuant to the milestones set forth in the DIP Credit Agreement and RSA:

within 37 days of the Petition Date, the Debtors shall have a hearing to approve the

Disclosure Statement Hearing (the “Disclosure Statement Hearing Deadline”);

within 60 days of the Petition Date, the Debtors shall have filed a motion seeking rejection

of any railcar leases designated by the Debtors and with the consent of the Required

Lenders (as defined in the DIP Credit Agreement);

within 35 days after the Disclosure Statement Hearing Deadline, the Debtors shall have a

hearing to seek confirmation of the Plan (the “Confirmation Hearing Deadline”); and

within the earlier of (i) 15 days after the Confirmation Deadline; and (ii) 100 days after the

Petition Date, the Effective Date of the Plan shall have occurred.

See DIP Credit Agreement § 6.16; RSA Term Sheet at Appendix I.

28. The Committee, which was formed only 11 days ago, should have an opportunity

to, among other things, vet the Debtors’ prepetition marketing efforts; independently test the

market for interest in the Debtors’ assets; understand and analyze the go-forward business plan;

perform a valuation analysis; investigate the Prepetition Secured Parties’ alleged liens and claims;

investigate potential claims against the Prepetition Secured Parties, including claims related to the

apparent mandate that the board abdicate its duties in favor of hand-picked proxies for the

Prepetition Secured Parties; understand the prepetition negotiations and analyses regarding entry

into the RSA; analyze tax-related issues that may be driving the structure of the Plan; analyze the

insider releases contained in the Plan; and analyze other Plan provisions including the rationale for

inexplicably providing consideration to equity despite the woeful consideration provided to

general unsecured creditors.


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VI. The Waivers of Sections 506(c) and 552(b) of the Bankruptcy Code and

Related Provisions are Unwarranted and Not Supported by the Record

29. The Debtors are seeking a waiver of the estates’ right to surcharge collateral

pursuant to section 506(c) of the Bankruptcy Code, as well as a marshaling waiver and a waiver

of the estates’ right under section 552(b) of the Bankruptcy Code. These waivers are entirely

inappropriate at this time, and in any event, not justified by the record.

A. Surcharge Rights Under Section 506(c) Should Not be Waived

30. The Interim Order provides that subject to entry of the Final Order, neither the DIP

Collateral nor Prepetition Collateral shall be subject to any surcharge pursuant to section 506(c) of

the Bankruptcy Code. See Interim Order at ¶ 16. Section 506(c) of the Bankruptcy Code is a rule

of fundamental fairness for all parties in interest and provides that secured creditors shall share the

burden of satisfying administrative expenses where funds are expended for the purpose of

preserving and selling their collateral. Section 506(c) ensures that the cost of liquidating a secured

lender’s collateral is not paid from unsecured recoveries. See, e.g., Precision Steel Shearing v.

Fremont Fin. Corp. (In re Visual Indus., Inc.), 57 F.3d 321, 325 (3d Cir. 1995) (stating, “section

506(c) is designed to prevent a windfall to the secured creditor”). As such, the Debtors’ unilateral

waiver of Bankruptcy Code section 506(c) would eliminate a further avenue of recovery for the

Debtors’ estates and foist the costs of the Debtors’ reorganization onto unsecured creditors.

31. By waiving the estates’ section 506(c) rights, the Debtors are agreeing to pay for

any and all expenses associated with the preservation and disposition of the collateral of the DIP

Secured Parties and the Prepetition Secured Lenders. Here, such a waiver is highly inappropriate

given that these cases are being run as a vehicle for the exclusive benefit of the Prepetition Secured

Parties. Indeed, if these cases proceed according to the RSA as currently proposed, the Prepetition

Secured Parties will reap almost all of the benefit of these cases with unsecured creditors being


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relegated to a de minimis recovery, if any. Courts have routinely rejected similar surcharge waivers

under these circumstances. See In re AFCO Enters., Inc., 35 B.R. 512, 515 (Bankr. D. Utah 1983)

(“When the secured creditor is the only entity which is benefited by the trustee’s work, it should

be the one to bear the expense. It would be unfair to require the estate to pay such costs where

there is no corresponding benefit to unsecured creditors.”); see also Transcript of Hearing at 20-

21, In re Mortgage Lenders Network USA, Inc., No. 07-10146 (PJW) (Bankr. D. Del. Mar. 27,

2007) [D.I. No. 346]; Transcript of Hearing at 212-13, In re Energy Future Holdings Corp., No.

14-10979 (CSS) (Bankr. D. Del. June 5, 2014) [D.I. No. 3927]; Hartford Fire Ins. Co. v. Norwest

Bank Minn., N.A. (In re Lockwood Corp.), 223 B.R. 170, 176 (B.A.P. 8th Cir. 1998).

32. While the Committee suspects that the Debtors are hopeful (or perhaps cautiously

optimistic) that the budget captures all of the expenses that will be incurred in the administration

of these cases, there can be no assurance at this early juncture that the administrative expenses of

these cases will be paid by the Debtors in the ordinary course. Furthermore, if an event of default

is called under the DIP Facility, the budgeted amounts that were incurred and not paid at such time

could remain unpaid. For these reasons, the Court should not approve a section 506(c) waiver at

this time.

B. The Equities of the Case Exception Under 552(b) and Marshaling Rights Must

be Preserved

33. The Debtors’ willingness to waive their rights under section 552(b) is, at best,

premature. The Court should also not permit a section 552(b) waiver before allowing parties in

interest – including the Committee – to properly examine the “equities of the case”. See Sprint

Nextel Corp. v. U.S. Bank Nat’l Ass’n (In re TerreStar Networks, Inc.), 457 B.R. 254, 272-73

(Bankr. S.D.N.Y. 2011) (denying request for 552(b) waiver as premature because factual record

was not fully developed). If unencumbered assets are used to increase the value of the secured


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creditors’ collateral, unsecured creditors should be able to argue that such value inures to them,

and not to secured creditors. See In re Metaldyne, No. 09-13412 (MG) 2009 WL 2883045, at *6

(Bankr. S.D.N.Y. June 23, 2009) (holding, in the context of a proposed 552(b) waiver, that “the

waiver of an equitable rule is not a finding of fact…and the Court, in its discretion, declines to

waive prospectively an argument that other parties in interest may make”); see also In re iGPS Co.

LLC, No. 13-11459 (KG) 2013 WL 4777667, at *5 (Bankr. D. Del. July 1, 2013) (no waiver of

the “equities of the case” exception with respect to creditors committee). In the alternative, any

section 552(b) waiver should be subject in all respects to the Committee’s challenge rights.

34. The Debtors also should not waive any rights with respect to the marshaling

doctrine in the Final Order. Such favorable treatment, which would enable the Prepetition Secured

Parties to “cherry pick” the collateral they want to liquidate most expeditiously is unwarranted

under the circumstances of these cases where the DIP Lenders are receiving excessive fees and

liens on assets previously unencumbered prepetition. Accordingly, marshalling rights should be

preserved for the Committee.10 See, e.g., In re Newcorn Enters. Ltd., 287 B.R. 744, 750 (Bankr.

E.D. Mo. 2002) (granting unsecured creditors’ committee derivative standing to bring marshaling

claim against secured lender, and thereby increase payout to unsecured creditors, where debtor

refused to do so); Official Comm. Of Unsecured Creditors v. Hudson United Bank (In re America’s

Hobby Ctr., Inc.), 223 B.R. 275, 287 (Bankr. S.D.N.Y. 1998) (“[S]tanding in the shoes of the

debtor in possession, the Committee can assert [marshaling] claim.”).

10 As noted above, marshaling should be required before the new money portion of the DIP Facility and

Adequate Protection Claims are satisfied from previously unencumbered assets, including assets

encumbered by the Prepetition Secured Parties’ prepetition liens that are subsequently avoided.


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VII. The Proposed DIP Fees are Excessive

35. In the context of a $35 million new money DIP Facility, the proposed DIP fees are

excessive and should be reduced. The proposed DIP fees include:

Commitment Fee: 1.00%

Closing Fee 3.00%

DIP Fee (if DIP replaced) 5.00%

36. With these fees in place, the “all in” financing cost is effectively 18%. It is self-

evident that these fees, which are for a DIP facility that furthers the DIP Lenders’ agenda of

effectuating the restructuring set forth in the RSA, are excessive and insulting from the perspective

of unsecured creditors who are slated to receive a de minimis recovery, if any. At a bare minimum,

the Committee requests that the 5% DIP Fee be reduced to 2.5%.

VIII. Other Objectionable Provisions

37. The Committee also objects to the provisions referenced below and requests that

the Final Order be amended accordingly. The Committee notes that by objecting to these

provisions in bullet point format, the Committee is by no means suggesting that these objections

are either technical or minor in nature.

Deposit/Security Accounts. The Final Order should make clear that with respect to deposit

or securities accounts being within the “control” of the Prepetition Secured Parties, the

term “control” is as defined in the Uniform Commercial Code. See Interim Order at ¶ 6(d).

Release. The plan-like release is overbroad for a DIP financing order and should be

stricken. See Interim Order at ¶ 7.

Indemnity. The indemnity provisions in favor of the DIP Agent and DIP Lenders needs to

be limited to their respective capacities as such. See Interim Order at ¶ 8(f).

Section 364(e) Good Faith Finding. The Debtors’ stipulation that the DIP Obligations are

deemed to have been extended by the DIP Secured Parties in good faith, as that term is

used in section 364(e) of the Bankruptcy Code, needs to be subject to the Committee’s

challenge rights. See Interim Order at ¶ 8(f).

Material Modifications. Any material modifications, amendments, updates and


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supplements to the Approved Budget need to be subject to further Court approval. See

Interim Order at ¶ 8(i).

Remedies Notice Period. The Remedies Notice Period should be elongated to five business

days’ notice. See Interim Order at ¶ 14(d).

Information Rights. The Committee should receive the same reporting at the same time as

the DIP Lenders. See Interim Order at ¶ 18(e).

Use of Proceeds/Carve-Out. The Interim Order prohibits the use of proceeds or access to

the Carve-Out for efforts related to: (i) “preventing, hindering, or otherwise delaying the .

. . enforcement or realization on the [Prepetition Debt];” and (ii) “seek[ing] to modify any

of the rights and remedies granted to the Prepetition Secured Parties, the DIP Agent . . .

under this Interim Order”. See Interim Order at ¶¶ 11(k) and 27. The Final Order should

include an overarching provision providing that nothing in the order shall limit the use of

proceeds or the Carve Out with respect to fees and expenses incurred by the Committee in

contesting the DIP Motion prior to entry of the Final Order, contesting the Disclosure

Statement, Plan, or credit bid, or any other action adverse to the Prepetition Secured

Parties/DIP Secured Parties other than investigating or asserting a challenge.

Limitation of Liability. The limitations of liability in favor of the DIP Agent and DIP

Lenders needs to be limited in their respective capacities as such. See Interim Order at ¶

31.

Credit Bidding. The Committee echoes the objection from Market and Johnson, Inc., Stout

Excavating Group LLC, and A-1 Excavating, Inc. [D.I. 134] regarding the Prepetition

Secured Parties’ ability to credit bid their claims without properly accounting for possible

senior liens such as Prior Permitted Liens. See Interim Order at ¶ 38.

Section 503(b)(9) Claims. So as to ensure administrative solvency, the DIP Lenders should

fund a segregate account not subject to the control or liens of the DIP Secured Parties or

the Prepetition Secured Parties with funds sufficient to pay all allowed claims arising under

section 503(b)(9) of the Bankruptcy Code.

IX. Objectionable Provisions in DIP Credit Agreement

38. The Committee also objects to the provisions in the DIP Credit Agreement

referenced below and requests that as a condition to approval of the DIP Motion, the DIP Credit

Agreement be revised accordingly.

Roll-Up Loans. The terms Pre-Petition Loans and Prior Lender Obligations encompasses

the entirety of the Prepetition Debt, not just the Prepetition Revolver Obligations. So as to

be consistent with the DIP Motion, Interim Order, and proposed Final Order, the DIP Credit


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Agreement needs to be clear that the Roll-Up only applies to the Prepetition Revolver

Obligations. See DIP Credit Agreement § 6.16.

Cross-Defaults. As the entire of the Prepetition Debt is not being rolled-up, the Credit

Parties will have indebtedness of more than $250,000 and, as a result, are susceptible to

triggering the cross-default provisions at section 10.11. See DIP Credit Agreement § 10.11.

Prohibition Language. The DIP Credit Agreement should not “prohibit any effort” by the

Debtors, the Committee or other party to prime or create pari passu liens. While such

efforts may trigger an event of default under the DIP Credit Agreement, this provision

should not be the equivalent of a restriction under contempt upon Court approval of the

DIP Motion and attendant DIP Credit Agreement. See DIP Credit Agreement § 7.2.

Corporate Governance Default. An event of default should not be triggered if (i) the charter

for the Special Committee is terminated or the Special Committee is dissolved; (ii) the

chief restructuring officer for the General Partner is terminated or replaced; and (iii) the

“[operational consultant]” engaged by the Special Committee is terminated or replaced;

and (iv) the Permitted Holders or the board of directors of the General Partner fail to

support the Approved Chapter 11 plan. See DIP Credit Agreement § 10.19

DIP/RSA Cross Defaults. For the same reasons discussed in this Objection, the DIP Credit

Agreement needs to remove the cross-defaults with the RSA, especially as it relates to the

Debtors’ exercising their fiduciary out. If the cross defaults remain as-is, the fiduciary out

is effectively illusory. See DIP Credit Agreement §§ 10.7(c) and 11.1(a).

Case Milestones. For the same reasons discussed in this Objection, each of the milestones

contained in the DIP Credit Agreement need to be extended by at least thirty (30) days.

See DIP Credit Agreement § 6.16.


The Committee reserves its respective rights, claims, defenses, and remedies, including,

without limitation, the right to amend, modify, or supplement this Objection, to seek discovery,

and to raise additional objections during any further hearing on the DIP Motion.


21

IMPAC - 6339100V.2 08/10/2019 10:21 PM

CONCLUSION

WHEREFORE, the Committee respectfully requests that the Court (i) condition entry of

an order approving the DIP Motion on a final basis unless the Final Order and DIP Credit

Agreement are modified as requested in this Objection; and (ii) granting such other and further

relief as the Court deems just and proper.

[Remainder of Page Intentionally Left Blank]


IMPAC - 6339100V.2 08/10/2019 10:21 PM

Dated: August 10, 2019

Wilmington, Delaware

Respectfully submitted,

POTTER ANDERSON & CORROON LLP

/s/ L. Katherine Good

Jeremy W. Ryan (DE Bar No. 4057)

Christopher M. Samis (DE Bar No. 4909)

L. Katherine Good (DE Bar No. 5101)

Aaron H. Stulman (DE Bar No. 5807)

1313 North Market Street, Sixth Floor

P.O. Box 951

Wilmington, DE 19801

Telephone: (302) 984-6000

Facsimile: (302) 658-1192


[email protected]

[email protected]

[email protected]

-and-

KILPATRICK TOWNSEND & STOCKTON LLP

Todd C. Meyers

David M. Posner

Kelly Moynihan

The Grace Building

1114 Avenue of the Americas

New York, NY 10036

Telephone: (212) 775-8700

Facsimile: (212) 775-8800


[email protected]

[email protected]

-and-

KILPATRICK TOWNSEND & STOCKTON LLP

Lenard M. Parkins

700 Louisiana Street, Suite 4300

Houston, TX 77002

Telephone: (281) 809-4100

Facsimile: (281) 929-0797


Proposed Counsel to the Official Committee of Unsecured

Creditors of Emerge Energy Services LP, et al.


mailto:[email protected]



In re: Brookstone Holdings Corp., et al.

Objection of the Official Committee of Unsecured Creditors to Debtors’ Motion for Entry

of an Order Approving Certain Bidding Protections for the Sale of Certain Assets to Blue Star Alliance, LLC

{BAY:03350798v1}

IN THE UNITED STATES BANKRUPTCY COURTFOR THE DISTRICT OF DELAWARE

--------------------------------------------------------------X

In re:

BROOKSTONE HOLDINGS CORP., et al.,1

Debtors.

(Chapter 11)

Case No. 18-11780 (BLS)


Hearing Date: September 6, 2018 at 11:00 a.m. (ET)Obj. Deadline: September 5, 2018 at 4:00 p.m. (ET)(extended for Committee)

--------------------------------------------------------------XOBJECTION OF THE OFFICIAL COMMITTEE OF

UNSECURED CREDITORS TO DEBTORS’ MOTION FOR ENTRYOF AN ORDER APPROVING CERTAIN BIDDING PROTECTIONS

FOR THE SALE OF CERTAIN ASSETS TO BLUESTAR ALLIANCE, LLC

The Official Committee of Unsecured Creditors (the “Committee”) of Brookstone

Holdings Corp., and its affiliated debtors and debtors-in-possession (the “Debtors”), by and

through its undersigned proposed counsel, hereby submits this objection (the “Objection”) to the

Debtors’ motion [D.I. 287] (the “Motion”)2 for entry of an order approving proposed bidding

protections (the “Bidding Protections”) for the sale of the Debtors’ intellectual property assets to

a newly-formed subsidiary or affiliate of Bluestar Alliance, LLC (“Bluestar”). In support of the

Objection, the Committee respectfully represents as follows:

1 The Debtors, along with the last four digits of each Debtor’s tax identification number, are:Brookstone Holdings Corp. (4638), Brookstone, Inc. (2895), Brookstone Company, Inc. (3478),Brookstone Retail Puerto Rico, Inc. (5552), Brookstone International Holdings, Inc. (8382), BrookstonePurchasing, Inc. (2514), Brookstone Stores, Inc. (2513), Big Blue Audio LLC (N/A), BrookstoneHoldings, Inc. (2515), and Brookstone Properties, Inc. (2517). The Debtors’ corporate headquarters andthe mailing address for each Debtor is One Innovation Way, Merrimack, NH 03054.

2 Capitalized terms not expressly defined herein shall be given the meanings ascribed to them inthe Motion.

Case 18-11780-BLS Doc 319 Filed 09/05/18 Page 1 of 6

{BAY:03350798v1} 2

OBJECTION

A. ABG Should Be Designated the Stalking Horse Bidder

1. Over the past 10 days, the Debtors received multiple proposals for stalking horse

designation from Bluestar and Authentic Brands Group (“ABG”)3:

Date Received BidForm

Bidder Cash Purchase Price Purchased Assets

August 24 LOI ABG $35 million Intellectual Property

August 28 LOI 4

August 30 LOI ABG $41 million IP/$36 millionGoing-Concern

Intellectual Property orGoing-Concern

August 31 LOI Bluestar $43 million Intellectual Property5

September 2 LOI ABG $50 million Intellectual Property orGoing-Concern

2. Over the past 36 hours, both Bluestar and ABG have each submitted proposed

asset purchase agreements (“APAs”) memorializing and documenting their stalking horse bids.

The bid submitted by Bluestar provides for the purchase of the Debtors’ intellectual property

3 True and correct copies of the ABG and Bluestar LOI’s are annexed hereto in chronological order asExhibits B through F.

4 With respect to a potential going-concern transaction, August 28 bid provides:

”

5 With respect to a potential going-concern transaction, Bluestar’s August 31 bid provides: “As part ofour bid, we will also consider, in conjunction with the Company, a restructuring transaction that providesthat the post-restructured Company operates as a going concern (i.e. we will consider keeping 40-50stores open, and will work with the company and third parties to review all options). If we do not keep atleast 40-50 stores open, we will provide the Debtors (or a post-effective date trust, the format to be at theDebtors’ option) with a guaranteed cash payment of $100,000 on January 2, 2020, and $100,000 onJanuary 2, 20211. In addition, we will also evaluate, and will consider implementing, any alternativetransaction proposed by any other bidder in conjunction with a sale of the IP and related assets.”


{BAY:03350798v1} 3

assets for a cash purchase price of $43 million. The Bluestar bid makes only vague reference to

a potential going-concern transaction, while remaining silent on the assumption of liabilities

related to the Debtors’ real property and payment of cure costs.6

3. The APA submitted by ABG provides for an alternative IP or going-concern

transaction (which election shall be made no later than September 19, 2018) for the purchase of

the Debtors’ intellectual property assets or a going-concern purchase of the company. A copy of

the APA is annexed hereto as Exhibit A. The purchase price for either transaction is $50

million. The APA submitted by ABG expressly contemplates an assumption of liabilities related

to the Debtors’ real property and payment of cure costs for Assumed Contracts in the event of a

going-concern transaction, and provides for the purchase of limited causes of action related to

Assumed Contracts only.

4. The APA submitted by ABG is the superior bid. Not only does it provide for $7

million of additional cash consideration, but it represents the best and perhaps only chance of a

going-concern transaction that could preserve a significant portion of the Debtors’ mall and

airport stores, an ongoing business relationship with the Debtors’ vendors and landlords, and

jobs for hundreds of the Debtors’ employees. Moreover, having previously stewarded a going-

concern purchase of Aéropostale, a retailer currently operating more than 500 retail stores that

was once on the brink of chapter 11 liquidation, ABG has an established track record in

executing retail going-concern transactions. Under these circumstances, the Committee submits

that the best interests of these estates will be served by designating ABG as the stalking horse

bidder. Through this designation, creditors can be assured that over the next several weeks,

6 The Bluestar bid provides for payment of a token $200,000 over the next several years if it doesnot purchase the assets as a going concern. The Committee is not aware of Bluestar having had anyadvanced discussions with landlords or retail partners.


{BAY:03350798v1} 4

ABG will be provided with information and resources on a wide range of going-concern issues,

including mall and airport inventory levels, store closing strategy, leasehold monetization,

license review, inventory replenishment strategies, and workforce review, which must be

analyzed and resolved on this expedited sale timeline.

5. While the most recent ABG bid was technically submitted after the deadline set

forth in the Bidding Procedures, the ABG bid should be accepted because it is a superior bid and

no parties would be prejudiced by its acceptance. Further, the bid deadline can be extended by

the Debtors. See Bidding Procedures, § XVI (“Notwithstanding any of the foregoing, the

Debtors and their estates, in consultation with the Consultation Parties, and with the consent of

the DIP Administrative Agent, which consent shall not be unreasonably withheld, and consistent

with the terms of the DIP Documents, reserve the right to modify these Bid Procedures at or

prior to the Auction, including, without limitation, to extend the deadlines set forth herein…”).7

These cases have moved forward on an expedited basis and under challenging circumstances, but

it is incumbent on the estate representatives to ensure that value is preserved and maximized to

the greatest extent possible. The Bidding Procedures provide the flexibility to do just that.

B. Bluestar Should Not Receive the Bidding Protections

6. In the event that Bluestar remains the stalking horse, it should not receive the

Bidding Protections given the existence of a superior bid from ABG. In the Third Circuit, courts

review the appropriateness of bid protections under section 503(b) of the Bankruptcy Code. See

In re O’Brien Envtl. Energy, Inc., 181 F.3d 527, 535 (3d Cir. 1999). The Debtors’ business

judgment is afforded no deference with respect to bid protections. Id. (concluding “that the

business judgment rule should not be applied” to break-up fees); see also In re Reliant Energy

7 Similarly, while the DIP facility required a stalking horse bid to be received by August 31, 2018,that deadline was (a) met and (b) also subject to extension upon the consent of the DIP lenders.


{BAY:03350798v1} 5

Channelview LP, 594 F.3d 208-09 (3d Cir. 2010).

7. The most common justification for granting bidding protections is to encourage a

stalking horse to submit a bid, which, in turn, provides a baseline valuation that encourages other

bidders to participate in the auction. See O’Brien, 181 F.3d at 537 (bidding protections, such as

expense reimbursements, may be justified if they “promote[] more competitive bidding”); see

also Collier on Bankruptcy ¶ 363.02[7] (“[Bidder protections, such as expense reimbursements,]

are appropriate only where the prospective buyer provides something of value to the estate in

exchange, typically setting a floor under the auction by committing to purchase the assets at a

minimum price.”).

8. That justification is lacking here given that the Debtors have already entertained

multiple stalking horse proposals from both ABG and Bluestar, and previously issued a press

release designating ABG as the stalking horse bidder. Providing Bluestar with bid protections

would, at this point, serve no purpose other than to tilt the playing field in its favor. Courts have

denied approval of bidding protections in similar circumstances. See, e.g., O’Brien, 181 F.3d at

529 (noting that bankruptcy court “refused to approve the break-up fee and expense provisions,

expressing concern that allowing such fees and expenses would 'perhaps chill or at best certainly

complicate the competitive bidding process’”; also recognizing that bidding protections may

impermissibly “serve to advantage a favored purchaser over other bidders by increasing the cost

of the acquisition to the other bidders”).

[Remainder of page intentionally left blank]


{BAY:03350798v1} 6

WHEREFORE, the Committee respectfully requests entry of an order denying the relief

requested in the Motion, designating ABG as the stalking horse bidder, and granting such other

relief as is proper.

Dated: September 5, 2018 BAYARD, P.A.Wilmington, Delaware

/s/ Gregory J. FlasserJustin R. Alberto (No. 5126)Erin R. Fay (No. 5268)Gregory J. Flasser (No. 6154)600 N. King Street, Suite 400Wilmington, Delaware 19801Telephone: (302) 655-5000Facsimile: (302) 658-6395Email: [email protected]

[email protected]@bayardlaw.com

-and-

COOLEY LLPSeth Van AaltenCathy HershcopfRobert Winning1114 Avenue of the AmericasNew York, New York 10036Telephone: (212) 479-6000Facsimile: (212) 479-6275Email: [email protected]@[email protected]

Proposed Co-Counsel for the Official Committee ofUnsecured Creditors of Brookstone Holdings Corp.,et al.


In re: 24 Hour Fitness Worldwide, Inc., et al.

Response and Limited Objection of the Official Committee of Unsecured Creditors to the Debtors’ Motion for

Entry of Order (I) Extending Time for Performance of Obligations Arising Under Expired Non-Residential Real

Property Leases, and (II) Granting Related Relief

11822985/1



-------------------------------------------------------------- X

In re:

24 HOUR FITNESS WORLDWIDE, INC., et al.,

Debtors.1

Chapter 11

Case No. 20-11558 (KBO)


Hearing Date: July 1, 2020 at 3:30 p.m. (ET)

Obj. Deadline (as extended for the Committee):

June 30, 2020 at 4:00 p.m. (ET)

RE D.I. 132

-------------------------------------------------------------- X

RESPONSE AND LIMITED OBJECTION OF THE OFFICIAL COMMITTEE OF

UNSECURED CREDITORS TO THE DEBTORS’ MOTION FOR

ENTRY OF ORDER (I) EXTENDING TIME FOR PERFORMANCE OF

OBLIGATIONS ARISING UNDER UNEXPIRED NON-RESIDENTIAL REAL

PROPERTY LEASES, AND (II) GRANTING RELATED RELIEF

The Official Committee of Unsecured Creditors (the “Committee”)2 of 24 Hour Fitness

Worldwide, Inc. and its affiliated debtors and debtors-in-possession (the “Debtors”), by and

through its proposed counsel, Cooley LLP and Morris James LLP, hereby files this response and

limited objection (the “Response”) to the Motion of Debtors for Entry of Order (I) Extending Time

for Performance of Obligations Arising Under Unexpired Non-Residential Real Property Leases,

and (II) Granting Related Relief (the “Motion”) [D.I. 132] and respectfully represents as follows:3

1 The Debtors in these chapter 11 cases, along with the last four digits of each Debtor’s federal tax identification

number, as applicable, are 24 Hour Holdings II LLC (N/A); 24 Hour Fitness Worldwide, Inc. (5690); 24 Hour Fitness

United States, Inc. (8376); 24 Hour Fitness USA, Inc. (9899); 24 Hour Fitness Holdings LLC (8902); 24 San Francisco

LLC (3542); 24 New York LLC (7033); 24 Denver LLC (6644); RS FIT Holdings LLC (3064); RS FIT CA LLC

(7007); and RS FIT NW LLC (9372). The Debtors’ corporate headquarters and service address is 12647 Alcosta Blvd.,

Suite 500, San Ramon, CA 94583.

2 The United States Trustee for Region 3 appointed the Committee on June 25, 2020. The Committee consists of the

following seven members: (i) Kellermeyer Bergensons Services, LLC; (ii) Precor, Incorporated; (iii) Wells Fargo

Bank, National Association, as indenture trustee; (iv) Geneva Crossing Carol Stream IL LLC; (v) SMA Architects,

PC; (vi) A.T. Kearney Inc.; and (vii) Brookfield Properties Retail, Inc.

3 Capitalized terms used but not defined herein shall have the respective meanings ascribed to them in the Motion.


2 11822985/1

RESPONSE AND LIMITED OBJECTION

1. Understanding the Debtors’ stated commitment to a measured approach to their

liquidity, and sharing in the Debtors’ resolve to prudently respond to the unprecedented business

challenges arising from COVID-19 as they transition into chapter 11, the Committee does not

object to a sixty-day period of rent deferral that is limited in its duration by the plain language of

Bankruptcy Code section 365(d)(3). The Committee does object, however, to the Debtors’

suggestion that it may be entitled to a potentially indefinite “rent holiday” in signaling through the

Motion that further extensions may be sought. Each additional month in which rent deferral is

permitted will deepen the potential of administrative insolvency of these cases by deferring

approximately $30 million of rent expenses that must be paid before these Debtors can emerge.

2. The Committee is concerned that the Debtors seek to continue a troubling trend in

retail chapter 11 cases, in which lenders—faced with uncertainty caused by COVID-19 and related

“shelter in place” orders—refuse to pay the costs of administering chapter 11 cases. But unlike in

J.C. Penney, J.Crew, Art Van Furniture, Pier 1, Modell’s, and other retail cases, 24 Hour Fitness

did not incur prepetition indebtedness based on the value of its inventory, hard assets, and saleable

personal property. Here, the Debtors’ secured lenders cannot be paid in full through “store

closing” or similarly-themed liquidation sales should the Debtors falter in their efforts to

reorganize. The only way to ensure that these cases maintain administrative solvency is to use the

DIP financing wisely and pay administrative expenses as they come due.

3. If current trends continue and the re-opening of the economy is thwarted by a

nationwide resurgence of new COVID-19 cases (particularly in Texas, California, and Florida

where more than half of the Debtors’ clubs are located), factors beyond the Debtors’ control may

preclude them from meeting the postpetition revenue forecasts that indicate that they will be able


3 11822985/1

to “true-up” their Landlords with catch-up payments later in these cases. The risk that COVID-19

may impair the Debtors’ ability to perform in accord with financial projections should not be borne

by these estates and their administrative creditors. Nor should delayed rent payments be used as

points of leverage by which to extract concessions from the Landlords. On the contrary, every

precaution should be taken to minimize the likelihood that the Debtors will incur postpetition

obligations that they will be unable to repay by the 61st day of these cases or otherwise in the

ordinary course. Any other result delivers an option to the DIP lenders, who (1) have negotiated

a $250 million dollar-for-dollar roll-up of their prepetition claims into an enhanced collateral

package through the DIP Facility, (2) are receiving payment of generous interest (including interest

on their roll-up) and fees, and (3) are poised to capture significant value if the Debtors are able to

return to a more normalized state of operations as our nation recovers from this unprecedented

pandemic.

4. The Committee recognizes that the uncertainty inherent in the day-to-day lives of

the Debtors’ members (and all Americans) represents a major hurdle in the Debtors’ ability to

effectuate a successful reorganization. However, the disruptions caused by COVID-19 do not

justify a rent deferral program that would enable the Debtors to shift unlimited risk to holders of

administrative claims and further subordinate any possibility of a recovery for general unsecured

creditors. The Landlords should not be forced to provide this significant additional involuntary

unsecured financing (and without the Debtors’ provision of any adequate protection), while the

Debtors use their DIP financing to fund the DIP lenders’ interest and fees.

5. The Committee reiterates its unambiguous support for the Debtors’ efforts to

reorganize in a manner that is both swift and value-maximizing. But, much like section 365(d)(3),


4 11822985/1

the Committee’s support for the Debtor’s rent deferral program is not without its limitations. The

Committee is willing to support a rent deferral program that:

Provides for the escrow of all rent deferred from the second draw of the DIP Facility to be

paid upon expiration of the Expiration Period;4 and

Does not permit the Debtors to seek an additional extension beyond the 60 days provided

in section 365(d)(3).5

The Committee submits that these modifications reflect a sensible balance that would allow the

Debtors to preserve short-term liquidity without placing undue risk of non-payment on their

Landlords, and as such are in the best interests of these estates.

6. The Debtors cite to a number of retail cases in which bankruptcy courts have

provided periods of rent deferral that exceed the 60-day period allowed by the Bankruptcy Code

upon a showing of cause. But unlike traditional retailers (whose substantial inventory can be

liquidated and those liquidation proceeds can be surcharged to pay the costs and expenses of

preserving and disposing of inventory), the Debtors are entirely dependent on the DIP financing

and payment of membership dues to pay rent and other administrative obligations. If the Debtors

are forced to close and cease operations, they will do so without assets to liquidate to satisfy the

administrative rent and other claims they are currently accruing.

7. Moreover, and unlike the precedent cases cited in the Motion, the Debtors

anticipate opening almost all of their locations during the Extension Period. Whether these

4 Pursuant to the proposed terms of the DIP Facility, the Debtors would be authorized to borrow an additional $200

million upon entry of the final DIP order. These funds should be used to pay the deferred rent payments instead of

being used as leverage to negotiate rent concessions from the Landlords.

5 Section 365(d)(3) permits the court to extend, “for cause” the time for performance of an obligation arising under

an unexpired lease of real property “that arises within 60 days after the date of the order for relief, but the time for

performance shall not be extended beyond such 60-day period.” 11 U.S.C. § 365(d)(3) (emphasis added). The

statute, therefore, makes clear that the Debtors must pay these obligations on day 61.


5 11822985/1

locations will remain open or profitable at the later date on which the Debtors wish to pay their

landlords is an open question. These meaningful differences render all prior precedents inapposite,

and granting any open-ended rent deferral program requested by the Debtors would constitute a

drastic extension of the already extraordinary relief granted in other post-COVID-19 retail cases.


8. The Committee reserves the right to raise additional arguments at or prior to the

hearing on the Motion.

WHEREFORE, the Committee respectfully requests that the Court deny approval of the

Motion, and grant such other relief as the Court deems just and proper, consistent with the

arguments raised herein.


6 11822985/1

Dated: June 30, 2020

/s/ Eric J. Monzo____________

Eric J. Monzo (DE Bar No. 5214)

Brya M. Keilson (DE Bar No. 4643)

MORRIS JAMES LLP

500 Delaware Avenue, Suite 1500


Tel: (302) 888-6800

Fax: (302) 571-1750


[email protected]

-and-

Cathy Hershcopf, Esq.

Michael Klein, Esq.

Lauren A. Reichardt, Esq.

COOLEY LLP

55 Hudson Yards

New York, NY 10001

Tel: (212) 479-6000

Fax: (212) 479-6275


[email protected]

[email protected]

-and-

Cullen D. Speckhart, Esq. Admitted to practice in New York, Virginia, Missouri and

Texas; Not admitted to practice in DC, supervised by

members of DC bar

Olya Antle, Esq. Admitted to practice in Virginia Not admitted to practice

in DC, supervised by members of DC bar

COOLEY LLP

1299 Pennsylvania Avenue, NW

Washington, DC 20004

Tel: (202) 842-7800

Fax: (202) 842-7899


[email protected]

Proposed Counsel for the Official Committee of

Unsecured Creditors of 24 Hour Fitness

Worldwide, Inc., et al.



Objection of the Official Committee of Unsecured Creditors to Motion of Debtors for Entry of Order (I) Approving the Proposed

Disclosure Statement and Form and Manner of Notice of Disclosure Statement Hearing, (II) Establishing Solicitation and Voting Procedures, (III) Scheduling Confirmation Hearing, (IV)

Establishing Notice and Objection Procedures for Confirmation Of the Proposed Plan, and (V) Granting Related Relief



In re:

24 Hour Fitness Worldwide, Inc., et al.,

Debtors.1

:

Chapter 11

Case No. 20-11558 (KBO)

(Jointly Administered)

Re D.I. 1017, 1021

Hearing Date: November 12, 2020 at 2:00 p.m. (ET)

Objection Deadline: November 4, 2020 at 4:00 p.m. (ET)

OBJECTION OF THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS TO

MOTION OF DEBTORS FOR ENTRY OF ORDER (I) APPROVING THE PROPOSED

DISCLOSURE STATEMENT AND FORM AND MANNER OF NOTICE OF

DISCLOSURE STATEMENT HEARING, (II) ESTABLISHING SOLICITATION AND

VOTING PROCEDURES, (III) SCHEDULING CONFIRMATION HEARING, (IV)

ESTABLISHING NOTICE AND OBJECTION PROCEDURES FOR CONFIRMATION

OF THE PROPOSED PLAN, AND (V) GRANTING RELATED RELIEF2

The Official Committee of Unsecured Creditors (the “Committee”) of 24 Hour Fitness

Worldwide, Inc., et al., as debtors and debtors-in-possession (collectively, the “Debtors” or “24

Hour Fitness”), by and through its counsel Cooley LLP and Morris James LLP, submits this

objection (the “Objection”) to the Debtors’ motion (the “Motion”) [D.I. 1021] for entry of an

order (i) approving the proposed disclosure statement (the “Disclosure Statement”) and form and

manner of notice of disclosure statement hearing, (ii) establishing solicitation and voting

procedures, (iii) scheduling confirmation hearing, (iv) establishing notice and objection

1 The Debtors in these chapter 11 cases, along with the last four digits of each Debtor’s federal tax

identification number, as applicable, are 24 Hour Holdings II LLC (N/A); 24 Hour Fitness Worldwide, Inc. (5690);

24 Hour Fitness United States, Inc. (8376); 24 Hour Fitness USA, Inc. (9899); 24 Hour Fitness Holdings LLC

(8902); 24 San Francisco LLC (3542); 24 New York LLC (7033); 24 Denver LLC (6644); RS FIT Holdings LLC

(3064); RS FIT CA LLC (7007); and RS FIT NW LLC (9372). The Debtors’ corporate headquarters and service

address is 12647 Alcosta Blvd., Suite 500, San Ramon, CA 94583.

2 The Debtors have not provided the Committee with the exhibits to the Disclosure Statement, including the

Liquidation Analysis and Financial Projections, nor have the Debtors provided the Committee with any valuation

analyses performed to date. The Debtors have, however, provided certain, limited, information regarding the

Debtors’ business plan, and the Committee has relied upon that information for purposes of this Objection. To the

extent that the exhibits, once filed, are inconsistent with anything herein, the Committee will supplement this

Objection.


2

procedures for confirmation of the proposed plan, and (v) granting related relief. In support of

this Objection, the Committee respectfully states as follows:3


1. The proposed Plan delivers the vast majority of the Debtors’ considerable

enterprise value to their DIP Lenders. The Plan is premised on an artificially low valuation, a

lucrative rights offering, and a new money exit financing package, each structured to deliver

outsized returns to the DIP Lenders without a proper market test. The Committee is prepared to

submit compelling evidence at the Confirmation Hearing that the Debtors’ businesses are far

more valuable than the Debtors conclude and, therefore, that the Plan is unconfirmable under the

Bankruptcy Code.

2. While the Debtors’ DIP Lenders are poised to recover a multiple of the value of

their claims, the Debtors’ unsecured creditors are left with a pro rata share of warrants to

purchase 8% of the Reorganized Debtors’ common stock, unprotected from the massive dilution

from the New Preferred Equity Interests and Management Incentive Plan, and exercisable only at

a strike price equal to the excess of total enterprise value of $1.2 billion. This formula all but

ensures general unsecured creditors will recover nothing under the Plan.4 In light of this patently

unfair allocation of value, the Committee opposes the Plan, rendering it unlikely that Class 4,

comprised of General Unsecured Claims, will vote in favor of the Plan.

3. The Debtors nevertheless seem intent on proceeding down this path, and now ask

this Court to bless a Disclosure Statement that fails to provide creditors with a complete picture

3 Capitalized terms used but not otherwise defined herein shall have the meanings ascribed to them in the

Disclosure Statement.

4 To put the Debtors’ proposal into perspective, if the Reorganized Debtors are sold for $1.5 billion 5 years

after the Effective Date, the unsecured creditors would potentially recover $8.6 million or less than 1% of the

projected claims. In contrast, the participants in the rights offering would likely recover $609 million on their $80

million investment.


3

of the Debtors’ projections, cost savings, valuation, and proposed restructuring. Far more

disclosure is needed and the Committee respectfully submits that the following deficiencies must

be addressed before the Court allows the Debtors to solicit this Plan:

(a) First and foremost, the Disclosure Statement lacks clear and conspicuous language

informing creditors that the Committee: (i) does not support the Plan; (ii) does not believe the

proposed Plan is fair; and (iii) recommends that creditors vote against the Plan absent

modification providing for a meaningful distribution to unsecured creditors.

(b) Second, the Disclosure Statement must clearly inform creditors that the Committee

believes that the $538 million total enterprise value ascribed to the Debtors under the Plan

materially understates the Debtors’ actual value. Based on the Debtors’ business plan provided

to the Committee and other financial projections, the Committee believes that this valuation

unreasonably discounts the strong performance projected by the Debtors’ business plan and the

potential for 24 Hour Fitness to flourish with valuable real estate concessions in a post-COVID-

19 environment. Moreover, the enterprise value ascribed to the Debtors under the Plan fails to

adequately account for strong financial and operational projections that the Debtors themselves

believe are achievable upon emergence from chapter 11, including, but not limited to the

following:

i. The Debtors’ business plan projects that by 2023 and in 2024, the Debtors’

business will be more valuable than it ever was, including in 2018 when the

Debtors had $1.4 billion of funded debt that traded at par.

ii. The Debtors forecast 296 operating clubs next year, increasing to 311 in 2024.

The forecasted EBITDA per club ratio is $498,000 in 2022, increasing to

$791,000 in 2024, compared to an EBITDA per club ratio of $460,000 in

2018.

iii. The Debtors forecast revenue growth of 19.2% in 2022 and 9% in 2023,

leveling off at 6.3% in 2024.


4

The Disclosure Statement should provide creditors with detailed information concerning the

assumptions underlying the Debtors’ enterprise valuation and clearly state that the Committee is

prepared to prove that the Debtors’ purported valuation materially understates the actual

enterprise value of a business that continues to improve and has potential for success upon

emergence from chapter 11.5

(c) Third, and related to the aforementioned defects with respect to the Debtors’

valuation, the Disclosure Statement also (i) fails to provide adequate information with respect to

the Rights Offering, including the effects of the liquidation preference and any dilution, pricing

of the Liquidation Preference Amount and its potential effect on other stakeholders, and what

information the Debtors relied upon in determining the aggregate purchase price for the

Reorganized Debtors’ preferred stock being made available to the DIP Lenders through the

proposed Rights Offering, and (ii) fails to provide adequate information with respect to the

Debtors’ Postpetition Marketing Process, including why the proposed short timeline for the

Postpetition Marketing Process is adequate, to how many parties received the Debtors’

marketing materials and which of these parties expressed an interest in the Debtors’ assets

previously, what information was or will be made available to these parties, and how many

parties (if any) already have access to the Debtors’ data room, among other deficiencies. The

Debtors’ creditors are entitled to have the information necessary to make an informed judgment

on the Plan.

5 See Declaration of Daniel Hugo In Support of Debtors’ Chapter 11 Petitions and First Day Relief (“Hugo

Declaration”) [D.I. 4], ¶ 7. (“With the protection of this Court and the tools that chapter 11 provides, however, the

Debtors are confident that they not only can endure the crisis that COVID-19 has presented, but can also transform

and modernize their business in a way that leads to long-term success and relevancy for the 24 Hour Fitness brand

and enhances the fitness experience of their millions of loyal members.”).


5

(d) Fourth, the Disclosure Statement fails to provide creditors with information

concerning the assets and liabilities of the Debtors. It also does not identify or value the

unencumbered assets of these estates, and does not contain any discussion of the extent to which

the value of the unencumbered assets will (or will not) be preserved for the benefit of unsecured

creditors under the Plan. The Debtors’ unencumbered assets, which include (i) up to

approximately $8.4 million of cash on hand as of the Petition Date (the “Unencumbered Cash”);

(ii) Avoidance Actions; and (iii) approximately $10 million in funds held under the Debtors’

non-qualified deferred compensation plan (the “NQDC Plan”), are not mentioned in the

Debtors’ Disclosure Statement as part of the Debtors’ unencumbered assets. In fact, the only

mention of the NQDC Plan is with respect to the Debtors’ intent to assume such Plan. The

Debtors’ valuation of $538 million is based on the value of the Debtors’ assets as well as those

of their non-debtor affiliates, but the Disclosure Statement provides no information as to what

these assets are. Moreover, the term “unencumbered” is wholly absent from the Disclosure

Statement. Creditors should be provided an explanation as to how the distributable value of

unencumbered assets flows to creditors under the Plan.

(e) Fifth, the Disclosure Statement inadequately explains the nature of the Exit Facility

and the impact it is likely to have on the Debtors’ post-effective date capital structure and cash

flow, and specifically provides no information with respect to the Incremental Facility. With

respect to the Term Loan Facility, the proposed debt burdens the Debtors with approximately $4

million of cash interest and $8 million of PIK interest per year, with the potential for interest

payments to exceed $14 million per year following the “Cash Interest Step-Up Trigger”

described in the Exit Facility. The Disclosure Statement should inform creditors about the costs


6

of this facility as compared to financing that would be available to 24 Hour Fitness if the Debtors

sought exit financing from the marketplace.

(f) Sixth, the Disclosure Statement provides no factual or legal justification for the

proposed Plan releases in favor of the Released Parties, which includes the Debtors’ current and

former directors and officers, the Debtors’ sponsors, as well as the DIP Lenders’ pre- and post-

petition agents for the secured facilities. Importantly, the Disclosure Statement is devoid of any

information with respect to what consideration has been provided in exchange for the releases.

These Disclosure Statement deficiencies, as well as others discussed herein, must be remedied

before the Disclosure Statement is approved and before the Plan is solicited.

4. The Committee appreciates the Debtors’ desire to not languish in chapter 11 and

is committed to resolving any disputes over the Debtors’ enterprise value if practicable.

Nonetheless, and in light of the deficiencies set forth herein, the solicitation period and the

scheduling of any Confirmation Hearing, must take into account the need for coordinated

discovery among the parties so that the Committee may vigorously test the Debtors’ assumptions

underlying their proposed valuation. The Committee respectfully requests the Disclosure

Statement Hearing also be used as a scheduling conference in anticipation of a contested

Confirmation Hearing.

FACTUAL BACKGROUND

5. On June 15, 2020 (the “Petition Date”), the Debtors filed voluntary petitions for

relief under Chapter 11 of the Bankruptcy Code in this Court. Pursuant to sections 1107 and

1108 of the Bankruptcy Code, the Debtors continue to operate their businesses and properties as

debtors-in-possession. No trustee or examiner has been appointed in these cases.


7

6. On June 25, 2020, the United States Trustee for Region 3 appointed the

Committee, which consists of the following seven members: (i) Kellermeyer Bergensons

Services, LLC; (ii) Precor, Incorporated; (iii) Wells Fargo Bank, National Association, as

indenture trustee; (iv) Geneva Crossing Carol Stream IL LLC; (v) SMA Architects, PC; (vi) A.T.

Kearney Inc.; and (vii) Brookfield Properties Retail, Inc.6 See Notice of Appointment of

Committee of Unsecured Creditors [D.I. 284].

7. On October 7, 2020, the Debtors filed a proposed plan of reorganization (the

“Plan”) [D.I. 1016] and the Disclosure Statement [D.I. 1017]. No amendments have been filed

since the initial filings. Essential information has not been filed or shared with the Committee,

including the Debtors’ Liquidation Analysis, Financial Projections, and information regarding

any valuation analyses performed by or for the Debtors.

8. The Plan is designed to disproportionately benefit the DIP Lenders at the expense

of a truly fair chapter 11 process, while relying on a faulty valuation that provides an inadequate

recovery to general unsecured creditors. The Disclosure Statement further lacks other key details

that a creditor needs in order to make an informed decision when voting on the Plan, including,

but not limited to, the Debtors’ financial projections and valuation analyses.

9. The Disclosure Statement states—in only a footnote and short paragraph—that

the proposed recoveries to each Class of Claims is based on a total enterprise value of

approximately $538 million for the Debtors, together with their non-debtor affiliates. The

Disclosure Statement provides no information on how the Debtors’ reached this conclusion. In

addition, the Disclosure Statement is completely lacking of any statements making clear that the

Committee (i) has concluded that the $538 million total enterprise value ascribed to the Debtors

6 On July 16, 2020, the Committee voted to allow Softek Integration Systems, Inc. to serve as an ex officio


8

under the Plan materially understates actual value and (ii) is prepared to present evidence that the

Debtors’ business is more valuable than the Debtors state.

10. The Plan also contemplates broad releases, including third-party releases for the

Debtors’ current and former officers and directors, the Debtors’ sponsors, as well as the Debtors’

DIP Lenders and pre- and postpetition agents under the Debtors’ secured facilities, among other

parties. However, neither the Plan nor Disclosure Statement addresses what, if any,

consideration is being provided in exchange for these releases.

11. And, although the Disclosure Statement provides a brief description of the exit

financing reflected in the Plan, noting that it will be comprised of: (i) a $200 million senior

secured Term Loan Facility, and (ii) up to $200 million in an uncommitted Incremental Facility,

the Disclosure Statement is notably void of any statements regarding the impact this Exit Facility

is likely to have on the Debtors’ post-emergence capital structure or cash flow and provides no

information with respect to the Incremental Facility. Specifically, the Disclosure Statement does

not adequately explain the burden that the annual financing costs imposed by the Exit Facility

will place upon the Reorganized Debtors.

ARGUMENT

I. The Disclosure Statement Does Not Contain Adequate Information

12. A disclosure statement cannot be approved unless it contains “adequate

information.” 11 U.S.C. § 1125(b). Adequate information is:

[I]nformation of a kind, and in sufficient detail, as far as is

reasonably practicable in light of the nature and history of the

debtor and the condition of the debtor’s books and records,

including a discussion of the potential material Federal tax

consequences of the plan to . . . a hypothetical investor typical of

the holders of claims or interests in the case, that would enable

member of the Committee.


9

such a hypothetical investor of the relevant class to make an

informed judgment about the plan[.]

11 U.S.C. § 1125(a)(1). The standard is a high one. As the Third Circuit stated: “The

importance of full disclosure is underlaid by the reliance placed upon the disclosure statement by

the creditors and the court. Given this reliance, we cannot overemphasize the debtor’s obligation

to provide sufficient data to satisfy the Code standard of ‘adequate information.” Oneida Motor

Freight, Inc. v. United Jersey Bank, 848 F.2d 414, 417 (3d Cir. 1988); see also Ryan Operations

G.P. v. Santiam-Midwest Lumber Co., 81 F.3d 355, 362 (3d Cir. 1996) (“[T]he importance of

full and honest disclosure cannot be overstated.”).

13. The Disclosure Statement is deficient in the following ways:

(a) Critically, it fails to provide adequate information concerning the Debtors’

valuation analysis and the Committee’s disagreement therewith. It estimates a

$538 million total enterprise value, but does not describe how the Debtors

arrived at that conclusion. The Disclosure Statement provides no information

on whether the Debtors performed other valuation methods or what metrics

were used in coming up with this valuation. Creditors should be informed that

the Committee is prepared to substantiate a materially higher valuation at Plan

confirmation that will render the Plan unconfirmable.

(b) It fails to provide adequate information concerning (i) the Debtors’ assets and

liabilities, including the Debtors’ unencumbered assets and the substantial

value thereof and (ii) the extent to which unencumbered assets will (or will

not) inure to the benefit of unsecured creditors under the Plan.

(c) It fails to provide adequate information concerning the nature of the Exit

Facility and the impact it is likely to have on the Debtors’ post-effective date

capital structure and cash flow, and provides no information regarding the

Incremental Facility. Creditors should be informed of (i) the costs and

reasonableness of the terms of this facility, and (ii) the potential windfall of

this facility on its participants and how that will impact the Debtors’ ability to

address future working capital needs.

(d) It fails to provide adequate information concerning the proposed releases of

the Released Parties and lacks any information concerning the potential claims

to be released under the Plan, including the investigation of those claims by

the Debtors. The Disclosure Statement provides no information about the

merits of the claims being released, including claims arising from the


10

substantial bonus payments made to certain of the Debtors’ insiders on the eve

of filing these cases, the costs of prosecuting the claims, the duration of any

such litigation, or the potential likely recoveries. Most critically, the

Disclosure Statement makes no mention of the consideration paid in exchange

for the releases, and why the Debtors believe that the Released Parties are

deserving of the releases.

(e) It fails to provide adequate information with respect to the Rights Offering,

including the effects of the liquidation preference and any dilution, how the

Liquidation Preference Amount was priced and its potential effect on other

stakeholders, and what information the Debtors relied upon in determining the

aggregate purchase price for the Reorganized Debtors’ preferred stock being

made available to the DIP Lenders.

(f) It fails to describe what actions the Debtors are taking with respect to the

Postpetition Marketing Process, why the short timeframe for postpetition

marketing is sufficient, how many parties the Debtors have spoken to with

respect to marketing their assets, or any other details about the process.

(g) It also fails to provide adequate information regarding other issues arising

under the Plan, including:

details of the Management Incentive Plan and how it was negotiated;

treatment of membership agreements under the Plan and whether all such

agreements will be assumed by the Reorganized Debtors; and

why claims are being disallowed under section 502(d) before an avoidance

action is even brought.

14. Critically fatal, the Disclosure Statement fails to provide creditors with its

Liquidation Analysis and Financial Projections, making it impossible for any creditor to make an

informed decision about the Plan and the proposed recoveries thereunder. Absent the Debtors

providing adequate information as mandated by the Bankruptcy Code to cure these numerous

defects, the Disclosure Statement should not be approved.

II. The Disclosure Statement Cannot be Approved Because the Plan is Patently

Unconfirmable

15. The Third Circuit has held that “if it appears there is a defect that makes a plan

inherently or patently unconfirmable, the Court may consider and resolve that issue at the


11

disclosure stage before requiring the parties to proceed with solicitation of acceptances and

rejections and a contested confirmation hearing.” See In re Am. Capital Equip., LLC, 688 F.3d

145, 154 (3d Cir. 2012). A plan is considered “patently unconfirmable” if (i) confirmation

defects cannot be overcome by creditor voting results and (ii) those defects concern matters upon

which all material facts are not in dispute or have been fully developed at the disclosure

statement hearing. Id. at 154–55. Here, the Plan suffers from infirmities that meet these criteria.

16. First, the recoveries to the DIP Lenders under the Plan violate the Bankruptcy

Code requirements that a plan comply with the applicable provisions of the Bankruptcy Code

and that a plan be proposed in good faith. See 11 U.S.C. §§ 1129(a)(1), (3). It is axiomatic that

a creditor cannot recover in excess of the amount of its allowed claim and any such windfall to a

creditor would be inconsistent with the objectives of the Bankruptcy Code. See In re American

Capital Equip., LLC, 688 F.3d 145, 158 (3d Cir. 2012) (“A plan is proposed in good faith only if

it will ‘fairly achieve a result consistent with the objectives and purposes of the Bankruptcy

Code.’”). Moreover, the Plan violates the requirement under section 1129(b) that a plan be “fair

and equitable.” 11 U.S.C. § 1129(b)(2). Section 1129(b)(2) sets forth the “absolute priority

rule,” which provides that a plan may be confirmed despite rejection by a class of unsecured

creditors if it does not offer a junior creditor any property before each unsecured claim receives

full satisfaction of its allowed claim. In re Exide Technologies, 303 B.R. 48, 61 (Bankr. D. Del.

2003). Bankruptcy courts have found that “a corollary of the absolute priority rule is that a

senior class cannot receive more than full compensation for its claims.” Id. (finding that the

Debtors undervalued the company and denying confirmation of a plan that would provide the

Prepetition Lenders with more than 100% of the value of claims).


12

17. Here, the DIP Lenders are set to receive (i) 95% of the New Common Equity

Interests in the reorganized Debtors and (ii) Subscription Rights for those holders that are party

to the Restructuring Support Agreement. The Committee is prepared to submit evidence that

will establish that based on the valuation of the Debtors and their non-debtor affiliates, this

recovery greatly exceeds the amount of their claims. In addition, each DIP Lender is given the

opportunity to be a DIP Backstop Party, entitling it to the Backstop Commitment Premium and

thereby receive another 10% of the New Preferred Equity Interests. This lucrative participation

right further solidifies the windfall to be received at the expense of unsecured creditors—who do

not have the same opportunities to share in the Debtors’ upside. Accordingly, the Plan is

patently unconfirmable because it violates the Bankruptcy Code requirements that (i) a plan

comply with the applicable provisions of the Bankruptcy Code as set forth in section 1129(a)(1),

(ii) a plan must be proposed in good faith pursuant to section 1129(a)(3), and (iii) that a plan

must be “fair and equitable” as required under section 1129(b)(2). The Committee submits that

through only a confusing and obfuscatory process would general unsecured creditors vote in

favor of a plan that gives senior creditors a recovery in excess of 100% of their claims at the

expense of unsecured creditors—further underscoring the lack of adequate information in the

Disclosure Statement.

18. Second, the Debtors’ releases, which are being provided for no consideration, also

render the proposed Plan patently unconfirmable. This Court has made clear that releases are not

appropriate for parties that “have not contributed cash or anything else of a tangible value to the

Plan or to creditors nor provided an extraordinary service that would constitute a substantial

contribution to the Plan or case.” In re Washington Mutual, Inc., 442 B.R. 314, 348 (Bankr. D.

Del. 2011). Moreover, negotiating a plan and participating in an Restructuring Support


13

Agreement that provides significant benefits to the Debtors’ lenders cannot justify a broad

release. See Hr’g Tr. at 9:16-19, In re Boomerang Tube, LLC, Case No. 15-11247 (MFW),

(Bankr. D. Del. Nov. 10, 2015), ECF No. 689 (“The Court concludes that simply negotiating a

plan is not sufficient substantial contribution by a director and officer, such as to warrant a

release.”).

III. The Solicitation and Voting Procedures Should Be Modified

19. Though the Committee shares the Debtors’ concerns that 24 Hour Fitness should

not remain in chapter 11 longer than necessary, the Committee cannot support the expedited

timeline contemplated by the Solicitation Procedures, especially in light of the lack of

disclosures provided in the Disclosure Statement. In fulfilling its fiduciary duties to all

unsecured creditors, the Committee must vigorously test the Debtors’ assumptions underlying

their proposed valuation. To do so will require a coordinated schedule for targeted discovery

from the Debtors and Lenders, including document production, depositions, and the preparation

of expert testimony to be presented at the Confirmation Hearing. The Committee respectfully

requests the Disclosure Statement Hearing also be treated as a scheduling conference to address

these needs.

20. In addition, with respect to the proposed Tabulation Procedures, the Committee

objects to each provision that allows the Debtors to unilaterally decide to not count a ballot that

is cast. Specifically, the Committee should be informed of any Ballots that the Debtors

determine to be defective, whether by way of a missing signature, failure to clearly indicate an

acceptance or rejection of the Plan, or otherwise, and the Committee should have the right to

reach out to such voter and inform them of the defect and the process for correcting it.


14


21. This Objection is submitted without prejudice to, and with a full reservation of,

the Committee’s rights to object to confirmation of the Plan or any other plan of reorganization

proposed in these cases on any and all grounds.

[The remainder of this page has been left intentionally blank.]


15

WHEREFORE, the Committee respectfully requests entry of an order denying the

Motion, and granting such other and further relief as the Court deems just and proper.

Dated: November 4, 2020

/s/ Brya M. Keilson

Eric J. Monzo (DE Bar No. 5214)

Brya M. Keilson (DE Bar No. 4643)

MORRIS JAMES LLP

500 Delaware Avenue, Suite 1500


Tel: (302) 888-6800

Fax: (302) 571-1750


[email protected]

-and-

Cathy Hershcopf

Michael Klein

Lauren A. Reichardt

COOLEY LLP

55 Hudson Yards

New York, NY 10001

Tel: (212) 479-6000

Fax: (212) 479-6275


[email protected]

[email protected]

-and-

Cullen D. Speckhart Admitted to practice in New York, Virginia, Missouri and

Texas; Not admitted to practice in DC, supervised by

members of DC bar

Olya Antle Admitted to practice in Virginia

Not admitted to practice in DC, supervised by members of

DC bar

COOLEY LLP

1299 Pennsylvania Avenue, NW

Washington, DC 20004

Tel: (202) 842-7800

Fax: (202) 842-7899


[email protected]

Counsel for the Official Committee of

Unsecured Creditors



The Official Committee of Unsecured Creditors’ Objection to Motion of Debtors for Order (I) Approving Rights

Offering Procedures and Related Forms, (II) Authorizing Debtors To Conduct Rights Offering in Connection with Debtors’ Plan

Of Reorganization, (III) Authorizing Entry into Backstop Commitment Agreement, (IV) Approving Obligations

Thereunder, and (v) Granting Related Relief

237724792 v4

IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE

In re:

24 Hour Fitness Worldwide, Inc., et al.,1

Debtors.

Chapter 11

Case No. 20-11558 (KBO) Jointly Administered Hearing Date: Nov. 16, 2020 at 1:00 p.m. (ET) Objection Date: Nov. 9, 2020 RE D.I.: 1143, 1144

THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS’

OBJECTION TO MOTION OF DEBTORS FOR ORDER (I) APPROVING RIGHTS OFFERING PROCEDURES AND RELATED FORMS, (II) AUTHORIZING DEBTORS TO CONDUCT RIGHTS OFFERING IN CONNECTION WITH DEBTORS’ PLAN OF

REORGANIZATION, (III) AUTHORIZING ENTRY INTO BACKSTOP COMMITMENT AGREEMENT, (IV) APPROVING OBLIGATIONS

THEREUNDER, AND (V) GRANTING RELATED RELIEF The Official Committee of Unsecured Creditors (the “Committee”) of 24 Hour Fitness

Worldwide, Inc., and its affiliated debtors and debtors in possession (the “Debtors”) submits this

objection (the “Objection”) to Motion of Debtors for Order (I) Approving Rights Offering

Procedures and Related Forms, (II) Authorizing Debtors to Conduct Rights Offering in

Connection with Debtors’ Plan of Reorganization, (III) Authorizing Entry Into Backstop

Commitment Agreement, (IV) Approving Obligations Thereunder, and (V) Granting Related Relief

(the “Rights Offering Motion”)2 [Docket No. 1143]. In support of this Objection, the Committee

respectfully states as follows:

1 The Debtors in these Chapter 11 cases, along with the last four digits of each Debtor’s federal tax identification number, as applicable, are 24 Hour Holdings II LLC (N/A); 24 Hour Fitness Worldwide, Inc. (5690); 24 Hour Fitness United States, Inc. (8376); 24 Hour Fitness USA, Inc. (9899); 24 Hour Fitness Holdings LLC (8902); 24 San Francisco LLC (3542); 24 New York LLC (7033); 24 Denver LLC (6644); RS FIT Holdings LLC (3064); RS FIT CA LLC (7007); and RS FIT NW LLC (9372). The Debtors’ corporate headquarters and service address is 12647 Alcosta Blvd., Suite 500, San Ramon, CA 94583.

2 Capitalized terms not otherwise defined herein shall have the meaning ascribed to them in the Rights Offering Motion or the Backstop Commitment Agreement appended thereto as Exhibit C, as applicable.


2

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Throughout these Chapter 11 cases, the Committee steadfastly supported the Debtors’

efforts to restructure their balance sheet during an exceedingly difficult time for their business, the

fitness industry in general, and the country at large. As these proceedings progressed, many of the

Debtors’ key stakeholders, including hundreds of landlords, trade vendors, and rank and file

employees, made significant concessions and/or suffered material losses in order to give the

Debtors the best chance to stabilize their operations and return their business to the consistent

profitability and substantial enterprise value that characterized their pre-COVID-19 operations.

The Committee, which represents a diverse creditor body with claims nearing $1 billion in

the aggregate, did so under the good faith presumption that the ultimate plan of reorganization

proposed by the Debtors in these cases would treat all stakeholders fairly, and not merely serve as

a vehicle to transfer the Debtors’ considerable value to the handful of private equity funds that

bought into the Debtors’ prepetition secured debt facility at deep discounts and then provided the

Debtors with postpetition financing (the “DIP Lenders”) in furtherance of a loan-to-own strategy

(and to protect themselves from the significant risk of loss they would face—and continue to face

—should the Debtors liquidate their assets). The Plan, and the proposed rights offering procedures

upon which the Debtors’ emergence from Chapter 11 is now premised, demonstrate that the

Committee’s reliance on the Debtors’ and the DIP Lenders’ reciprocation of its good faith was

severely misplaced.

As is more fully set forth in the Committee’s Disclosure Statement Objection, the Plan

materially understates the value of the Company and proposes to deliver a substantial windfall to

the DIP Lenders at the expense of all other creditors and in contravention of section 1129 of the

Bankruptcy Code. If the Debtors have their way, general unsecured creditors, including over


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22,000 creditors who have filed claims in the cases, will receive next to nothing. The relief

requested in the Rights Offering Motion only exacerbates the potential for that injustice by

providing the DIP Lenders (the “Commitment Parties”) with even more undeserved equity in the

Reorganized Company while obligating these estates to pay certain of the Commitment Parties

(the “Backstop Parties”) a break-up fee when the Plan’s obvious flaws inevitably lead to the Plan’s

failure. Indeed, the Debtors now ask this Court to (i) bless the process through which they propose

to obtain approximately $65 million3 (the “Rights Offering Amount”) from the Commitment

Parties to fund administrative expenses and post-Effective Date working capital that were

forecasted to remain unbudgeted throughout these cases even after the Debtors obtained DIP

financing following a contested multi-day hearing; and (ii) approve payment of a litany of

unwarranted fees, expenses, and indemnification obligations to the Commitment Parties, including

the Backstop Parties, who are being provided with the exclusive opportunity to purchase equity in

the Reorganized Company on advantageous terms. None of the requested relief is warranted.

Notwithstanding their failure to seek better terms from a market awash with well-

capitalized investors searching for high-yield opportunities, the Debtors submit that the Backstop

Parties, who have committed to fund 50% of the Rights Offering Amount, and have further

committed to backstop the remaining 50% in the event that the remaining eligible DIP Lenders

fail to subscribe, represent the Debtors’ only avenue to raise exit financing, and only if they agreed

the following terms (collectively, the “Commitment Obligations”):

Payment of a “Backstop Commitment Premium” as an unavoidable administrative expense of these estates in an amount equal to 10% of the entire Rights Offering Amount in the form of New Preferred Equity Interests;

3 Upon consent of the Requisite Consenting Creditors, the Rights Offering Amount may be increased to $80.0 million.


4

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Payment of a “Termination Payment” equal to 10% of the Rights Offering Amount (or $6.5 million) payable in cash as a break-up fee if the Debtors’ plan of reorganization is not consummated;

Payment of various “Transaction Expenses,” consisting of all reasonable and documented fees and expenses incurred before, on or after the execution date of the Backstop Commitment Agreement by counsel of the Commitment Parties and their financial advisor regardless of whether the transactions contemplated by the Backstop Commitment Agreement are achieved, and payable as an allowed administrative expense under sections 503(b) and 507 of the Bankruptcy Code;

The incurrence by the Debtors of unlimited indemnification obligations for any losses suffered by the Commitment Parties (or their affiliates, representatives, and others) under the Backstop Commitment Agreement, regardless of whether such losses are due to proceedings brought by the Debtors, their equity holders, creditors or any other person and regardless of whether the transactions contemplated by the Backstop Commitment Agreement or the Plan are consummated or whether the Backstop Commitment Agreement is terminated by the Debtors; and

The incurrence by the Debtors of potential additional liabilities for breaches of covenants, representations, and warranties.

As is further discussed herein and as the Committee will demonstrate at the November 16, 2020

hearing (with the benefit of the results of an expedited fact discovery process expected to

commence today), the Debtors cannot meet their burdens under sections 363(b), 503 and 507 to

bestow these generous and potentially punitive benefits on the Commitment Parties.

The Committee anticipates that the evidence that the risk factors that typically warrant the

granting and approval of backstop commitment fees and related lender protections are not present

in these cases. Unlike most instances in which such fees are appropriate, this is not a circumstance

in which the Debtors lack for sources of exit financing, and therefore need to offer investors a fee

in order to induce investors to provide new capital. Nor does the Committee believe that this is a

case in which the Backstop Parties are taking on risk that they will be forced to invest more than

they would otherwise be comfortable committing. Rather, the Committee fully expects the

evidence to show that the Backstop Parties are also the DIP Lenders that are eligible to participate


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in the rights offering, and the Rights Offering Amount is something that the DIP Lenders always

intended to commit—and are still willing to commit—to effectuate a plan hatched months ago to

use these Chapter 11 cases to acquire the Debtors at a depressed valuation in order to generate

outsize returns at the expense of all of the Debtors’ other stakeholders. Against this backdrop, the

Backstop Parties are essentially backstopping themselves in connection with a financing that they

have already agreed to make. And in the absence of any quantifiable risk to the Backstop Parties,

there is no justifiable basis for the Backstop Parties to be gifted additional stock in the Reorganized

Entity or any other of the Commitment Obligations.

Moreover, the Debtors lack a sound business justification for pursuing a path that only

serves to further enrich select DIP Lenders at the expense of all other stakeholders who have

sacrificed so that the Debtors could succeed in lieu of a fair fundraising process open to all market

participants wishing to capitalize on the attractive investment opportunity manifested by the

Debtors’ need to raise additional capital pre-emergence. Moreover, because the Backstop

Commitment Agreement is inextricably linked to the reorganization of the Debtors on the terms

and conditions set forth in the Plan, which is neither confirmable nor supported by the Committee

as proposed, the decision as to whether to burden the estates with the Commitment Obligations

would, in many respects, serve as a referendum on the Plan itself, and thus, should be postponed

until confirmation. Accordingly, the relief requested in the Rights Offering Motion is not in the

best interests of creditors or these estates and should be denied.

RELEVANT BACKGROUND

1. On June 15, 2020 (the “Petition Date”), the Debtors filed voluntary petitions for

relief under Chapter 11 of the Bankruptcy Code in this Court. Pursuant to sections 1107 and 1108


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of the Bankruptcy Code, the Debtors continue to operate their businesses and properties as debtors-

in-possession. No trustee or examiner has been appointed in these cases.

2. The Debtors’ cases are being jointly administered for procedural purposes only

pursuant to Rule 1015(b) of the Bankruptcy Rules.

3. On June 25, 2020, the United States Trustee for Region 3 appointed the Committee,

which consists of the following seven (7) members:4 (i) Kellermeyer Bergensons Services, LLC;

(ii) Precor, Incorporated; (iii) Wells Fargo Bank, National Association, as indenture trustee; (iv)

Geneva Crossing Carol Stream IL LLC; (v) SMA Architects, PC; (vi) A.T. Kearney Inc.; and (vii)

Brookfield Properties Retail, Inc.

The DIP Facility

4. On August 3, 2020, the Court granted the Debtors’ DIP financing motion on a final

basis [Docket No. 652], approving an expensive DIP facility that provided the DIP Lenders with

various forms of generous non-cash consideration while failing to fully solve the Debtors’

postpetition funding needs. Among other things, the DIP Lenders received:

a dollar-for-dollar roll-up of $250 million of their pre-existing loans;

exorbitant fees consisting of (i) a 3.0% commitment fee on each borrowing payable

in cash, (ii) an alternate transaction payment of 4.0% payable in cash under certain

circumstances, (iii) a backstop commitment premium of 6.0% payable in kind, and

(iv) a 4% upfront equity investment right payable in reorganized common equity

issued through a plan of reorganization; and

4 On July 16, 2020, the Committee voted to allow Softtek Integration Systems Inc. to serve as an ex officio member of the Committee.


7

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expanded liens on previously unencumbered assets without any commitment from

the DIP Lenders to a restructuring support agreement or plan.

Although the DIP facility also provided $250 million of new money loans, based upon all

projections at the time, it was never likely this amount would allow the Debtors to emerge from

Chapter 11 and cover the administrative expenses of these cases and the Reorganized Company’s

funding needs.

The Plan and Committee’s Objection

5. On October 7, 2020, the Debtors filed the Joint Chapter 11 Plan of Reorganization

of 24 Hour Fitness Worldwide, Inc. and its Debtor Affiliates (the “Plan”) [Docket No. 1016], a

proposed Disclosure Statement for the Joint Chapter 11 Plan of Reorganization of 24 Hour Fitness

Worldwide, Inc. and its Debtor Affiliates (the “Disclosure Statement”) [Docket No. 1017], and a

motion for entry of an order approving the Disclosure Statement and related relief (the “Disclosure

Statement Motion”) [Docket No. 1021].

6. The Committee filed its objection to the Disclosure Statement on November 4, 2020

(the “Disclosure Statement Objection”) [Docket No. 1152], highlighting that the Plan, as proposed,

is based on an artificially low valuation of the Debtors’ business that is structured to deliver the

vast majority of the Debtors’ considerable enterprise value to the DIP Lenders without a proper

market test.

The Rights Offering Motion

7. On November 3, 2020, the Debtors filed the Rights Offering Motion, the

declaration of Tyler W. Cowan in support thereof (the “Cowan Declaration”) [Docket No. 1144],

and the motion to shorten the notice required for a hearing on the Rights Offering Motion (“Motion


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to Shorten”) [Docket No. 1145], seeking to schedule such a hearing on November 12, 2020, to be

heard concurrently with the Disclosure Statement Motion.

8. On the same date, the Committee objected to the Motion to Shorten [Docket No.

1147], asking this Court for additional time to evaluate the relief requested and conduct discovery

into whether the Backstop Commitment Agreement and fees associated with the same are

reasonable.

9. On November 4, 2020, the Court entered an order denying the Motion to Shorten

and scheduling the hearing on the Rights Offering Motion for November 16, 2020 (the “Order”)

[Docket No. 1150].

10. Following the entry of the Order, the Committee issued two sets of discovery

requests to the Debtors with one of the sets specifically related to the Rights Offering Motion. The

Committee additionally filed a Notice of Deposition [Docket No. 1168], seeking to depose a

representative of the Debtors on issues related to the Rights Offering Motion. The Committee is

also in the process of serving informal discovery and deposition requests upon the Ad Hoc Lender

Group.5

11. On November 6, 2020, the Debtors filed the Liquidation Analysis and Financial

Projections exhibits to the Disclosure Statement [Docket No. 1174]. These analyses underscore

that if the Debtors were to liquidate, the DIP Lenders would only recover between 43% to 61% of

their claims with no recoveries available to the Debtors’ other creditors, but stand to reap

significant payouts in excess of their investment if the Debtors hit their financial projections.

5 It is important to note that the Committee made numerous efforts to reach a global resolution of its objections. However, to-date, the Committee has not received an acceptable proposal that would resolve the issues raised by the Committee.


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OBJECTION

A. The Rights Offering Motion Should Not Be Approved Under Section 363(b)

12. Section 363(b) of the Bankruptcy Code, provides, in relevant part, that a debtor,

“after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business,

property of the estate.” 11 U.S.C. § 363 (b)(1). Before authorizing a debtor’s use of estate property

outside the ordinary course, “courts require the debtor to show that a sound business purpose

justifies such actions.” In re Montgomery Ward Holding Corp., 242 B.R. 147, 153 (D. Del. 1999)

(citations omitted); Comm. of Equity Sec. Holders v. Lionel Corp. (In re The Lionel Corp.), 722

F.2d 1063, 1071 (2d Cir. 1983); Myers v. Martin (In re Martin), 91 F.3d 389, 395 (3d Cir. 1996).

A debtor must show that (a) a sound business reason justifies the proposed use, (b) adequate and

reasonable notice was provided to all interested parties, (c) the proposed use was requested in good

faith, and (d) fair and reasonable consideration is provided in exchange for the use of estate assets.

See In re Exaeris, Inc., 380 B.R. 741 (Bankr. D. Del. 2008); In re Decora Indus., Inc., No. 00-

4459, 2002 WL 32332749, at *7 (D. Del. May 20, 2002).

13. The burden of proving that the proposed use of estate property is supported by

sound business judgment lies with the debtor, and such business judgment must be exercised fairly.

See, e.g., In re Nortel Networks, Inc., No. 09-10138, 2011 Bankr. LEXIS 3971, at *21 (Bankr. D.

Del. July 11, 2011) (finding that the transaction met the business judgment standard because it was

“in the best interests of the Debtors, their estates, their creditors, and all parties in interest”); see

also Institutional Creditors of Continental Air Lines, Inc. v. Continental Air Lines, Inc. (In re

Continental Air Lines, Inc.), 780 F.2d 1223, 1226 (5th Cir. 1986) (“[F]or the debtor-in-possession

or trustee to satisfy its fiduciary duty to the debtor, creditors and equity holders, there must be

some articulated business justification . . . .” (citation omitted)). In considering motions brought


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under section 363(b), bankruptcy courts should “consider all salient factors pertaining to the

proceeding and, accordingly, act to further the diverse interests of the debtor, creditors and equity

holders, alike.” See In re The Lionel Corp., 722 F.2d at 1071 (2d Cir. 1983).

14. Here, the Debtors have not demonstrated a sound business purpose for agreeing to

the litany of fees, unpaid-for equity and other commitments that comprise the Commitment

Obligations. In short, the record is bereft of evidence that the Debtors cannot raise the capital

contemplated by the Rights Offering without burdening the estates in this way. The Debtors have

not market tested the Rights Offering, nor do they contemplate to affirmatively undertake this

process. Further, the Debtors cannot demonstrate that they will receive fair consideration for the

Commitment Obligations, which, when viewed relative to the aggregate investment, are onerous

and (as discussed more fully below) not comparable to the commitments and fees approved in the

cases cited by the Debtors. Given the Commitment Parties’ significant risk of loss should the Plan

not be confirmed, and the Company’s considerable enterprise value (as reflected in the go-forward

projections filed by the Debtors on November 6, 2020), the Debtors’ conclusory statements that

the Commitment Obligations are necessary to obtain exit financing in these cases simply are not

credible. As such, the Debtors cannot show that the funds generated from the Rights Offering on

the economic terms proposed by the Commitment Parties are the best or only option for the estates.

15. Even if such a demonstration could be made, the Debtors provide no support for

calculating the Backstop Commitment Premium as a percentage of the total Rights Offering

Amount, and not the 50% of that amount that represents the purported backstop. In contrast, the

Backstop Parties’ incentive for requiring the Debtors to raise exit financing in this manner is clear.

Because (i) the Backstop Commitment Premium converts into preferred equity in the Reorganized

Debtors, and (ii) the preferred equity is convertible into a substantial amount, and, in some cases,


11

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nearly all of the common stock of the new entity, the Backstop Parties are poised to receive an

unimaginable windfall when the Reorganized Debtors return to their projected pre-COVID-19

levels of profitability.

16. Further, if the Reorganized Company is sold for $1.5 billion6 five years from the

Effective Date, the unsecured creditors would potentially recover $9.2 million7 under the Plan as

proposed, or approximately 1% of their projected claims. In contrast, the Commitment Parties

would likely recover $689 million8 on the $65 million investment, which is in addition to a $648

million recovery on account of their $250 million new money DIP loan.9. The Debtors should not

be empowered to facilitate this result by precluding the market from bidding on the Rights

Offering.

B. The Backstop Commitment Premium and Termination Payment Are Not Necessary to Preserve the Value of the Estate Under 11 U.S.C. § 503 and Are Unjustified

17. The Backstop Commitment Premium is an over-market break-up fee that should

not be payable if the Plan of Reorganization cannot be confirmed.

18. Courts in the Third Circuit permit debtors to use property of the estate for the

payment of break-up and termination fees only in certain narrow circumstances prescribed by

6 Prior to the Petition Date, the Debtors’ total funded debt was nearly $1.5 billion. Throughout 2018 and much of 2019, the Debtors’ unsecured notes were trading at or above par, indicating the market’s view that the Debtors’ total enterprise value was greater than that. If the Debtors, buoyed by rent concessions and the shedding of nearly $1 billion of unsecured debt, meet the financial projections recently appended to their Disclosure Statement, then by 2023, they will surpass their 2018 EBIDTA, and their total enterprise value will have returned to or surpassed these pre-COVID-19 levels. 7 The estimated recovery to unsecured creditors accounts for the dilutive effect of the Backstop Commitment Premium. If the Rights Offering Amount is increased to $80 million, the unsecured creditors would potentially recover $8.1 million, or less than 1% of their projected claims. 8 This amount reflects the Backstop Commitment Premium, which would be worth approximately $63 million under the $1.5 billion total enterprise value scenario. 9 Recovery estimates exclude the impacts of the potential incremental exit facility, but do factor in a 10% Management Incentive Plan that could be worth $130 million under this scenario.


12

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Bankruptcy Code section 503(b). See Calpine Corp. v. O’Brien Envtl. Energy, Inc. (In re O’Brien

Envtl. Energy, Inc.), 181 F.3d 527, 532 (3d Cir. 1999); In re Energy Future Holdings Corp., 575

B.R. 616, 633–34 (Bankr. D. Del. 2017), aff’d, 904 F.3d 298 (3d Cir. 2018). To be allowed as an

administrative expense, a claim must be one of the “actual, necessary costs and expenses of

preserving the estate.” 11 U.S.C. § 503(b)(1)(A); see also In re Reliant Energy Channelview, LP,

403 B.R. 308, 311 (Bankr. D. Del. 2009).

19. For break-up fees, the question is not whether actually paying a break-up fee

provides a benefit to the estate (as payment of a fee always leaves an estate with less to distribute

to creditors than it would otherwise have), the question is whether awarding a break-up fee in the

first place was necessary to obtain a benefit to the estate. See In re O’Brien Envtl. Energy, Inc.,

181 F.3d at 536–37; In re Reliant Energy Channelview LP, 594 F.3d 200, 206 (3d Cir. 2010). The

burden of proof to establish this is on the movant. See In re Energy Future Holdings Corp., 575

B.R. at 634 (citing O’Brien, 181 F.3d at 533).

20. The Debtors have failed to meet their burden of demonstrating that the commitment

of any fee is necessary to obtain exit financing from the DIP Lenders or any other party. Nor can

they, as the Debtors’ own projections illustrate that the exit financing represents a prime

opportunity that investors would likely compete with one another to consummate if given the

opportunity. Not surprisingly, other than a conclusory representation to this effect in the Cowan

Declaration, the Debtors have provided no evidence that the Backstop Commitment Premium and

Termination Payment were necessary predicates to the Debtors’ receipt of the exit financing.

21. The Debtors cite eight precedents in support of their contention that approval of the

Backstop Commitment Premium and Termination Payments are warranted. See Rights Offering

Motion at ¶ 38. The authorities cited by the Debtors are not persuasive or compelling. In the


13

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majority of the cases cited by the Debtors as approving backstop fees of a similar magnitude, the

backstop terms were entirely uncontested and the rights offering amounts were between 2 to 11

times higher than here.

22. The two cases cited by the Debtors involving backstop fees even close to the range

proposed here that were approved over the objection of a creditors’ committee are In re

Windstream Holdings, Inc., No. 19-22312 (RDD) (Bankr. S.D.N.Y. May 12, 2020) and In re EP

Energy Corp., No. 19-35654 (MI) (Bankr. S.D. Tex. Oct. 18, 2019). The facts and circumstances

of these cases, however, are distinguishable from those presently before the Court.

23. First, in Windstream, the debtors, unlike the Debtors here, publicly disclosed

materials demonstrating that they had explored a number of alternative options, including a rights

offering that would include junior stakeholder participation. Id., ECF No. 1769 at 3 (May 5,

2020). Second, the record before the court in Windstream included a valuation analysis that was

filed prior to the date that the debtors sought approval of the backstop commitment agreement. See

id. at ¶ 18. Third, the declaration submitted by the debtors in support of the backstop commitment

agreement in Windstream explicitly stated that, unlike here, the commitment was the subject of

extensive negotiations and that a number of written and verbal proposals and counterproposals had

been exchanged among the debtors and equity backstop parties. Id., ECF No. 1746 at ¶ 28 (May

3, 2020). Notably, the Windstream debtors submitted evidence that the 8% backstop fee that they

sought to be approved was reflective of the high end of market rate and that an average market rate

for commitment premiums is 6%—significantly lower than the 10% fee sought by the

Debtors. See id., ECF No. 1769 at ¶ 9 (May 5, 2020).

24. The circumstances leading to entry of the backstop commitment agreement in In re

EP Energy Corp., No. 19-35654 (MI) (Bankr. S.D. Tex. Oct. 18, 2019) are likewise distinguishable


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from those presently before the Court. EP Energy was a partially prepackaged Chapter 11 case in

which the debtors reached an agreement in principle on the terms of a restructuring, including an

equity rights offering, prior to the petition date. See id., ECF No. 381 at ¶ 13 (Nov. 15, 2019). The

backstop agreement ultimately approved by the court materialized only after the debtors

considered competing restructuring proposals—both solicited and unsolicited—from several

creditor groups prior to the petition date. See id. ¶¶ 11–15. Here, in contrast, and as set forth

above, the Debtors present no evidence of a market test, let alone solicitation or receipt of any

alternative proposals.

C. Consideration of the Rights Offering Motion is Premature

25. The Backstop Commitment Agreement is inextricably connected to the

reorganization of the Debtors on the terms and conditions set forth in the Plan that is neither

confirmable nor supported by the Committee as proposed for the reasons stated in the Disclosure

Statement Objection. Therefore, proceeding with the approval of the Backstop Commitment

Agreement and burdening the estates with significant Backstop Commitments is premature. To

reduce the risk of these burdens on the Debtors’ estates and creditors, as well as to allow the

Committee and other parties in interest to further evaluate the Backstop Commitment Agreement

and conduct discovery, the Committee respectfully requests that the Rights Offering Motion be

considered at confirmation.


26. This Objection is submitted without prejudice to, and with a full reservation of, the

Committee’s rights to supplement and amend this Objection, including the filing of a declaration

in support thereof, to introduce evidence at any hearing relating to this Objection, and to further

object to the Motion, on any ground that may be appropriate.


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CONCLUSION

27. For the foregoing reasons, the Committee respectfully requests this Court to

(i) deny the Rights Offering Motion; and (ii) grant such other and further relief as may be proper

and just.

Dated: November 9, 2020

/s/ Brya M. Keilson____________ Eric J. Monzo (DE Bar No. 5214) Brya M. Keilson (DE Bar No. 4643) MORRIS JAMES LLP 500 Delaware Avenue, Suite 1500 Wilmington, DE 19801 Tel: (302) 888-6800 Email: [email protected] [email protected] -and- Cathy Hershcopf Michael Klein Lauren A. Reichardt COOLEY LLP 55 Hudson Yards New York, NY 10001 Tel: (212) 479-6000 Email: [email protected] [email protected] [email protected]

-and- Cullen D. Speckhart Olya Antle Admitted to practice in Virginia Not admitted to practice in DC, supervised by members of DC bar COOLEY LLP 1299 Pennsylvania Avenue, NW Washington, DC 20004 Tel: (202) 842-7800 Email: [email protected] [email protected] Counsel for the Official Committee of Unsecured Creditors


In re: Emerge Energy Services LP, et al.

Objection of the Official Committee of Unsecured Creditors to

Confirmation of the First Amended Joint Plan of

Reorganization of Emerge Energy Services LP and Its Affiliate

Debtors Under Chapter 11 of the Bankruptcy Code

IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE

In re:

EMERGE ENERGY SERVICES LP, et al.

Debtors.1

) ) ) ) ) ) ) ) ) )

Chapter 11

Case No. 19-11563 (KBO)


Hearing Date: October 24, 2019 at 1:00 p.m. (ET) Objection Deadline: October 15, 2019 at 4:00 p.m. (ET)

OBJECTION OF THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS TO CONFIRMATION OF

THE FIRST AMENDED JOINT PLAN OF REORGANIZATION OF EMERGE ENERGY SERVICES LP AND ITS AFFILIATE DEBTORS

UNDER CHAPTER 11 OF THE BANKRUPTCY CODE

1 The Debtors in these cases, along with the last four digits of each Debtor’s federal tax identification number, are: Emerge Energy Services LP (2937), Emerge Energy Services GP LLC (4683), Emerge Energy Services Operating LLC (2511), Superior Silica Sands LLC (9889), and Emerge Energy Services Finance Corporation (9875). The Debtors’ address is 5600 Clearfork Main Street, Suite 400, Fort Worth, Texas 76109.

IMPAC 6445103v.3


¨1¤{/_3,) "<«

1911563191209000000000002

Docket #0676 Date Filed: 12/09/2019

i

TABLE OF CONTENTS

PRELIMINARY STATEMENT .....................................................................................................1

Valuation in Dispute ....................................................................................3

The Committee Has Identified Valuable Unencumbered Assets ................5

The Plan Was Not Proposed in Good Faith .................................................8

FACTUAL BACKGROUND ..........................................................................................................9

I. General Case Background........................................................................................9

II. Debt Structure ........................................................................................................11

III. The Plan .................................................................................................................12

IV. Valuations ..............................................................................................................12

Houlihan Valuation. ...................................................................................12

Miller Buckfire Valuation. .........................................................................14

ARGUMENT .................................................................................................................................14

I. The Plan Does Not Satisfy Bankruptcy Code Section 1129(a)(7) Because a Liquidation of the Debtors’ Unencumbered Assets Would Provide More Value to General Unsecured Creditors Than the Proposed Recovery Under the Plan...................................................................................................................16

A. The Oklahoma Facility ..............................................................................17

B. Business Interruption Insurance Payments ................................................19

II. The Plan Is Not “Fair And Equitable” Under Section 1129(b)(1) .........................20

A. The Plan is Not “Fair and Equitable” Because it Provides Value to the Prepetition Noteholders in Excess of the Value of Their Claims ........21

III. The Plan Should Not Be Confirmed Because It Is Not Proposed In Good Faith Under Section 1129(a)(3) Of The Bankruptcy Code ....................................28

A. The Failure to Conduct a Market Test for Value .......................................28

B. The Negotiation of the Plan and the RSA. .................................................30

C. The Combined Death Trap/Equity Recovery Provision ............................31


ii

D. The RSA Provides for an Impermissible Post-Emergence Release in Potential Contravention of this Court’s Order .......................................31

IV. The Plan is Not Confirmable Because the Releases are Inappropriate and Contravene Applicable Law ..................................................................................32

A. The Debtor Releases are Inappropriate ......................................................33

B. The Non-Consensual Third-Party Releases are Impermissible .................38

V. The Exculpation Provision in the Plan Exceeds the Scope of Section 1125(e) of the Bankruptcy Code ............................................................................42

VI. Additional Confirmation Objections......................................................................43

CONTESTED MATTER ...............................................................................................................44

RESERVATION OF RIGHTS ......................................................................................................44

CONCLUSION ..............................................................................................................................45


iii

TABLE OF AUTHORITIES

CASES

Page(s)

Bank of Am. Nat’l Tr. & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434 (1999) ...........................................................................................................16, 28

Buncher Co. v. Official Comm. of Unsecured Creditors of GenFarm Ltd. P’ship IV, 229 F.3d 245 (3d Cir. 2000).....................................................................................................44

In re Abeinsa Holding, Inc., 562 B.R. 265 (Bankr. D. Del. 2016) ........................................................................................33

In re Aegean Marine Petroleum Network, Inc., 599 B.R. 717 (Bankr. S.D.N.Y. 2019) ...............................................................................37, 39

In re Armstrong World Indus., 348 B.R. 111 (Bankr. D. Del. 2006) ........................................................................................21

In re Boomerang Tube, Inc., 548 B.R. 69 (Bankr D. Del. 2016) ...........................................................................................38

In re Cantu, 784 F.3d 253 (5th Cir. 2015) ...................................................................................................16

In re Chemtura, Corp., 439 B.R. 561 (Bankr. S.D.N.Y. 2010) ...............................................................................28, 30

In re Cont’l Airlines, 203 F.3d 203 (3d Cir. 2000)............................................................................................... 38-39

In re Exide Techs., 303 B.R. 48 (Bankr. D. Del. 2003) ........................................................................ 14-15, 21, 39

In re Genco Shipping & Trading Ltd., 513 B.R. 233 (Bankr. S.D.N.Y. 2014) .....................................................................................15

In re Genesis Health Ventures, Inc., 266 B.R. 591 (Bankr. D. Del. 2001) ...................................................................... 15, 21, 38-39

In re Glob. Indus. Techs., Inc., 645 F.3d 201 (3d Cir. 2011).....................................................................................................39

In re Glob. Ocean Carriers Ltd., 251 B.R. 31 (Bankr. D. Del. 2000) ..........................................................................................34

In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013) .................................................................................. 41-42


iv

In re Jorgensen, 66 B.R. 104 (B.A.P. 9th Cir. 1986)..........................................................................................28

In re Leslie Fay Cos., Inc., 207 B.R. 764 (Bankr. S.D.N.Y. 1997) .....................................................................................28

In re Master Mortg. Inv. Fund, Inc., 168 B.R. 930 (Bankr. W.D. Mo. 1994)....................................................................................33

In re MCorp Fin., Inc., 137 B.R. 219 (Bankr. S.D. Tex. 1992) ....................................................................................16

In re Penn Cent. Transp. Co., 596 F.2d 1102 (3d Cir. 1979)...................................................................................................21

In re Prussia Assoc., 322 B.R. 572 (Bankr. E.D. Pa. 2005) ......................................................................................39

In re PTL Holdings LLC, No. 11-12676 (BLS), 2011 WL 5509031 (Bankr. D. Del. Nov. 10, 2011) .............................43

In re Spansion, Inc., 426 B.R. 114 (Bankr. D. Del. 2010) ........................................................................................40

In re Tribune, 464 B.R. 126 (Bankr. D. Del. 2011) ........................................................................................43

In re W.R. Grace & Co., 475 B.R. 34 (D. Del. 2012) ......................................................................................................39

In re Wash. Mut. Inc., 442 B.R. 314 (Bankr. D. Del. 2011) ......................................................................34, 37, 41, 43

In re Zenith Elecs. Corp., 241 B.R. 92 (Bankr. D. Del. 1999) ..........................................................................................34

Kane v. Johns-Manville Corp., 843 F.2d 636 (2d Cir. 1988).....................................................................................................28

Koelbl v. Glessing (In re Koelbl), 751 F.2d 137 (2d Cir. 1984).....................................................................................................28

United Artists Theatre Co. v. Walton, 315 F.3d 217 (3d Cir. 2003).....................................................................................................35

STATUTES

Page(s)

11 U.S.C. § 1129(a)(3) ................................................................................................... 9, 28, 31-32


v

11 U.S.C. § 1129(a)(5) ...................................................................................................................44

11 U.S.C. § 1129(a)(7) ........................................................................................................... passim

11 U.S.C. § 1129(a)(8) ...................................................................................................................15

11 U.S.C. § 1129(b) ............................................................................................................... passim

11 U.S.C. § 1129(b)(1) ............................................................................................................20, 28

11 U.S.C. § 1129(b)(2) ............................................................................................................ 20-21

OTHER AUTHORITIES

Page(s)

7 COLLIER ON BANKRUPTCY ¶ 1129 (16TH REV. ED. 2019) ................................................. 15-16, 21


The Official Committee of Unsecured Creditors (the “Committee”) of the debtors and

debtors-in-possession in the above-captioned cases (referenced alternatively herein as “Emerge”

the “Debtors” or the “Company”), by and through its undersigned counsel, respectfully submits

this objection (the “Objection”) to confirmation of the Debtors’ First Amended Joint Plan of

Reorganization for Emerge Energy Services LP and its Affiliate Debtors Under Chapter 11 of the

Bankruptcy Code [D.I. 362], dated September 11, 2019 (the “Plan”). In support of its Objection,

the Committee contemporaneously files herewith the Declaration of Matthew Rodrigue in Support

of the Objection of the Official Committee of Unsecured Creditors to Confirmation of the First

Amended Joint Plan of Reorganization for Emerge Energy Services LP and Its Affiliate Debtors

Under Chapter 11 of the Bankruptcy Code (the “Rodrigue Decl.”)2; and the Declaration of David

M. Posner in Support of the Objection of the Official Committee of Unsecured Creditors to

Confirmation of the First Amended Joint Plan of Reorganization of Emerge Energy Services LP

and Its Affiliate Debtors Under Chapter 11 of the Bankruptcy Code, (the “Posner Decl.”)3; and

respectfully states as follows:

PRELIMINARY STATEMENT4

1. The Debtors are pursuing a Plan that is premised on a deeply flawed, outcome

driven valuation analysis that was prepared after entry into the RSA and, remarkably, after

publishing a Disclosure Statement fixing the Debtors’ position to such value. The Plan is a blatant

attempt by a lender-in-possession, through its hand-picked “Special Restructuring Committee” of

the Debtors’ board, to effect an inequitable transfer to itself of all of the value of the Debtors’

2 The Exhibits attached to the Rodrigue Decl. are referenced herein as Exhibits A and B.

3 The Exhibits attached to the Posner Decl. are referenced herein as Exhibits C – BB.

4 Undefined terms used in this Objection shall have the meanings ascribed to them below, in the Plan, or in the Disclosure Statement, as applicable.


2

material encumbered assets through what is effectively a private sale (one falling far short of arms’

length no less).5 Just as bad6, the Plan also affects a transfer to the lender-in-possession of all

unencumbered assets.7 The Committee’s principal objections to the Plan are driven by (i) the

Debtors’ total enterprise value (“TEV”)8, which pursuant to the valuation prepared by the

Committee’s expert, Miller Buckfire & Co., LLC and Stifel, Nicolaus & Co. (“Miller Buckfire”),

mandates that unsecured creditors receive substantially larger recoveries; (ii) valuable

unencumbered assets that should inure to the benefit of unsecured creditors irrespective of TEV;

and (iii) the complete elimination of the “at best” de minimus recovery for unsecured creditors

unless they are willing (by voting to accept the Plan) to permit the distribution of consideration

to the out of the money equity sponsor.

2. As discussed herein, unless the Plan is substantially revised to appropriately

account for the true value of the Debtors’ assets and the unencumbered nature of certain of them,

the sole beneficiaries of the Plan will be the parties that negotiated it: HPS, Insight Equity, and the

Debtors’ management team. Meanwhile, general unsecured creditors, whose claims are, according

5 Notably, the Debtors’ valuation is belied by HPS’s own valuation work done just prior to the Petition Date, which reflects a midpoint value ($370 million) almost twice as high as the Debtors’ midpoint value ($200 million) and within striking distance of the Committee’s midpoint value ($390 million).

6 The Debtors inexplicably refused to market test their assets pre- or postpetition. Thus, the sole source of evidence in support of permitting the HPS-selected Debtor decision-makers, and “fiduciary out holders”, to wipe out, according to the Debtors, approximately $574 million in unsecured debt for HPS’s benefit is the outcome driven and deeply flawed valuation analysis performed by the Debtors’ investment banker.

7 On or before October 17, 2019, unless the deadline is further extended, the Committee will file a standing motion and proposed complaint that set forth claims with respect to valuable unencumbered assets. The Committee believes that such unencumbered value is worth as much as approximately

.

8 The Committee’s expert report from Miller Buckfire (as defined below) uses the term “Total Distributable Value” for their overall value conclusion, consisting of TEV plus certain miscellaneous or presently non-operational assets. The Debtors’ valuation analysis from Houlihan (as defined below) uses the term TEV to include all such assets. For consistency, the Committee will use the term TEV when referring to Miller Buckfire’s overall value conclusion.


3

to the Debtors, in excess of $570 million, will receive a recovery as small as 0.13% (using the

Debtors’ midpoint valuation), and that is only if such class of creditors votes to accept the Plan.9

In the event general unsecured creditors reject the Plan, the recovery is zero. Neither outcome is

legally supportable given (i) the fatal flaws contained in the Debtors’ valuation analysis, which

analysis serves as the underpinning to the Debtors’ unconfirmable Plan; and (ii) the existence of

valuable unencumbered assets that are not only artificially devalued, but also improperly allocated

under the Plan to HPS rather than unsecured creditors.

Valuation in Dispute

3. The Debtors’ midpoint range valuation from Houlihan Lokey Capital, Inc.

(“Houlihan”)10 of $200 million is $190 million less than the Committee’s expert’s midpoint

valuation. Conveniently, Houlihan’s valuation supports the Debtors’ massive value transfer in

favor of the party who not only hand selected the “Special Restructuring Committee” of the

Debtors’ board that solely controls the contents of the Plan and the exercise of the fiduciary out,

but also who believed in a midpoint valuation of approximately $370 million just prior to the

Petition Date: HPS.11 The Committee will vigorously dispute the Debtors’ valuation analysis at

the Confirmation Hearing.

4. As discussed more fully below, Houlihan’s valuation analysis is premised upon

certain inherent flaws that make its conclusions of value unreliable. The Committee’s testifying

9 As the Voting Deadline is October 17, 2019, the voting results with respect to the Plan were not known to the Committee at the time this Objection was filed.

10 Notably, the very same outfit that served as placement agent for the sale to HPS of the Prepetition Notes.

11 See Discussion Materials [-] Project Sandman – Mezz Watchlist, dated May 7, 2019, attached to the Posner Decl. as Exhibit C [HPS0014584].


4

expert from Miller Buckfire prepared a valuation analysis that demonstrates that the Reorganized

Debtors’ TEV is between $335 million and $445 million, with a midpoint of $390 million.12

5. Aside from its numerous methodology flaws (described below), the credibility of

Houlihan’s valuation is seriously undermined in that (i) inexplicably, the Debtors’ assets were not

subject to any market test (where HPS could easily have attempted to credit bid its secured claims

to obtain control of the Debtors’ assets subject to its liens if the value was as the Debtors assert);

(ii) it curiously concludes with the same valuation range set forth in the Disclosure Statement

despite the valuation analysis being prepared after the filing of the Disclosure Statement13; (iii)

internal HPS documents reveal that as of May 7, 2019, HPS valued the Company at approximately

$290 million to $450 million14, which range hews to the conclusions in Miller Buckfire’s valuation

analysis; and (iv) internal HPS communications

15 Put simply,

by utilizing Houlihan’s flawed and unreliable valuation analysis, HPS is pilfering tens of millions

of dollars of value that should otherwise be distributed to unsecured creditors irrespective of the

existence of unencumbered assets.

6. The relevance of the Debtors’ flawed valuation to confirmability of its Plan is

straightforward: because the Plan transfers to HPS (i) either 95% or 100% of the Reorganized

Debtors’ equity value worth up to approximately $205 million (based on Miller Buckfire’s $390

12 See Miller Buckfire Valuation (as defined below), attached to the Rodrigue Decl. as Exhibit A at pg. 9.

13 See relevant portions of deposition of Mr. Adam Dunayer attached to the Posner Decl. as Exhibit D (the “Dunayer Depo. Tr.”) at 30:7-16.

14 See Discussion Materials [-] Project Sandman – Mezz Watchlist, dated May 7, 2019, attached to the Posner Decl. as Exhibit C [HPS0014584].

15 See E-Mail from B. Pertuz, HPS, to P. Russo, HPS, copying D. Dimitrievich, HPS; R. Manideep, HPS, dated May 6, 2019, attached to the Posner Decl. as Exhibit E [HPS0032173].


5

million midpoint valuation, less $185 million in debt and preferred equity to be issued) or up to

$260 million (based on Miller Buckfire’s $445 million high end valuation, less $185 million in debt

and preferred equity to be issued); plus (ii) $85 million in preferred equity (worth at least $85

million), and because the Prepetition Notes Claims are only approximately $217 million, the Plan

provides HPS with value well in excess of a 100% recovery at the expense of unsecured creditors.

As a result, and assuming arguendo that Class 6 votes to reject the Plan, the Plan is not “fair and

equitable” to unsecured creditors and in violation of section 1129(b)(1) the Bankruptcy Code.

The Committee Has Identified Valuable Unencumbered Assets

7. As will be set forth in the Motion of the Official Committee of Unsecured Creditors

for Order Granting Leave, Standing and Authority to Commence and Prosecute Certain Claims

on Behalf of the Debtors’ Estates and Related Relief (the “Standing Motion”), the Committee seeks

standing, to the extent necessary, inter alia, (i) to obtain a declaratory judgment that the Debtors’

facility in Kingfisher County, Oklahoma (the “Oklahoma Facility”) is unencumbered; (ii) to obtain

a declaratory judgement that any payments under the Debtors’ business interruption insurance

related to the June 21, 2019 berm breach that occurred at the Debtors’ San Antonio, Texas facility

(the “BII Payments,” and together with the Oklahoma Facility, the “Unencumbered Assets”) are

not encumbered by the Prepetition Liens; and (iii) to avoid liens (to the extent there are any) on

the BII Payments.

8. Unsurprisingly, the Debtors also ascribe artificially low values to the

Unencumbered Assets so as to impede unsecured creditors from realizing any meaningful

recoveries therefrom (even assuming the value of such unencumbered assets were allocated to

unsecured creditors, which they are not). The Committee disputes the Debtors’ conveniently HPS-

favorable valuations and asserts that the Unencumbered Assets are worth as much as


6

approximately

.16 Such value is driven, in part, by the Committee’s view,

.18 In fact, internal HPS documents reflect that

.19

9. The evidence and clear intention of

suggests that the value of the Oklahoma Facility is

approximately

In fact, if the Debtors truly believe the Oklahoma Facility is worth

. Instead, the Debtors are preserving the asset for the benefit for

HPS, thereby exposing their true beliefs in the value of the allegedly worthless Oklahoma Facility.

16 Both amounts are net of alleged mechanics’ liens totaling approximately $8 million. If such liens are invalid, the value of the Unencumbered Assets commensurately increases.

17 See Miller Buckfire Valuation (as defined below), attached to the Rodrigue Decl. as Exhibit A at pg. 24.

18 See EMES UCC Presentation, dated Aug. 19, 2019, attached to the Posner Decl. as Exhibit F provided by the Debtors to the Committee.

19 See Discussion Materials [-] Emerge Energy Services – Situation Update, dated Aug. 2019, attached to the Posner Decl. as Exhibit G [HPS0041517].


7

10. The balance of the value in the Unencumbered Assets resides in the BII Payments

related to the June 2019 berm breach. Miller Buckfire estimates that the BII Payments have a mid-

point value of

Yet, the Plan, as currently proposed, fails to provide unsecured

creditors with even a fraction of that value. In an effort to rob unsecured creditors of the recoveries

that may otherwise be derived from the value of the BII Payments,

11. The Debtors’ artificially low valuation of the Unencumbered Assets not only has

the effect described above of aiding the Debtors’ overall lowball TEV (to the detriment of

unsecured creditors irrespective of the existence of the Unencumbered Assets), but also of severely

limiting the Plan value that should be allocable to unsecured creditors if such assets are in fact

unencumbered. Utilizing the Committee’s midpoint valuation of the Unencumbered Assets of

approximately (which assumes $8 million of valid mechanics’ liens), and assuming

the Debtors’ estimate for the total amount of general unsecured claims is accurate, the

Unencumbered Assets alone (i.e., irrespective of value that would need to be allocated to

unsecured creditors if Miller Buckfire’s overall midpoint valuation, or anything close to it, is

accepted) would generate an approximate as compared to

an approximate 0.13% recovery under the Plan utilizing the Debtors’ midpoint valuation or an

approximate utilizing the Committee’s midpoint valuation (and

20 This amount alone results in an approximately 4.4% recovery on general unsecured claims assuming the Debtors’ $574 million unsecured claims pool number is correct.


8

zero in either case if Class 6 votes to reject the Plan). Remarkably, under the Plan, even at the

Debtors’ valuations of the Unencumbered Assets

, unsecured creditors are still getting less than that to which they are entitled. Under

these facts, the Plan could only be confirmable under section 1129(a)(7) if the Debtors are not only

correct about overall TEV, but also (i) correct about the value of the Oklahoma Facility, (ii) correct

about the validity of the alleged mechanics’ liens; and (iii) able to convince the Court at the

Confirmation Hearing that the BII Payments are validly and unavoidably encumbered. Because

this showing cannot be made, the Plan fails to satisfy the best interests of creditors test under

section 1129(a)(7) of the Bankruptcy Code and should not be confirmed.

The Plan Was Not Proposed in Good Faith

12. The totality of the circumstances concerning the negotiation of the Plan and certain

of its most inequitable provisions (from the perspective of unsecured creditors) including, among

other things, the Class 6 “death trap” coupled with a distribution to the Debtors’ “out of the money”

equity sponsor, reflect that the Plan was not negotiated in good faith, or anything close to it. The

lack of “good faith” is further supported by the Debtors’ inexplicable decision not to market test

its assets pre- or postpetition and the fact that the HPS-favorable Plan is being pushed through by

any means necessary at the behest of two “independent” Special Restructuring Committee

members that were handpicked by HPS itself. Put simply, if there was a case clearly

demonstrating that a debtor’s plan was not proposed in good faith, this it.

13. For these reasons, the Debtors cannot satisfy their burden under the applicable legal

standards for plan confirmation. Specifically, the Debtors cannot demonstrate that the Plan (i)

21 Net of alleged mechanics’ liens totaling approximately $8 million. If such liens are invalid, the value of the Unencumbered Assets increases.


9

satisfies the “best interests of creditors” test of section 1129(a)(7); (ii) is “fair and equitable” as

required by section 1129(b)(1); and (iii) was proposed in “good faith” under section 1129(a)(3).

In addition, the Plan is unconfirmable for numerous other reasons including that it includes

impermissible Debtor and third party releases and an unduly broad exculpation provision.

Accordingly, the Committee respectfully requests that the Court deny confirmation of the Plan so

as to permit the Committee, the Debtors, and HPS to go back to the drawing board and negotiate

a confirmable plan of reorganization that treats unsecured creditors owed potentially over a half a

billion dollars in a legally permissible manner.

FACTUAL BACKGROUND

I. General Case Background

14. On July 15, 2019 (the “Petition Date”), the Debtors commenced voluntary cases

under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”). The Debtors

continue to operate their businesses and manage their properties as debtors in possession pursuant

to sections 1107(a) and 1108 of the Bankruptcy Code.

15. Also on the Petition Date, the Debtors filed the Declaration of Bryan M. Gaston,

Restructuring Officer of the Debtors, in Support of Chapter 11 Petitions and First Day Pleadings

[D.I. 14] (the “First Day Declaration”). Attached to the First Day Declaration as Exhibit B is a

restructuring support agreement (the “RSA”) dated as of April 18, 2019 by and among the Debtors,

their Prepetition Secured Lenders, and certain equity owners of the Debtors.

16. On July 30, 2019, pursuant to section 1102 of the Bankruptcy Code, the United

States Trustee for the District of Delaware appointed the Committee [D.I. 111]. The Committee

consists of the following five members: (i) Trinity Industries Leasing Company; (i) The

Andersons, Inc. an Ohio Corporation; (iii) Iron Mountain Trap Rock Co.; (iv) Greenbrier Leasing

Company, LLC; and (v) BMT Consulting Group, LLC.


10

17. On August 29, 2019, the Debtors filed a revised version of the Plan [D.I. 268] and

a revised version of the Disclosure Statement. The August 29th revised Disclosure Statement

attached, for the first time, a Liquidation Analysis and Valuation Analysis at Exhibits D and F,

respectively.

18. On September 5, 2019, the Debtors filed a further revised version of the Plan [D.I.

324] and a further revised version of the Disclosure Statement [D.I. 325]. On September 10, 2019,

the Disclosure Statement was further amended [D.I. 350].

19. On September 11, 2019, the Court entered its Order (I) Approving the Disclosure

Statement, (II) Establishing the Voting Record Date, Voting Deadline and Other Dates, (III)

Approving Procedures for Soliciting, Receiving and Tabulating Votes on the Plan and for Filing

Objections to the Plan, (IV) Approving the Manner and Forms of Notice and Other Related

Documents, and (V) Granting Related Relief [D.I. 361]. As part of the Debtors’ solicitation

package, the Committee included a letter to unsecured creditors urging them to vote to reject the

Plan.

20. On September 16, 2019, the Court entered an order authorizing the employment

and retention of Houlihan as financial advisor and investment banker to the Debtors nunc pro tunc

to the Petition Date. [D.I. 374].

21. On September 25, 2019, the Court entered an order authorizing the employment

and retention of Miller Buckfire as investment banker to the Committee nunc pro tunc to August

2, 2019. [D.I. 406].

22. The deadline to file the Committee’s Objection was extended from October 14,

2019 to October 15, 2019.


11

23. The deadline to file the Committee’s Standing Motion was extended from October

15, 2019 to October 17, 2019.

24. A hearing to consider confirmation of the Plan is scheduled for October 24, 2019

(the “Confirmation Hearing”).

II. Debt Structure

25. As of the Petition Date, the Debtors had funded debt obligations of approximately

$283 million, comprised primarily of indebtedness of approximately $67 million under the

Prepetition Credit Agreement and $216 million under the Prepetition Notes Agreement. See First

Day Declaration ¶¶ 23-24.

26. Pursuant to the Final DIP Order, on August 14, 2019, the Court approved a $35

million senior secured priming and superpriority debtor-in-possession credit agreement (the “DIP

Facility”). The DIP Facility lenders are the Prepetition Lenders and Prepetition Noteholders, and

the DIP Facility includes an incremental roll up of the Prepetition Credit Agreement Claims.22 On

the Effective Date, the Reorganized Debtors will enter into a $100 million exit facility asset-based

loan, the proceeds of which will be used to, inter alia, repay in part the DIP Facility loans and

Allowed Prepetition Credit Agreement Claims.

27. Accordingly, as of an assumed effective date for the Plan of October 31, 2019, the

Debtors’ valuation hurdle to achieve recovery to unsecured creditors, aside from unencumbered

assets, totals approximately $317 million.

22 As of the anticipated Effective Date, the DIP Facility and the Prepetition Credit Agreement Claims are estimated to total approximately $100 million.


12

III. The Plan

28. The Plan, as currently proposed, is consistent in all material respects with, and

indeed seeks to implement, the RSA. The Plan contemplates that the New General Partner will

issue the New Emerge GP Equity Interests to holders of Allowed Prepetition Notes Claims, subject

only to (i) dilution on account of the New Warrants and New Management Incentive Plan; (ii) a

distribution to Holders of Allowed Class 6 General Unsecured Claims comprised of 5.0% of the

New Limited Partnership Interests and New Warrants representing 10.0% of the New Limited

Partnership Interests, but only if Class 6 votes to accept the Plan; and (iii) a distribution to Holders

of Allowed Class 9 Old Emerge LP Equity Interests comprised of New Warrants representing

5.0% of the new Limited Partnership Interests, but only if Class 6 votes to accept the Plan.

29. The Plan proposes to satisfy (i) the approximately $100 million of DIP Facility

Loans and Prepetition Credit Agreement Claims with $50 million of new debt and $50 million of

preferred equity; and (ii) the Prepetition Notes Claims with $85 million of preferred equity and

95% to 100% of the Reorganized Debtors’ equity value.

30. Utilizing Houlihan’s midpoint TEV of $200 million, the total estimated value of

the New Limited Partnership Interests at emergence is approximately $15 million ($200 million

TEV less $185 million of debt and preferred equity). Thus, if Class 6 votes to accept the Plan,

such creditors will share in 5% of that purported value, or $750,000, pro rata among a pool of

claims estimated at approximately $574 million, representing a recovery of approximately 0.13%.

If Class 6 votes to reject the Plan, creditors holding such claims will get nothing.

IV. Valuations

Houlihan Valuation

31. On September 25, 2019, the Debtors provided the Committee’s advisors with

Houlihan’s valuation report (the “Houlihan Valuation”), which is attached to the Posner Decl. as


13

Exhibit F. Houlihan considered two generally accepted valuation methodologies to arrive at its

TEV estimate: (i) discounted cash flow analysis (“DCF”); and (ii) comparable companies

approach.

32. Based on the Debtors’ August 9, 2019 business plan, Houlihan first projected

operating cash flows through December 31, 2021, which were discounted back to the Valuation

Date (October 31, 2019) using a calculated Weighted Average Cost of Capital (“WACC”) for the

Reorganized Debtors, to arrive at a present value for the expected operating cash flows during the

projection period. The Debtors’ projected 2021 EBITDA was then multiplied against an exit

multiple and discounted back to the Valuation Date using the same WACC to arrive at a discounted

terminal value. The TEV estimate is the result of adding together the discounted cash flows and

discounted terminal value.

33. In its comparable company analysis, Houlihan identified two peer companies with

characteristics that it deemed relevant to valuing the Reorganized Debtors: Hi-Crush and Smart

Sand. Houlihan considered, but excluded, (i) Covia, (ii) U.S. Silica, and (iii) Source Energy

Services. Houlihan utilized observed TEV to EBITDA multiples to inform a range of multiples

applicable to the Reorganized Debtors. Houlihan limited its potential comparable companies to

publicly-traded silica sand extraction companies whose operations focused primarily on serving

the oil and gas industry.

34. According to the Houlihan Valuation, Houlihan estimates that the TEV for the

Reorganized Debtors as of October 31, 2019 is between $180 million and $220 million. See

Houlihan Valuation, attached to the Posner Decl. as Exhibit H at pg. 13. As discussed more fully

below, the Houlihan Valuation contains fundamental flaws that lead to an unsupportable TEV

conclusion for the Reorganized Debtors.


14

Miller Buckfire Valuation

35. On October 3, 2019, Miller Buckfire finalized its valuation (the “Miller Buckfire

Valuation”). See Miller Buckfire Valuation, attached to the Rodrigue Decl. as Exhibit A. Miller

Buckfire used the same two generally accepted valuation methodologies as Houlihan: DCF and

comparable companies. Id. at pg. 8. As set forth in the Miller Buckfire Valuation, Miller Buckfire

calculated a TEV for the Reorganized Debtors ranging between $335 million and $445 million.

Id. at pg. 9.

36. On October 11, 2019, Miller Buckfire issued a rebuttal report (the “Rebuttal

Report”). See Rebuttal Report, attached to the Rodrigue Decl. as Exhibit B. The Rebuttal Report

analyzes the flaws contained in the Houlihan Valuation and made corrections to such flaws to

arrive at an adjusted Houlihan Valuation between $354.2 million and $456.0 million, with a

midpoint of $405.1 million, without the errors and other valuation infirmities embedded in the

Houlihan Valuation.

37. As discussed more fully below, the Court should rely on the Miller Buckfire

Valuation as it remedies the various material flaws in the Houlihan Valuation and, as a result, asserts

(i) a TEV midpoint of $390 million; (ii) as a component thereof, a midpoint valuation of the

unencumbered Oklahoma Facility of (net of an estimated $8 million in alleged

mechanics’ liens); and (iii) also as a component thereof, a midpoint valuation of the unencumbered

BII Payments of

ARGUMENT

38. The requirements for confirmation are set forth in section 1129 of the Bankruptcy

Code. A plan proponent bears the burden of proving to the Court that a proposed plan satisfies

every applicable confirmation requirement under Bankruptcy Code section 1129(a). See In re


15

Exide Techs., 303 B.R. 48, 58 (Bankr. D. Del. 2003); In re Genco Shipping & Trading Ltd., 513

B.R. 233, 241 (Bankr. S.D.N.Y. 2014); 7 Collier on Bankruptcy ¶ 1129.05[1][d] (16th rev. ed.

2019) [hereinafter “7 Collier”] (“At [the confirmation] hearing, the proponent bears the burdens

of both introduction of evidence and persuasion that each subsection of section 1129(a) has been

satisfied . . . . If nonconsensual confirmation is sought, the proponent of such a plan will have to

satisfy the court that the requirements of section 1129(b) are also met. In either situation, the plan

proponent bears the burden of proof by a preponderance of the evidence.”). For the reasons

discussed herein, the Plan cannot be confirmed because the Debtors have not and cannot carry

their burden to satisfy each and every statutory requirement under section 1129(a) of the

Bankruptcy Code in particular, sections 1129(a)(7) (best interests test) and 1129(a)(3) (good faith).

39. In addition, where an impaired class rejects a plan of reorganization, the plan

proponent must also demonstrate that the plan meets the additional requirements of Bankruptcy

Code section 1129(b), including the requirements that the plan does not unfairly discriminate

against dissenting classes and the treatment of the dissenting classes is fair and equitable.23 11

U.S.C. § 1129(b); see also In re Exide Techs., 303 B.R. at 58; In re Genesis Health Ventures,

Inc., 266 B.R. 591, 599 (Bankr. D. Del. 2001) (“A nonconsensual plan requires the proponent to

prove all but one of the thirteen elements [of Bankruptcy Code Section 1129(a)], that all classes

consent or are unimpaired, 11 U.S.C. § 1129(a)(8), plus the additional requirements of section

1129(b), that the plan does not unfairly discriminate against dissenting classes and that treatment

of such dissenting classes is fair and equitable.”).

23 Although the Voting Deadline has not passed, the Solicitation Package included a letter from the Committee urging general unsecured creditors to vote to reject the Plan. The arguments below regarding the “fair and equitable” requirement are premised upon Class 6 voting to reject the Plan.


16

40. As discussed below, assuming Class 6 votes to reject the Plan, the Debtors also

cannot satisfy their burden under section 1129(b) of the Bankruptcy Code. Accordingly, the Plan

should not be confirmed for this reason as well.

I. The Plan Does Not Satisfy Bankruptcy Code Section 1129(a)(7) Because a Liquidation of the Debtors’ Unencumbered Assets Would Provide More Value to General Unsecured Creditors Than the Proposed Recovery Under the Plan

41. The Plan fails because, among other things, unsecured creditors would receive

materially larger recoveries in a liquidation than they would under the Plan. Section 1129(a)(7) of

the Bankruptcy Code requires that a debtor’s plan of reorganization provide each creditor in an

impaired class with at least as much as that creditor would receive in a chapter 7 liquidation. 11

U.S.C. § 1129(a)(7)(A)(ii). A plan of reorganization “may not be confirmed where the evidence

is not sufficient on which to base an independent factual determination that the proposed plan is

in the best interests of the creditors pursuant to § 1129(a)(7).” In re MCorp Fin., Inc., 137 B.R.

219, 228 (Bankr. S.D. Tex. 1992); see also In re Cantu, 784 F.3d 253, 262 (5th Cir. 2015) (“A

reorganization plan must either be accepted by each creditor or satisfy the Code’s ‘best interests

of the creditor’ rule, which requires that the holder of a claim receive under the reorganization plan

at least as much as the holder would receive in the event of a chapter 7 liquidation”); 7 Collier,

supra, ¶ 1129.02[7] (Section 1129(a)(7) provides “an individual guaranty to each creditor or

interest holder that it will receive at least as much in reorganization as it would in liquidation”).

The best interests test applies to individual creditors holding impaired claims, even if the class as

a whole votes to accept the plan. See Bank of Am. Nat’l Tr. & Sav. Ass’n v. 203 N. LaSalle St.

P’ship, 526 U.S. 434, 441 n.13 (1999).

42. Here, the proposed Plan does not provide recoveries to Class 6 unsecured creditors

that meet, much less exceed, the recoveries that could be obtained in a chapter 7 liquidation. In

particular, as will be set forth in the Committee’s soon-to-be-filed Standing Motion, the Committee


17

has concluded that certain of the Debtors’ assets are not encumbered by valid, perfected and

unavoidable liens of the Prepetition Secured Parties (or in certain cases, any liens at all) and, as a

result, should be available for distribution to unsecured creditors. Among these assets are the

Oklahoma Facility24 and the BII Payments related to the June 21, 2019 berm breach at the Debtors’

San Antonio, Texas facility.

A. The Oklahoma Facility

43. The Debtors own forty (40) acres of real property located in Kingfisher, Oklahoma

consisting, in part, of a partially developed plant site. According to the Disclosure Statement, “[t]he

Debtors are not aware of the existence of any mortgage on the Debtors’ property at Kingfisher,

Oklahoma, securing the obligations under the Prepetition Credit Agreement” and “the Prepetition

Notes Agreement.” Disclosure Statement § II.C.1 -2.25 In fact, in a blatant disregard for the

treatment of unsecured creditors, the Special Restructuring Committee

. As more fully set forth in the Standing Motion, the Committee has determined

that the Oklahoma Facility is indeed unencumbered (except as noted above regarding equipment

and fixtures, the value of which is not believed to be substantial in comparison to the overall value

of the Oklahoma Facility) and as a result, is seeking a declaratory judgement providing same.

24 Except to the extent of any equipment and fixtures, the value of which is not believed to be substantial in comparison to the overall value of the Oklahoma Facility.

25 The Committee is aware of the Debtors’ contention that some portion of the Oklahoma Facility consists of equipment and fixtures that are subject to perfected security interests in favor of the Prepetition Secured Parties, which may be true. The Committee does not believe, however, that a substantial portion of the value of the Oklahoma Facility is attributable to any such equipment and fixtures.


18

44. Miller Buckfire values the Oklahoma Facility

See Miller Buckfire Valuation, attached to the Rodrigue Decl. as Exhibit A at pgs.

23-25. Only for purposes of a liquidation, the Committee believes that the low range of $15 million

is appropriate.26 The Committee understands that there are approximately $8 million in alleged

mechanics’ liens asserted against the Oklahoma Facility, leaving a net liquidation value of

approximately $7 million.27

45. The Houlihan Valuation, on the other hand, ascribes a value range of

See Houlihan

Valuation, attached to the Posner Decl. as Exhibit F at pg. 13. However, as set forth in the Rebuttal

Report, Houlihan’s valuation of the Oklahoma Facility is flawed and unreliable. See Rebuttal

Report, attached to the Rodrigue Decl. as Exhibit B at pg. 23. In fact, on October 9, 2019, despite

the absence of any marketing process, the Debtors received an unsolicited offer to purchase the

Oklahoma Facility (inclusive of a credit bid of the alleged mechanics’ liens) for approximately

$11.2 million (the “Oklahoma Bid”), which is

See Pownall Service, LLC’s Objection to Debtors’ First Amended Joint Plan of

Reorganization [D.I. 466].

26 The Committee does not concede, however, that such liens are valid (to the extent they exist) or not subject to setoff.

27 Even if the equipment and fixtures are subject to valid perfected liens of the Prepetition Secured Parties, and even if they are worth at liquidation as much as $2 million, the net liquidation value would still be approximately $5 million.


19

further evidencing the Debtors’ desire to scare away all potentially interested parties so as to

preserve this valuable unencumbered asset for HPS’s sole benefit. And make no mistake, HPS

clearly sees value in this asset. In fact, HPS has stated

28

B. Business Interruption Insurance Payments

46. The Committee has also concluded that the BII Payments relating to the berm breach

are unencumbered and should be available for unsecured creditors. As set forth in the Standing

Motion, the Committee is seeking, inter alia, (i) a declaratory judgement that the BII Payments are

unencumbered by the Prepetition Liens; and (ii) avoidance of any Prepetition Liens that allegedly

encumber such BII Payments as a preferential transfer.

47. Miller Buckfire estimates that the BII Payments have

See Miller Buckfire Valuation, attached to the Rodrigue Decl. as

Exhibit A at pg. 9. For purposes of a liquidation, the Committee believes that

According to the Houlihan Valuation, the BII Payments are

See Houlihan Valuation, attached to the Posner Decl.

as Exhibit H at pg. 27. However, Houlihan’s valuation of the BII Payments is based on an

unsupported and , is otherwise flawed, and

. See Rebuttal Report, attached to the Rodrigue Decl. as Exhibit B at pg. 25.

28


20

48. Based on the foregoing, the Committee believes that the liquidation value of the

Unencumbered Assets, which conservatively totals approximately

would be distributable to unsecured creditors in

a liquidation scenario and result in recoveries of approximately Such a recovery is a far cry

from the proposed Plan recoveries of 0.4% – 1.3%, if any at all.29 In fact, even using the Debtors’

artificially low values for the Unencumbered Assets, unsecured creditors would still receive in a

liquidation an approximate , which is far greater than what unsecured

creditors would receive under the current Plan. As a result, the Plan fails to satisfy the best interests

of creditors test under section 1129(a)(7) of the Bankruptcy Code and should not be confirmed.

II. The Plan Is Not “Fair And Equitable” Under Section 1129(b)(1)

49. Although the voting results with respect to the Plan were not known to the

Committee at the time this Objection was filed,30 the Committee assumes for purposes of this

Objection that Class 6 will not vote to accept the Plan by the margins required under section

1126(c) of the Bankruptcy Code. Accordingly, the Debtors will be required to satisfy the

requirements of section 1129(b)—the “cramdown requirements”—as to each class that does not

vote to accept the Plan. A plan may only be confirmed as to a dissenting creditor class if it does

not discriminate unfairly and is fair and equitable. 11 U.S.C. § 1129(b)(1).

50. Section 1129(b)(2)(B) describes how a plan may be “fair and equitable” to a class

of impaired, non-accepting general unsecured claims. 11 U.S.C. § 1129(b)(2)(B). The “fair

29 As noted, in the event Class 6 votes to reject the Plan, recoveries for unsecured creditors would be zero.

30 The Voting Deadline is October 17, 2019.


21

and equitable” standard “can be seen to have at least two key components: the absolute priority

rule; and the rule that no creditor be paid more than it is owed.” 7 Collier, supra, ¶ 1129.03[4][a].

A. The Plan is Not “Fair and Equitable” Because it Provides Value to the Prepetition Noteholders in Excess of the Value of Their Claims

51. The second foundational component of the “fair and equitable” requirement—that

no creditor may be paid more than it is owed—may be briefly summarized: “[o]nce the participant

receives or retains property equal to its claim, it may receive no more.” Id. at ¶ 1129.03[4][a][ii].

No claim or interest holder may be paid a “premium” in excess of the allowed amount of its

claim. Id. For this reason, a plan that proposes to pay senior creditors value in excess of their

allowed claim amounts is not “fair and equitable” under section 1129(b)(2)(B) of the Bankruptcy

Code, and may not be confirmed. See In re Penn Cent. Transp. Co., 596 F.2d 1102, 1110 (3d

Cir. 1979) (“[A] plan is not ‘fair and equitable’ unless it provides participation for claims and

interests in complete recognition of their strict priorities, and unless the value of the debtor’s

assets supports the extent of the participation afforded each class of claims or interests

included in the plan.”); In re Exide Techs., 303 B.R. 48 at 61 (denying confirmation of plan

that afforded secured lenders value in excess of the amount of their claims); In re Genesis

Health Ventures, Inc., 266 B.R. at 612 (“A corollary of the absolute priority rule is that a senior

class cannot receive more than full compensation for its claims.”).

52. Here, the Reorganized Debtors’ TEV impacts whether the treatment of unsecured

creditors under the Plan is fair and equitable. See In re Exide Techs., 303 B.R. at 60-61 (“A

determination of [a] Debtor’s value directly impacts the issues of whether the proposed plan is

‘fair and equitable,’ as required by 11 U.S.C. § 1129(b).”). As Plan proponent, it is the Debtors’

burden to prove to this Court that the Plan does not afford any Class value in excess of the amount

of its claim. See, e.g., In re Armstrong World Indus., 348 B.R. 111, 119 n.14, 120 (Bankr. D. Del.


22

2006) (plan proponent must establish by preponderance of the evidence the satisfaction of

requirements of both Bankruptcy Code section 1129(a) and 1129(b)). The Debtors cannot carry

their burden of proof.

53. The proposed Plan fails to satisfy the “fair and equitable” requirement under section

1129(b) because, based upon the analysis set forth in the Miller Buckfire Valuation, and assuming

unsecured creditors vote to reject the Plan, the Plan transfers (i) 100% of the Reorganized Debtors’

equity value worth $205 million (using a TEV of $390 million, the midpoint in the Miller Buckfire

Valuation, less $185 million in debt and preferred equity to be issued); and (ii) approximately $85

million in preferred equity to Holders of Class 5 Prepetition Note Claims (worth at least $85

million), despite the fact that the Prepetition Notes Claims have an estimated value of only

approximately $217 million. This results in a distribution to HPS of $73 million or more than they

are owed. Such treatment is antithetical to the Bankruptcy Code’s “fair and equitable”

requirement, especially where, as here, unsecured creditors are slated to recover as little as 0.4%, if

anything at all. As a result, the Plan cannot be confirmed.

54. Miller Buckfire prepared a valuation that conservatively concludes that the

Debtors’ TEV falls within a range of approximately $335 million to approximately $445 million,

with a midpoint of approximately $390 million. Miller Buckfire’s valuation is consistent with

HPS’s own prepetition value assessment on the Company, which valued the Company at

approximately $289 million to $451 million.

55. In support of its valuation, Miller Buckfire also prepared a Rebuttal Report

providing a specific factual analysis demonstrating the inherent and material flaws contained in

the Houlihan Valuation and the credibility of the Miller Buckfire Valuation. In brief, the Houlihan

Valuation contains numerous material errors that cause its conclusions regarding value to be


23

artificially depressed and, as a result, unreliable. These errors are, among others: (i) the selection

of an artificially low exit multiple and overstated discount rate in calculating TEV under the DCF

analysis; (ii) the exclusion of logical peers in its selection of comparable companies, which results

in a meaningfully lower multiple range under the Comparable Company Analysis; (iii) the fatal

flaw of applying an EBITDA multiple against an unadjusted 2020E EBITDA, which is significantly

impaired by the San Antonio, Texas berm breach and not representative of the Company’s

normalized operations; and (iv) the understatement of value of the Unencumbered Assets.

56. The conclusions in the Houlihan Valuation are also discredited by HPS’s own

internal documents, which just prior to the Petition Date, calculated a TEV midpoint of

approximately $370 million (and a high range of $451 million), which is $6 million higher than

Miller Buckfire’s high range of TEV.31

32

57. The Miller Buckfire Valuation, however, corrects many of the errors and flawed

assumptions utilized in the Houlihan Valuation. Indeed, the Rebuttal Report prepared by Miller

Buckfire highlights the flaws in the Houlihan Valuation and the corrections contained in the Miller

Buckfire Valuation so as to address such flaws. See Rebuttal Report, attached to the Rodrigue Decl.

at Exhibit B. Among those corrections are the following:

31 See Mezzanine Watchlist, dated Sept. 17, 2019 attached to the Posner Decl. as Exhibit K [HPS0005959].

32 See E-Mail from B. Pertuz, HPS, to P. Russo, HPS, copying D. Dimitrievich, HPS; R. Manideep, HPS, dated May 6, 2019, attached to the Posner Decl. as Exhibit E [HPS0032173].


24

Categories Issues in Houlihan’s Report TEV: $180 million - $220 million

Correction

Comparable Company Analysis

Unadjusted 2020E EBITDA

• Houlihan applies an EBITDA multiple against the Company’s 2020E EBITDA that is significantly impaired by the San Antonio berm breach. Houlihan applies equal weighting to an understated 2020E valuation and the 2021E valuation.

• The berm breach was a one-time event. Multiples should be applied to normalized 2020E EBITDA.

Selected Range of Comparable Company

• Houlihan’s multiple range is based on only two comparable companies: Hi-Crush and Smart Sand. Houlihan excludes logical peers of the Debtors, including U.S. Silica Holdings, Inc. (“U.S. Silica”) and Covia Holdings Corporation (“Covia”), in its selection of comparable companies, which results in a meaningfully lower multiple range. This omission is inexplicable as both U.S. Silica and Covia are cited as competitors of the Debtors in the Debtors’ 2018 Form 10-K filed with the Securities and Exchange Commission, the relevant portions of which are attached to the Posner Decl. as Exhibit L, and both Covia and U.S. Silica cite Emerge as a competitor in their respective filings the relevant portions of which are attached to the Posner Decl. as Exhibits M and N. Moreover, recent equity research by Barclay’s cites Hi-Crush Inc., Smart Sand, Inc. (“Smart Sand”), Covia and U.S. Silica as public comparable companies of the Debtors. See Stifel Update, Barclays Update, and Jefferies Update attached to the Posner Decl. as Exhibits O, P, and Q, respectively.

• Covia and U.S. Silica should be included as comparable companies..

Market Value of Debt

• Houlihan calculates enterprise value using market value of debt, which significantly understates the value and multiples of the comparable companies.

• Total enterprise value should be calculated using face value of debt. The equity of the comparable companies is generally liquid and trades on the assumption that debt will be repaid at face value.

Selection of Comparable Companies

• Since Houlihan only utilizes two comparable companies, a substantial portion of the comparable company analysis value is derived from Smart Sand, a company that trades at a noticeable discount to peers due

• The inclusion of additional comparable companies would reduce the reliance on Smart Sand and reduce the


25


Correction

to high exposure on take-or-pay contracts and recent customer litigation, set forth in Exhibits R attached to the Posner Decl. Additionally, Smart Sand only produces Northern White Sand, whereas the majority of the Debtors’ value, as presented in management’s business plan, is derived from in-basin operations in San Antonio.

idiosyncrasies of a limited sample size. Of all comparable companies, Smart Sand is perhaps the least relevant to Emerge due to its exclusive NWS business model, ongoing customer litigation and expiring take-or-pay contracts. As of June 30, 2019, Smart Sand reported $34.6 million of litigation related A/R balance, representing approximately 37%33 of its market capitalization.

Discounted Cash Flow Analysis

WACC Based on Pro Forma Capital Structure

• 81% of Houlihan’s weighted average cost of capital is based on the Company’s pro forma capital structure, which was not negotiated at arms-length.

• It is generally appropriate to utilize a hypothetical industry capital structure when calculating the weighted average cost of capital.

• Valuation should utilize a WACC based on the median debt to equity ratios of the adjusted comparable companies universe and market debt metrics.

Terminal Year & Terminal Multiple

• Terminal year EBITDA does not fully reflect a normalized level.

• Houlihan selected its terminal multiple based on two publicly traded comparables, which resulted in an artificially low range of multiples.

• Houlihan’s exit multiple has a negative implied perpetuity growth rate, implying Emerge is liquidating over time.

• Valuation should use a long-term run rate EBITDA beyond the projection period (annualized 2H 2021).

Size Premium

• Houlihan utilizes a size / distress premium of 11.14% resulting in a 40.0% cost of equity.

• A 6.85% size premium is the appropriate size premium for companies with equity capitalizations of $109.5 million to $184.8 million,

33 Per Bloomberg as of August 27, 2019.


26


Correction

• Size premium reflects companies with a market capitalization of $2.5 million to $109.5 million.

per the Duff and Phelps 2018 Valuation Handbook – U/S. Cost of Capital.

34

35

34

35 See deposition of Mr. Richard Shearer attached to the Posner Decl. as Exhibit T at 151:8-13.


27


Correction

36 On September 6, 2019, Sunoco filed a protective proof of claim of $10.127 million, comprising a $3.1 million Hydrotreater Completion Defect Claim and a $7.0 million Indemnification Notice Claim.


28

58. For these reasons, the Court should rely on the Miller Buckfire Valuation, which

demonstrates, among other things, that the Plan provides value to HPS that substantially exceeds

the estimated $217 million in Prepetition Notes Claims. Such a recovery violates the corollary of

the absolute priority rule and as a result, the Plan cannot be found to be “fair and equitable” under

section 1129(b)(1) of the Bankruptcy Code.

III. The Plan Should Not Be Confirmed Because It Is Not Proposed In Good Faith Under Section 1129(a)(3) Of The Bankruptcy Code

59. To be confirmable, a plan of reorganization must be “proposed in good faith and

not by any means forbidden by law.” 11 U.S.C. § 1129(a)(3). In determining whether a chapter

11 plan has been proposed in good faith, courts look to whether the plan is proposed “with ‘honesty

and good intentions’ and with ‘a basis for expecting that a reorganization can be effected.’” Kane

v. Johns-Manville Corp., 843 F.2d 636, 649 (2d Cir. 1988) (quoting Koelbl v. Glessing (In re

Koelbl), 751 F.2d 137, 139 (2d Cir. 1984)). “Whether a reorganization plan has been proposed in

good faith must be viewed in the totality of the circumstances, and the requirement of section

1129(a)(3) ‘speaks more to the process of plan development than to the content of the plan.’” In

re Chemtura, Corp., 439 B.R. 561, 608 (Bankr. S.D.N.Y. 2010) (citations omitted). Good faith

also requires a showing that the plan reflects “fundamental fairness in dealing with the creditors.”

See In re Leslie Fay Cos., Inc., 207 B.R. 764, 781 (Bankr. S.D.N.Y. 1997) (quoting In re

Jorgensen, 66 B.R. 104, 109 (B.A.P. 9th Cir. 1986)). The Plan does none of this.

A. The Failure to Conduct a Market Test for Value

60. The Supreme Court has identified two purposes of Chapter 11: (1) preserving going

concerns; and (2) maximizing property available to satisfy creditors. See Bank of Am. Nat’l Tr. &

Sav. Ass’n, 526 U.S. at 453. Here, the failure to conduct a market test for the Debtors assets


29

demonstrates that the Plan’s purpose is contrary to one of the Bankruptcy Code’s key objectives—

maximizing value.

61. Evidence adduced at the Confirmation Hearing will show that, notwithstanding the

clear need for a market test, the Debtors made the conscious decision not to conduct one. Indeed,

Mr. Adam Dunayer of Houlihan acknowledged that Houlihan did not undertake a market test,

“didn’t need to [take the asset to market]” and failed to explore or analyze other options to sell the

assets including through a 363 sale. See Dunayer Depo. Tr. 99:13-21, 198:21.

62. The Debtors’ deliberate decision not to conduct a market test and instead negotiate

with only one creditor demonstrates that the Debtors (and HPS) were not proposing the Plan in a

manner that was consistent with maximizing value. Indeed, the Plan is premised on what is

effectively a private sale that has only three beneficiaries: (i) HPS, who will acquire substantially

all of the Reorganized Debtors’ equity; (ii) the Debtors’ management team, who stand to gain from

the upside of the New Management Incentive Plan; and (iii) Insight Equity, who despite being in

a class junior to Class 6 unsecured creditors, is slated to receive a recovery in the form of New

Warrants (if Class 6 votes to accept the Plan) notwithstanding that more senior classes will not be

paid in full and, inexplicably, is receiving a broad sweeping release. Clearly, the Debtors’ decision

not to conduct a market test runs counter to the Debtors’ well-established obligation to maximize

the value of their estates.37

37 As noted above, despite the Debtors’ failure to conduct any market test and their position that the Oklahoma Facility is essentially worthless to the estates, the Debtors received an unsolicited offer to purchase the Oklahoma Facility at an amount in excess of the estimated mechanics’ liens.

demonstrates that the Debtors are not discharging their duties to maximize value for all creditors but rather, are attempting to maximize value for one creditor: HPS.


30

B. The Negotiation of the Plan and the RSA

63. Approximately three months prior to the Petition Date, the Debtors entered into the

RSA with Insight Equity and HPS. See First Day Declaration, Exhibit B. The RSA created the

Special Restructuring Committee that was empowered with some control and decision-making

authority regarding, among other things, the implementation of the RSA, the Plan and the exercise

of the Debtors’ fiduciary out.

38

39

64. With those highly troubling revelations, bolstered by incontrovertible written

admissions of their veracity, the process through which the RSA and the Plan were negotiated and

proposed reflects anything but fundamental fairness in dealing with creditors. See In re Chemtura

Corp., 439 B.R. at 608. To the contrary, it reflects a highly conflicted and tainted process that

continues unimpeded and is being defended at all costs.

38 See E-Mails between E. Davis, Pirinate Consulting, A. Dunayer, Houlihan Lokey, K. Simon, Latham & Watkins, B. Gaston, Ankura, and J. Zammit, Houlihan, dated May 3-4, 2019, attached to the Posner Decl. as Exhibit V [EMES00726228] (emphasis added).

39


31

C. The Combined Death Trap/Equity Recovery Provision

65. But there is more. The Plan itself includes provisions that easily demonstrate bad

faith. As the Court is aware, the Plan contains a so called “death trap” provision where the

unsecured creditors’ recovery is conditioned upon acceptance by that class. While such a

provision alone may be perfectly appropriate (assuming, of course, all other confirmation

requirements, including the best interests test, are met), the death trap provision in this Plan is

uniquely combined with a proposed distribution to the Debtors’ “way out of the money” equity

(i.e., Insight Equity, an insider that negotiated the RSA). Undersigned counsel is not aware of

other cases in which this combination has been employed, and it reeks. The Debtors have actually

proposed a plan that tells unsecured creditors (owed over half a billion dollars no less) that not

only are they getting at most a minimal recovery, and that they only get it if they accept the plan,

but “oh by the way”, if they accept the Plan to get these crumbs, they thereby allow a party below

them in the waterfall (the equity sponsor behind this mess no less) to also get a recovery. What

could be more repugnant to unsecured creditors? It is hard to imagine what violates section

1129(a)(3) if this does not.

D. The RSA Provides for an Impermissible Post-Emergence Release in Potential Contravention of this Court’s Order

66. The Committee has significant concerns regarding certain release terms set forth in

the RSA. While the Debtors are requesting that the Court approve the Debtor Releases, Third

Party Releases, and exculpation provisions set forth in the Plan (discussed in further detail below),

the RSA provides, in renegade fashion, that if the Court does not approve the release and

exculpation provisions set forth in the Term Sheet attached to the RSA (substantially similar to

those contained in the Plan), then HPS, as the controlling owner post-Effective Date, will cause

the Reorganized Debtors to agree to provide such releases and exculpation “as promptly as


32

reasonably possible after the occurrence of the Effective Date.” See RSA ¶ 5(b). Indeed, the

Debtors have stated that they intend to assume the RSA.40 The Court should not countenance the

HPS’s attempted end-run around this Court’s orders and applicable bankruptcy law.

67. As a result, this Court should deny confirmation of the Plan because it does not

comply with Bankruptcy Code section 1129(a)(3).

IV. The Plan is Not Confirmable Because the Releases are Inappropriate and Contravene Applicable Law

68. The Debtor Releases and Third Party Releases contained in the Plan Article X

provide for broad releases of various non-Debtor parties (each, a “Released Party” and,

collectively, the “Released Parties”)41 in these Chapter 11 Cases, including HPS, Insight Equity,

40 Deposition of Bryan Gaston, dated Oct. 23, 2019, attached to the Posner Decl. as Exhibit AA, 156:21-157:11.

41 “Released Party” is defined in the Plan as, “collectively: (a) the Debtors; (b) the Reorganized Debtors; (c) the Committee and the members thereof in their capacity as such; (d) the Prepetition Credit Agreement Agent and the Releasing Prepetition Credit Agreement Lenders; (e) the DIP Credit Agreement Agent and the DIP Credit Agreement Lenders; (f) the Prepetition Notes Agent and the Releasing Prepetition Noteholders; (g) the Releasing Old Emerge LP Equity Holders, and (h) each Specified Railcar Lessor, so long as the applicable New Railcar Lease Agreement(s) between the Debtors and the applicable Specified Railcar Lessor is in full force and effect as of the Effective Date; and in each case the respective Related Persons of each of the foregoing Entities. See Plan § I.C.

“Related Persons” is defined in the Plan as, “with respect to any Person, such Person’s predecessors, successors, assigns and present and former Affiliates (whether by operation of law or otherwise) and subsidiaries, and each of their respective current and former officers, directors, principals, employees, shareholders, members (including ex officio members and managing members), managers, managed accounts or funds, management companies, fund advisors, advisory or subcommittee board members, partners, agents, financial advisors, attorneys, accountants, investment bankers, investment advisors, consultants, representatives, and other professionals, in each case acting in such capacity at any time on or after the date of the Restructuring Support Agreement, and any Person claiming by or through any of them, including such Related Persons’ respective heirs, executors, estates, servants, and nominees; provided, however, that no insurer of any Debtor shall constitute a Related Person.” Id.

“Releasing Parties” is defined in the Plan to include: (a) the Debtors; (b) the Reorganized Debtors, (c) the Committee and the members thereof in their capacity as such; (d) the Prepetition Credit Agreement Agent and the Releasing Prepetition Credit Agreement Lenders; (e) the DIP Credit Agreement Agent and the DIP Credit Agreement Lenders; (f) the Prepetition Notes Agent and the Releasing Prepetition Noteholders; (g) the Releasing Old Emerge LP Equity Holders; (h) each Specified Railcar Lessor (to the extent it is Released


33

and current and former directors and officers. Section X.B.1 of the Plan (the “Debtor Releases”)

provides that the Debtors and their Estates will release the Released Parties from “any and all

Claims, Causes of Action . . . whether directly or derivatively held . . . ,” while Section X.B.2 (the

“Third Party Releases” and, together with the Debtor Releases, the “Releases”) provides that an

extensive list of third parties (the “Releasing Parties”) will release the Released Parties from the

same. See Plan §§ X.B.1 - 2.

A. The Debtor Releases are Inappropriate

69. The Debtor Releases are impermissible. Accordingly, the Plan cannot be confirmed

until the Debtor Releases are removed or substantially modified. With respect to a debtor’s release

of non-debtors as part of a chapter 11 plan, Courts in this District have routinely applied a non-

exclusive five-factor test set forth in Master Mortgage to determine whether such releases are

appropriate:

(1) the “identity of interest between the debtor and the third party, . . . such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete assets of the estate”;

(2) substantial contribution by the non-debtor of assets to the reorganization;

(3) the essential nature of the injunction to the reorganization to the extent that, without the injunction, there is little likelihood of success;

(4) an agreement by a substantial majority of creditors to support the injunction, specifically if the impacted class or classes “overwhelmingly” votes to accept the plan; and

(5) a provision in the plan for payment of all or substantially all of the claims of the class or classes affected by the injunction.

In re Master Mortg. Inv. Fund, Inc., 168 B.R. 930, 935, 97 (Bankr. W.D. Mo. 1994); see also In

re Abeinsa Holding, Inc., 562 B.R. 265, 282 (Bankr. D. Del. 2016) (applying the 5-factor Master

Party); and (i) those Holders of General Unsecured Claims or Old Emerge LP Equity Interests that do not affirmatively opt out of the Third Party Release as provided on their respective ballots. Id.


34

Mortgage test to debtors’ proposed release of third parties); In re Wash. Mut. Inc., 442 B.R. 314,

346 (Bankr. D. Del. 2011) (the “factors articulated in Master Mortgage form the foundation” for

the analysis of whether a debtor’s release of third parties is appropriate); In re Zenith Elecs. Corp.,

241 B.R. 92, 110 (Bankr. D. Del. 1999) (applying the five-factor Master Mortgage test to debtors’

release of third parties).

70. Although no single factor is dispositive, courts in this district have focused the

analysis on whether the parties to be released have provided a substantial contribution to the plan.

See Wash. Mut., 442 B.R. at 349-50 (approving releases of parties that had waived significant

claims against the debtors’ assets and the estates but concluding that “there is no basis whatsoever

for the Debtors to grant a release to directors and officers or any professionals . . . current or former

. . . [because] there has been no evidence presented of any ‘substantial contribution’ made to the

case by the directors, officers or professionals, justifying releases for those parties.”). Courts do

not grant third-party plan releases lightly, and the plan proponent bears the burden of establishing

the appropriateness of the non-debtor releases. See Zenith Elecs. Corp., 241 B.R. at 110 (releases

by the debtor against third parties may be provided under certain limited circumstances); In re

Glob. Ocean Carriers Ltd., 251 B.R. 31, 43 (Bankr. D. Del. 2000) (noting that it is the debtors’

burden to establish that releases are appropriate). Importantly, in order for a party to make a

“substantial contribution” worthy of a plan release, the party must contribute something tangible

to the Plan, whether in the form of cash or providing an “extraordinary service” to the case. In re

Wash. Mut., Inc., 442 B.R. at 348.

71. Section X.B.1 of the Plan sets forth the exceedingly broad releases by the Debtors.

Yet, the Plan fails to provide any analysis as to why the releases are essential to the reorganization

and/or how the Released Parties have made a “substantial contribution” to support the proposed


35

releases. See United Artists Theatre Co. v. Walton, 315 F.3d 217, 227 (3d Cir. 2003) (holding that

releases must be given in exchange for fair consideration). In fact, both members of the Special

Restructuring Committee testified that they had not performed an analysis of the alleged

substantial contributions the Released Parties made in order to obtain a release. Transier Depo.

Tr. 108:9-20, 109:25-111:9, 111:16-112:18-113:14; Davis Depo. Tr. 267:24-268:9. Furthermore,

both members of the Special Restructuring Committee, which members are empowered with the

authority to implement the restructuring transactions set forth under the RSA through these

Chapter 11 Cases and the Plan, admitted that the Special Restructuring Committee had not made

any inquiry or investigation into any potential claims or causes of action against Insight Equity,

HPS or any members of the Board (as defined below).42 Despite this lack of inquiry and

investigation, the Debtors now propose to release a wide swath of claims and causes of action in

exchange for no value whatsoever. Highlighting the uncertainty of whether valuable causes of

action are being released under the Plan is the fact that Mr. Davis curiously testified that the Plan

is not releasing Insight Equity, directors and officers, or any other parties related to the June 2019

berm breach until the Special Restructuring Committee completes its investigation into the berm

breach.43 Yet, that is contrary to the release provisions of the Plan, which contain no such

exception.

72. To justify the Debtor Releases of HPS, the Committee anticipates that the Debtors

will argue that HPS provided a “substantial contribution” to these Chapter 11 Cases by way of the

DIP Facility. This argument misses the mark because this supposed “contribution” is not a

contribution at all. Indeed, in exchange for this “contribution,” and in addition to the proposed

42 See Transier Depo. Tr. 113:20-114:11, 119:10-125:25; Davis Depo. Tr. 258:19-265:7, 275:14-24.

43 Davis Depo. Tr. 262:11-266:13; 281:14-283:7.


36

releases by the Debtors (and many other lender-favorable protections), HPS is slated to receive,

among other things, repayment of all indebtedness incurred under the DIP Facility, including

substantial fees, interest, and approximately $39 million in amounts rolled-up from the Prepetition

Credit Agreement, by way of the proceeds derived from the Exit Facility. Such a result cannot be

described as a “substantial contribution,” or any contribution, that warrants a broad sweeping

release. Instead, it is more appropriately characterized as a calculated investment to achieve HPS’s

ultimate endgame of owning the Reorganized Debtors while also receiving millions of dollars in

fees related to the DIP Facility, payment of all of its legal fees, a creeping roll up of the Revolving

Loan and interest on the Revolving Loan.

73. The Debtors also fail to explain why Insight Equity, which wholly owns the general

partner, Emerge Energy Services GP LLC (the “General Partner”), should receive a Debtor

Release (let alone a distribution under the Plan). With respect to the Debtor Release, Insight Equity

cannot be said to have made a substantial contribution to the Debtors and these Chapter 11 Cases.

Pursuant to the RSA, the General Partner delegated the power and authority related to the

management and control of the Debtors to the Board of Directors of the General Partner (the

“Board”). Subsequently, the Board executed a Voting and Standstill Agreement and Voting Proxy

abdicating the Board’s powers, including all control and decision-making authority for the Debtors

in its restructuring and these Chapter 11 Cases, to the Special Restructuring Committee in

accordance with the Amended and Restated Charter for the Special Restructuring Committee.44

Insight Equity agreed to the abdication of the Board’s powers to the Special Restructuring

Committee in order to complete the transactions contemplated under the RSA, including the

44 The RSA with the Voting and Standstill Agreement, Voting Proxy, and Amended and Restated Charter for the Special Restructuring Committee dated April 18, 2019, attached to the Posner Decl. as Exhibit BB.


37

distribution of the Debtors’ equity to HPS (and potentially warrants to itself). Indeed, a member

of the Special Restructuring Committee

45 Against this context, it is clear that Insight Equity’s

contribution to these cases was for the benefit of HPS and itself. Such a contribution is not

sufficient for a third party release in favor of Insight Equity and sets a dangerous precedent that

“out of the money” equity sponsors can receive plan releases for what is essentially just agreeing

to get out of the secured lender’s way.

74. With respect to the proposed releases for current and former directors and officers,

not only did such parties fail to provide any discernable contribution to warrant the broad releases

contained in the Plan, but certain of those directors and officers may be rewarded by the New

Management Incentive Plan. Wash. Mut., 442 B.R. at 354 (“[T]here is no basis for granting third

party releases of the Debtors’ officers and directors , . . . . [as] [t]he only ‘contribution’ made by

them was in the negotiation of the Global Settlement and the Plan, [which] activities are nothing

more than what is required of directors and officers of debtors in possession (for which they have

received compensation and will be exculpated) . . . .”); see also In re Aegean Marine Petroleum

Network, Inc., 599 B.R. 717, 728-29 (Bankr. S.D.N.Y. 2019) (Wiles, J.) (“I am sure that [the

officers and directors of non-bankrupt companies] would also like to dispose of potential litigation

claims against them as a reward for the work that they have done. But that is not recognized as a

ground on which to terminate litigation claims outside of bankruptcy. There is no reason why it

should constitute an excuse to terminate litigation claims just because a company is emerging from

bankruptcy . . . the directors did what they were paid to do, and that does not mean they are entitled

45 Davis Depo. Tr. 256:13-15.


38

to releases of third-party claims, particularly when those releases really are not necessary or

important to the accomplishment of the restructuring transactions.”); see In re Boomerang Tube,

Inc., 548 B.R. 69 (Bankr D. Del. 2016), H’rg Tr. at 9:16–9:19 (“The Court concludes that simply

negotiating a plan is not a sufficient substantial contribution by a director and officer, such as to

warrant a release.”).

75. Put simply, there are no facts present here to support that Released Parties provided

a substantial contribution that warrants a proposed Debtor Release. Furthermore, the Debtor

Releases also fall short of the five-factor test in that the Plan does not pay substantially all of the

claims of Class 6 creditors, or anything remotely close to it. In fact, if Class 6 votes to reject the

Plan, the Plan proposes to pay unsecured creditors nothing and the Debtor Releases will still remain

intact. Furthermore, it remains to be seen if a substantial majority of creditors voted to accept the

Plan and the Debtor Releases contained therein. For these reasons, the proposed Debtor Releases

are impermissible and cause the Plan to be unconfirmable as a matter of law.

B. The Non-Consensual Third-Party Releases are Impermissible

76. Although the Third Circuit has not adopted a per se rule that nonconsensual third-

party releases are impermissible, it has made clear that such releases are proper only in

extraordinary cases. In re Cont’l Airlines, 203 F.3d 203, 212 (3d Cir. 2000) (concluding that third-

party releases are valid only in “extraordinary” circumstances); see also In re Genesis Health

Ventures, Inc., 266 B.R. at 608 (interpreting Continental’s holding on non-debtor releases to mean

that, “limiting the liability of non-debtor parties is a rare thing that should not be considered absent

a showing of exceptional circumstances in which several key factors are present”) (emphasis

added) (citation omitted). Recently, the Bankruptcy Court for the Southern District of New York

reiterated “just how extraordinary a thing it is” to impose involuntary releases, noting that

bankruptcy courts “should do so only in those extraordinary cases where a particular release is


39

essential and integral to the reorganization itself.” In re Aegean Marine Petroleum Network, Inc.,

599 B.R. at 727 (“Getting a release may be a comfort the parties would like to have, but releases

are not supposed to be imposed involuntarily just to make people feel better.”). These Chapter 11

Cases are not reflective of such rare or extraordinary cases.

77. In the Third Circuit, the Debtors must satisfy the Continental standard for the Court

to approve the nonconsensual Third Party Releases sought by the Debtors through the Plan. In

general, to determine whether nonconsensual third party releases are appropriate, the Court in

Continental and its progeny have looked to certain “hallmarks”: “fairness, necessity to the

reorganization, and specific factual findings to support these conclusions.” 203 F.3d at 214-15

(noting that the debtors had failed to show the necessity of the injunction where they had not

demonstrated that the success of the reorganization hinged in any way on the issuance of the

injunction). Factors courts have considered when determining to approve nonconsensual third

party releases are: (i) whether the releases “were given in exchange for reasonable consideration”;

(ii) whether the success of a debtor’s reorganization bears a relationship to the release and

permanent injunctions; and (iii) whether the non-debtors “provided a critical financial contribution

to the” debtor’s plan “that was necessary to make the plan feasible in exchange for receiving a

release of liability.” Id.; see also In re W.R. Grace & Co., 475 B.R. 34 (D. Del. 2012) (“in order

for a reorganization plan that includes an injunction barring third-party claims against non-debtors

to be approved, the injunction must be “both necessary to the reorganization and fair” under 11

U.S.C. § 105(a)); accord In re Glob. Indus. Techs., Inc., 645 F.3d 201, 206 (3d Cir. 2011) (quoting

Cont’l Airlines) (nonconsensual releases permitted in exceptional circumstances when adequate

record in support was developed); In re Prussia Assoc., 322 B.R. 572, 596 (Bankr. E.D. Pa. 2005)

(citing Cont’l Airlines); In re Exide Tech., 303 B.R. at 72 (same); see also In re Genesis Health


40

Ventures, Inc., 266. B.R. at 608 (finding that nonconsensual third party release was a “rare thing”

that should only be considered in exceptional circumstances); In re Spansion, Inc., 426 B.R. 114

(Bankr. D. Del. 2010) (finding that third party releases of claims held by parties who are receiving

no contribution under the plan is not appropriate).

78. Section X.B.2 of the Plan provides third party releases of the Debtors, HPS, Insight

Equity, the Debtors’ current and former directors and officers, and a litany of other third parties.

The effect of the third-party releases is to improperly insulate not only the Debtors, but HPS and

Insight Equity from any and all prepetition causes of action. Yet, as discussed above, the Debtors

provide little analysis as to why these chapter 11 cases are extraordinary such that they require

broad sweeping third party releases. The absence of any real disclosure leads to the inescapable

conclusion that such a showing cannot be made. Indeed, the Committee is hard pressed to think

of how the Debtors’ current or former directors, officers, and managers were essential to the

Debtors’ reorganization so as to receive a third party release. As recognized in Spansion, efforts

by a debtors’ directors and officers in planning and negotiating the plan do not “rise to the level of

the ‘critical financial contribution’ contemplated in Continental and Genesis that is needed to

obtain approval of non-consensual releases.” Spansion, 426 B.R. at 145. The same also rings true

for Insight Equity and HPS, as these parties have not demonstrated an identity of interest between

them and the Debtors or made any “substantial contribution” to these cases. Cf. Millennium Lab

Holdings II, LLC, Case No. 15-12284 (LSS), Hr’g Tr. 16:12-26:8 (Bankr. D. Del. Dec. 11, 2015)

(demonstrating an identity of interest through indemnification and advancement obligations and

providing substantial contributions in the form of, among other things, a $325 million payment).

79. Put simply, the facts of these cases do not warrant approval of the nonconsensual

Third Party Releases requested in the Plan, and the Debtors cannot carry their burden to


41

demonstrate that these releases satisfy the standards set forth in Continental. Accordingly, the

Third Party Releases contravene applicable law and should be excised entirely from the Plan.

80. The Debtors will likely argue that the Third Party Releases are “consensual” due to

the opt-out election on the ballot and urge this Court to follow Judge Shannon’s ruling in

Indianapolis Downs. See In re Indianapolis Downs, LLC, 486 B.R. 286 (Bankr. D. Del. 2013).

However, Indianapolis Downs is distinguishable to these cases because the Debtors here have

proposed a death trap for creditors who will relinquish any recovery if they vote against the Plan.

Moreover, in Wash. Mut., Judge Walrath held, and cited several cases that stood for the

proposition, that the Court “does not have the power to grant a third party release of a non-debtor.”

In re Wash. Mut., Inc., 442 B.R at 352. As is discussed at length above, and as will be demonstrated

at the Confirmation Hearing, unsecured creditors are, in fact, “in the money” despite the Disclosure

Statement and Plan stating otherwise. However, because the Plan is premised on unsecured

creditors receiving a de minimis recovery or no recovery, creditors have no incentive to pay postage

to vote on the Plan, let alone opt-out of the Third Party Releases. For these same reasons, it is also

unfair for unsecured creditors who abstain from voting to be deemed to consent to the third party

releases. The woeful facts laid out in the Disclosure Statement and Plan combined with the lack

of incentive to participate is exactly what the Debtors (and all of the Released Parties) are counting

on. Under these facts, it is unfair to force creditors to affirmatively opt-out of the Third Party

Releases.

81. Based on the foregoing, the Committee submits that the proposed nonconsensual

third party releases contravene applicable law and render the Plan unconfirmable.


42

V. The Exculpation Provision in the Plan Exceeds the Scope of Section 1125(e) of the Bankruptcy Code

82. Section X.E of the Plan provides that the Released Parties will be exculpated from

liability for, in relevant part:

any claims, Causes of Action or Released and Settled Claim arising prior to or on the Effective Date for any act taken or omitted to be taken in connection with, or related to, formulating, negotiating, preparing, disseminating, implementing, administering, confirming or effecting the Confirmation or Consummation of this Plan, the Disclosure Statement, the Restructuring Documents or any contract, instrument, release or other agreement or document created or entered into in connection with this Plan, including the Restructuring Support Agreement, or any other prepetition or postpetition act taken or omitted to be taken in connection with or in contemplation of the restructuring of the Debtors, the approval of the Disclosure Statement or Confirmation or Consummation of this Plan

Plan § X.E.

83. The Plan’s exculpation provision is inconsistent with applicable law in this District

because it includes parties other than the estate fiduciaries. See In re Indianapolis Downs, LLC,

486 B.R. at 306 (“The Exculpations under the Plan as modified and filed with the Court are limited

so as to apply only to estate fiduciaries. The Third Circuit has held that ‘a creditors’ committee, its

members, and estate professionals may be exculpated under a plan for their actions in the

bankruptcy case except for willful misconduct or gross negligence.’” (citations omitted)); see also

In re Wash. Mut., Inc., 442 B.R. at 350-51 (limiting exculpation clause to estate fiduciaries who

have served during the chapter 11 proceeding: estate professionals, the committee and their

members, and the debtors’ directors and officers); In re Tribune, 464 B.R. 126, 189 (Bankr. D.

Del. 2011) (same); In re PTL Holdings LLC, No. 11-12676 (BLS), 2011 WL 5509031, at *11-12

(Bankr. D. Del. Nov. 10, 2011) (holding exculpation “must be reeled in to include only those

parties who have acted as estate fiduciaries and their professionals”).

84. Even worse, the Plan’s exculpation provision is in direct contravention of this

Court’s specific instructions regarding same. See Disclosure Statement Hr’g Tr. 91:5–15, Sept. 9,


43

2019 [D.I. 248] (“With respect to the exculpation, I will preview my thoughts on that. I think it’s

very clear what the district requires. Non-estate fiduciaries in this district are not entitled to get

exculpation, so you can either proceed soliciting with what you have in the plan or you can just

scale it back -- essentially scale it back now or scale it back later, but it’s going to be scaled back.”).

The Debtors’ refusal to entertain this Court’s specific instructions regarding certain Plan

provisions highlights the “by any means necessary” approach the Debtors and HPS are taking in

confirming the Plan.

85. Thus, unless all entities or persons that are not estate fiduciaries are removed from

the exculpation provision, it violates the Bankruptcy Code, and the Plan cannot be confirmed.

VI. Additional Confirmation Objections

86. In addition to the concerns raised above, the following additional provisions are

objectionable and should not be approved as part of the proposed Plan:

• Avoidance Actions: The Plan provides that the Reorganized Debtors will retain all Causes of Action, including Avoidance Actions, and shall have the exclusive right to enforce, sue on, settle, compromise, transfer or assign such actions. Plan § X.F. Avoidance powers are intended to allow a debtor-in possession or a trustee to recover certain payments for the benefit of unsecured creditors. Avoidance Actions should not be pursued for the exclusive benefit of a secured creditor. Accordingly, such actions should be transferred to a trust and preserved for the benefit of unsecured creditors. See Buncher Co. v. Official Comm. of Unsecured Creditors of GenFarm Ltd. P’ship IV, 229 F.3d 245, 250 (3d Cir. 2000) (“when recovery is sought under section 544(b) of the Bankruptcy Code, any recovery is for the benefit of all unsecured creditors”).

• Dissolution of Creditors’ Committee: Section XII.R of the Plan provides that on the Effective Date, the Committee shall automatically dissolve and the Reorganized Debtors “shall not be responsible for paying any fees, costs or expenses incurred by the members, professionals, or advisors to any Committee after the Effective Date.” The Plan should provide that, notwithstanding the Committee’s dissolution, the Committee shall continue to exist and be compensated for: (i) fees and expenses incurred in connection with requests for payment of Professional Fee Claims and reimbursement of expenses of members of the Committee, including preparing, defending, objecting and attending any hearings related to such requests; and (ii) any appeals of the Confirmation Order or other appeal to which the Committee is a part.


44

• Disclosure of New Board Members: The Plan fails to satisfy the requirements of section 1129(a)(5) of the Bankruptcy Code, requiring, among other things, the disclosure of the identities and affiliations of any individual proposed to serve as a director, officer or voting trustee of the debtor. See 11 U.S.C. § 1129(a)(5). The Committee submits that the Debtors should disclose the identity and affiliations (and compensation, if appropriate) of all new Board Members at or prior to the Confirmation Hearing.

CONTESTED MATTER

87. Pursuant to Bankruptcy Rule 9014, confirmation of the Plan is a contested matter

and the Committee reserves all rights to seek discovery and present evidence at the Confirmation

Hearing.


88. The Committee reserves its rights to raise such other or further objections to the

Plan as may be necessary or appropriate at or prior to the Confirmation Hearing.

CONCLUSION

89. Based on the foregoing, the Committee respectfully requests that the Court enter an

order (i) denying confirmation of the Plan; and (ii) granting such other and further relief as the

Court deems just and proper.


45

Dated: October 15, 2019 Respectfully submitted, Wilmington, Delaware

POTTER ANDERSON & CORROON LLP /s/ Jeremy W. Ryan Jeremy W. Ryan (DE Bar No. 4057) Christopher M. Samis (DE Bar No. 4909) L. Katherine Good (DE Bar No. 5101) Aaron H. Stulman (DE Bar No. 5807) 1313 North Market Street, Sixth Floor P.O. Box 951 Wilmington, DE 19801 Telephone: (302) 984-6000 Facsimile: (302) 658-1192 Email: [email protected]

[email protected] [email protected] [email protected]

-and-

KILPATRICK TOWNSEND & STOCKTON LLP Todd C. Meyers (admitted pro hac vice) David M. Posner (admitted pro hac vice) Kelly Moynihan (admitted pro hac vice) The Grace Building 1114 Avenue of the Americas New York, NY 10036 Telephone: (212) 775-8700 Facsimile: (212) 775-8800 Email: [email protected]

[email protected] [email protected]

-and-

KILPATRICK TOWNSEND & STOCKTON LLP Lenard M. Parkins (admitted pro hac vice) 700 Louisiana Street, Suite 4300 Houston, TX 77002 Telephone: (281) 809-4100 Facsimile: (281) 929-0797 Email: [email protected]

Counsel to the Official Committee of Unsecured Creditors of Emerge Energy Services LP, et al.


In re: Trident Holding Company, LLC, et al.

Notice of Motion of the Official Committee of Unsecured Creditors

for Order Granting Leave, Standing and Authority to Commence

and Prosecute Certain Claims on Behalf of the Debtors’ Estates

Against Certain Silver Point, Audax and Ares Defendants

US2008 15558340 6

Hearing Date: June 27, 2019 at 1:00 p.m. (ET) Objection Deadline: June 10, 2019 at 4:00 p.m. (ET)

KILPATRICK TOWNSEND & STOCKTON LLP David M. Posner, Esq. Gianfranco Finizio, Esq. Kelly Moynihan, Esq. The Grace Building 1114 Avenue of the Americas New York, NY 10036-7703 Telephone: (212) 775-8700 Facsimile: (212) 775-8800 Counsel to the Official Committee of Unsecured Creditors of Trident Holding Company, LLC, et al. UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK In re: TRIDENT HOLDING COMPANY, LLC, et al.,

Debtors.1

::::::::

Chapter 11 Case No. 19-10384 (SHL)


MOTION OF THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS FOR

ORDER GRANTING LEAVE, STANDING AND AUTHORITY TO COMMENCE AND PROSECUTE CERTAIN CLAIMS ON BEHALF OF THE DEBTORS’ ESTATES

AGAINST CERTAIN SILVER POINT, AUDAX AND ARES DEFENDANTS The Official Committee of Unsecured Creditors (the “Committee”) of the debtors and

debtors-in-possession in the above-captioned cases (collectively, the “Debtors” or the

1 The Debtors in these chapter 11 cases, along with the last four digits of their respective tax identification numbers, are as follows: Trident Holding Company, LLC (6396); American Diagnostics Services, Inc. (2771); Community Mobile Diagnostics, LLC (9341); Community Mobile Ultrasound, LLC (3818); Diagnostic Labs Holdings, LLC (8024); FC Pioneer Holding Company, LLC (6683); JLMD Manager, LLC (8470); Kan-Di-Ki LLC (6100); Main Street Clinical Laboratory, Inc. (0907); MDX-MDL Holdings, LLC (2605); MetroStat Clinical Laboratory – Austin, Inc. (4366); MX Holdings, LLC (8869); MX USA, LLC (4885); New Trident Holdcorp, Inc. (4913); Rely Radiology Holdings, LLC (3284); Schryver Medical Sales and Marketing, LLC (9620); Symphony Diagnostic Services No. 1, LLC (8980); Trident Clinical Services Holdings, Inc. (6262); Trident Clinical Services Holdings, LLC (1255); TridentUSA Foot Care Services LLC (3787); TridentUSA Mobile Clinical Services, LLC (0334); TridentUSA Mobile Infusion Services, LLC (5173); and U.S. Lab & Radiology, Inc. (4988). The address of the Debtors’ corporate headquarters is 930 Ridgebrook Road, 3rd Floor, Sparks, MD 21152.

19-10384-shl Doc 482 Filed 06/03/19 Entered 06/03/19 18:54:59 Main Document Pg 5 of 55

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“Company,” as applicable), by and through its undersigned counsel, hereby submits this motion

(the “Motion”) seeking entry of an order authorizing the Committee to commence and prosecute

certain claims on behalf of the Debtors’ estates (the “Estate”) against certain Silver Point, Audax

and Ares defendants (the “Defendants”) more specifically identified below. In support of this

Motion, the Committee respectfully represents as follows:


1. The Committee requests entry of an order authorizing it to pursue the following

claims (the “Claims”) against the following defendants, all as set forth more fully in the draft

Complaint, a copy of which is attached hereto as Exhibit A:

DEFENDANT CLAIM ASSERTED PRIMARY STATUTORY AUTHORITY

SPCP Group, LLC (“Silver Point,” and, collectively with Silver Point Finance, LLC, the “Silver Point Defendants”)

Equitably subordinate Silver Point’s prepetition secured claim, and transfer the lien securing such subordinated claim to the Debtors’ estate, to the limited extent necessary to provide an $11.9 million distribution to the general unsecured creditors classified in Class 6 of the Debtors’ plan (exclusive of any other recoveries by Class 6)

11 U.S.C. § 510(c)

Audax Management Company (NY) LLC (“Audax Management (NY)”) and (i) Audax Credit Opportunities Offshore Ltd., (ii) Audax Senior Loan Fund SPV LLC, (iii) CMFG Life Insurance Company, and (iv) Trustees of the Estate of Bernice Pauahi Bishop dba Kamehameha Schools (Defendants ((i) through (iv) identified hereinafter, collectively, as the “Audax Debt Funds”)

Avoid and recover insider preferential payments totaling about $4.1 million

11 U.S.C. §§ 547 and 550


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DEFENDANT CLAIM ASSERTED PRIMARY STATUTORY AUTHORITY

Ares Capital Corporation (“Ares”) Avoid and recover fraudulent transfers totaling $400,000

11 U.S.C. §§ 548 and 550; and NY DCL §§ 273, 274, 275, 278 and 290

2. The Committee has investigated the Claims and reviewed close to 10,000

documents and applicable law. It has concluded that the Estate has valid causes of action against

the Defendants, and the Committee is prepared to prosecute such Claims on behalf of the Estate.

The Committee requests such authority because the Final DIP Financing Order contains

stipulations that will prevent the Debtors from pursuing such Claims, and the Final DIP

Financing Order contains a deadline for the Committee to seek to assert such Claims.

3. The Claims arise out of the Debtors’ recapitalization transaction that occurred in

April of 2018 (the “2018 Recap”).2 The 2018 Recap involved amending the Debtors’ existing

credit agreements. Those amendments required the consent of Holders of a majority in

outstanding principal amount of the Debtors’ Pre-Recap First Lien Debt. In an effort to obtain

those consents, Silver Point went beyond the legitimate exercise by a creditor of its rights under

the Debtors’ loan documents. It instead engaged in egregious overreaching. In particular, with

the Silver Point Defendants’ knowledge, participation, and acquiescence, a truncated, coercive

consent solicitation process with respect to the 2018 Recap was conducted, during which time

highly relevant information known to the Silver Point Defendants and the Debtors’ insiders was

deliberately withheld from lenders whose consent was needed for the 2018 Recap to occur.

Those lenders were also misled regarding the level of consent for the 2018 Recap that had been

obtained as of the commencement of the three-day solicitation period and the amount of liquidity 2 Other capitalized terms that are used herein but not defined have the meanings ascribed to such terms in the draft Complaint attached hereto as Exhibit A.


4 US2008 15558340 6

that would be provided by the recapitalization. The Silver Point Defendants’ overreaching

conduct conferred an unfair advantage on the Silver Point Defendants, enabling them, through

the effectuation of the 2018 Recap, among other things, to obtain the benefit of lucrative fees, to

impose an onerous make-whole obligation on the Debtors that would be triggered by a

bankruptcy that had only been postponed temporarily by the 2018 Recap, and to further enhance

their position in a bankruptcy that was highly likely to occur in the future notwithstanding the

execution of the 2018 Recap.

4. This conduct forestalled a timely bankruptcy filing by the Debtors, inducing the

Debtors’ vendors to worsen their position by increasing their exposure to the Debtors by $11.9

million during the period from April 30, 2018 to the Petition Date. The Silver Point Defendants’

overreaching conduct in connection with the 2018 Recap provides ample support for equitable

subordination of Silver Point’s prepetition secured claim to the claims of those vendors (which

are classified in Class 6 of the Debtors’ plan) and for the transfer of the liens securing Silver

Point’s prepetition claim to the Debtors’ estates, in each case, to the limited extent necessary to

provide a distribution of property of a value of $11.9 million to the Class 6 creditors (exclusive

of recoveries from unencumbered assets).

5. As to the avoidance claims the Committee seeks standing to bring, in connection

with the 2018 Recap, the Audax Debt Funds, who are insiders of the Debtors, received payments

from the Debtors in the approximate amount of $4.1 million on account of antecedent debt at a

time when the Debtors were insolvent. In addition, Ares received a fraudulent transfer in the

amount of $400,000 to obtain its consent to the 2018 Recap after it was provided with highly

relevant financial information about the Debtors that was withheld (with the exception of Silver

Point and the Audax Debt Funds) from the other holders (the “Holders”) of Pre-Recap First Lien


5 US2008 15558340 6

Debt. The facts surrounding the Audax Transfers and the Ares Transfer provide ample support

for the avoidance claims the Committee seeks standing to bring.

6. The Committee satisfies the legal requirements for granting the Committee

standing to pursue the Claims against the Defendants. The Committee presents colorable

Claims, and the Debtors waived their right to pursue the Claims under the Final DIP Financing

Order. Accordingly, the Committee should be granted standing to pursue the Claims.

JURISDICTION AND VENUE

7. This Court has jurisdiction to consider this matter pursuant to 28 U.S.C. §§ 157

and 1334. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2). Venue is proper in this

District pursuant to 28 U.S.C. §§ 1408 and 1409. The statutory predicates for the relief

requested herein are §§ 105, 510(c), 544(b), 547, 548, 550, 551 and 1109 of title 11 of the United

States Code (the “Bankruptcy Code”).

BACKGROUND

8. On February 10, 2019, (the “Petition Date”), the Debtors each filed a voluntary

petition for relief (the “Chapter 11 Cases”) under chapter 11 of the Bankruptcy Code.

9. The Debtors continue to operate their businesses as debtors-in-possession

pursuant to sections 1107 and 1108 of the Bankruptcy Code. No trustee or examiner has been

appointed in the chapter 11 cases. The Debtors’ chapter 11 cases are jointly administered and

have been consolidated for procedural purposes only.

10. On February 20, 2019, the Office of the United States Trustee for the Southern

District of New York appointed the Committee. The members of the Committee are: (i)

McKesson Corporation; (ii) Quest Diagnostics; (iii) BioMerieux, Inc.; (iv) TIS International

(USA), Inc., d/b/a Infinx Healthcare; and (v) First Source, Inc.


6 US2008 15558340 6

11. On March 8, 2019, this Court entered the “Final Order (I) Authorizing Debtors

(A) to Obtain Postpetition Financing Pursuant to 11 U.S.C. §§ 105, 361, 362, 363, and 364 and

(B) to Utilize Cash Collateral Pursuant to 11 U.S.C. § 363, and (II) Granting Adequate

Protection to Prepetition Secured Parties Pursuant to 11 U.S.C. §§ 361, 362, 363, 364 and

507(b)” [ECF No. 166] (the “Final DIP Financing Order”).

12. Pursuant to the terms of the Final DIP Financing Order including Paragraph 18

therein, any adversary proceeding or contested matter objecting to or challenging the amount,

validity, perfection, enforceability, priority or extent of the Prepetition Debt or the Prepetition

Liens, or (B) otherwise asserting or prosecuting any action for preferences, fraudulent transfers

or conveyances, other avoidance power claims or any other claims, counterclaims or causes of

action, objections, contests or defenses against a Prepetition Secured Party or their

Representative in connection with matters related to the Existing Agreements, the Prepetition

Debt, the Prepetition Liens, and the Prepetition Collateral must be brought no later than, in the

case of the Committee, 85 calendar days after the entry of the Final DIP Financing Order, with

such period automatically tolled upon the filing of a standing motion.3

13. The Final DIP Financing Order provides that, as to the Debtors, the Debtors’

stipulations, admissions, agreements and releases contained in the Final DIP Financing Order

shall be binding upon the Debtors in all circumstances and for all purposes. Id. at ¶18.

14. By letter dated May 24, 2019 (the “Demand Letter”), the Committee demanded

that the Debtors assert such Claims. The Debtors have responded that they do not intend to

assert them. The Committee files this motion in order to meet the challenge deadline set forth in

the Final DIP Financing Order and preserve the Claims.

3 Defined terms used but not defined in this paragraph shall have the meanings ascribed to such terms in the Final DIP Financing Order.


7 US2008 15558340 6

RELIEF REQUESTED

15. The Committee is seeking permission from this Court to pursue the Claims

against the Defendants. Since these Claims are colorable and the Debtors have unjustifiably

refused to pursue them, the Court should grant derivative standing to the Committee to

commence and prosecute the Claims.

ARGUMENT

A. Legal Standard for Derivative Standing

16. “The practice of authorizing the prosecution of actions on behalf of an estate by

committees, and even by individual creditors, upon a showing that such is in the interests of the

estate, is one of long standing, and nearly universally recognized.” In re Adelphia Commc’ns

Corp., 330 B.R. 364, 373 (Bankr. S.D.N.Y. 2005); see also In re Cybergenics Corp., 330 F.3d

548, 568 (3d Cir. 2003) (recognizing that a “straightforward application” of a bankruptcy court’s

equitable powers allows for a grant of derivative standing upon creditors’ committees to assert

causes of action on behalf of, and for the benefit of, the debtor’s estate); La. World Exposition v.

Fed. Ins. Co., 858 F.2d 233, 247 (5th Cir. 1988) (similar); Neb. State Bank v. Jones, 846 F.2d

477, 478 (8th Cir. 1988) (similar).

17. In order to be granted derivative standing in the Second Circuit, a creditors’

committee must (a) “present[] a colorable claim or claims for relief that on appropriate proof

would support a recovery,” and (ii) demonstrate that the debtor “unjustifiably failed to bring

suit.” In re STN Enters., 779 F.2d 901, 905 (2d Cir. 1985); see also In re Applied Theory Corp.,

493 F.3d 82 (2d Cir. 2007).

18. A colorable claim is one “that on appropriate proof would support a recovery.”

STN, 779 F.2d at 905. The standard for presenting a “colorable” claim is a “relatively easy one


8 US2008 15558340 6

to meet,” and is satisfied where the proposed litigation will not be a “hopeless fling.” Adelphia,

330 B.R. at 376, 386; see also In re America’s Hobby Ctr., Inc., 223 B.R. 275, 288 (Bankr.

S.D.N.Y. 1998) (standing should be denied only if claim is “facially defective”); In re Colfor,

Inc., No. 96-60306, 1998 Bankr. LEXIS 158, at *7 (Bankr. N.D. Ohio Jan. 5, 1998) (a

“colorable” claim is one which is “plausible” or “not without some merit”).

19. A debtor’s refusal to bring suit is unjustifiable when bringing suit would be likely

to benefit the reorganization estate, after taking account of any associated costs or delays. STN,

779 F.2d at 905.

20. Both factors are satisfied here, and the Committee’s motion, it respectfully

submits, should be granted.

B. The Committee Has Identified Colorable Claims

21. The first factor in determining whether to grant the Committee standing to bring

the Claims is whether the Committee has identified colorable claims. The Complaint identifies

three categories of claims that satisfy the minimum standard needed to state a colorable claim.

As noted above, a colorable claim is a “plausible claim,” Colfor, 1998 Bankr. LEXIS at *7, and

the standard for effectively asserting a colorable claim is a “relatively easy one to meet.”

Adelphia, 330 B.R. at 376. Standing should be denied only if the claim is “facially defective.”

America’s Hobby, 223 B.R. at 288.

22. The first category of claims asserted in the Complaint is against the Silver Point

Defendants. The Claim in this category is a measured one that seeks limited equitable

subordination pursuant to Section 510(c) of the Bankruptcy Code of Silver Point’s prepetition

secured claim to the claims of the Class 6 creditors and transfer to the Estate of the liens that

secure that claim, only to the extent necessary to provide a distribution to the Class 6 creditors of


9 US2008 15558340 6

property of a value of $11.9 million. The limited subordination sought is proportionate to the

harm suffered by the Debtors’ trade creditors as a result of the improvident postponement of the

filing of the Chapter 11 Cases that resulted from the effectuation of the 2018 Recap. If a timely

chapter 11 filing had instead occurred, the trade creditors would not have been induced to

increase their exposure to the Debtors by $11.9 million by continuing to extend prepetition credit

during the period between April 30, 2018 and the Petition Date, $11.9 million regarding which

they are slated to receive no recovery under the plan.

23. Equitable subordination of the claim of a non-insider creditor requires a finding of

“substantial misconduct tantamount to fraud, misrepresentation, overreaching or spoilation.” In

re Aeropostale, Inc., 555 B.R. 369, 409 (Bankr. S.D. N.Y. 2016) (citations omitted). Notably,

overreaching is an independent ground for equitably subordinating a non-insider’s claim, and it

is unnecessary to prove fraudulent conduct to sustain an equitable subordination claim against a

non-insider. Here, the Silver Point Defendants engaged in egregious overreaching that extended

well beyond the exercise of their rights under the Pre-Recap First Lien Credit Agreement and

foisted injury on the Debtors’ trade creditors.

24. The Silver Point Defendants’ overreaching conduct in connection with the 2018

Recap is described more fully in the Complaint. It included active participation in a process that

was intended to coerce Holders into consenting to that transaction without the benefit of highly

relevant information about the Company’s financial condition and the amount of additional

liquidity that would be provided by the transaction.

25. In particular, every effort was made by the proponents of the 2018 Recap,

including the Silver Point Defendants, to structure the consent solicitation process to eliminate

the opportunity to organize opposition to the recapitalization. The consent solicitation period


10 US2008 15558340 6

was limited to three (3) days, during which the solicited Holders were told, at the outset, that

49% of the Pre-Recap First Lien Debt already had signified acceptance, thereby intimating that

opposition would be futile. This representation was not true, and, on information and belief, the

Silver Point Defendants knew that it was not true.

26. In addition, during the consent solicitation period, the Holders were presented

with projections, including about the Company’s financial performance in March 2018, without

providing them with readily available information about the Company’s actual performance in

March 2018 that had been provided to Silver Point as soon as it had become available. The

information about actual March 2018 performance revealed that the Company’s operational

EBITDA for that month fell short of projections by 31.6% and that cash on hand at the end of

March was 50% less than had been projected in the information provided to the Holders. As

described more fully in the Complaint, this highly relevant information was deliberately withheld

from the Holders, who were in the process of deciding whether to consent to the 2018 Recap. On

information and belief, the Silver Point Defendants were aware that this information was being

withheld from the Holders and concurred in that course of conduct.

27. Further, after trading in the Pre-Recap First Lien Debt had been frozen by the

agent during the consent solicitation period, and before the 50.01% consent threshold had been

reached, Silver Point agreed to purchase the claim of a Holder whose consent would be sufficient

to nudge the recap ball over the goal line, conditioned on the Holder’s agreement to consent to

the recapitalization before the April 27, 2018 deadline. Silver Point obtained an unfair advantage

in connection with that purchase because it was markedly better informed about the Company

than (with the exception of the Audax defendants and Ares) the other Holders. News of Silver


11 US2008 15558340 6

Point’s acquisition of this claim signaled to the hold-outs that further opposition was futile,

resulting in a cascade of additional consents.

28. The conduct of the Silver Point Defendants described above, and more fully in the

Complaint, constituted egregious overreaching by, among other things, fostering a climate of

misinformation within which the consent solicitation process took place. This misconduct

allowed the Silver Point Defendants to obtain an unfair advantage over the Company’s other

stakeholders. It contributed substantially to the Company obtaining the consents required for the

2018 Recap to be effectuated. That transaction simply slowed the Company’s slide into

bankruptcy and induced the Company’s vendors to increase their exposure to the Company to

their substantial detriment.

29. The equitable subordination Claim articulated by the Committee is a measured

response to the overreaching, inequitable misconduct of the Silver Point Defendants. It seeks

equitable subordination only to the extent necessary to remedy the injury suffered by the Class 6

creditors as a result of the 2018 Recap, in the consummation of which the Silver Point

Defendant’s overreaching conduct played an integral role. This equitable subordination claim is

a colorable claim.

30. The second category of claims asserted in the Complaint is against Ares. This

Claim seeks to set aside, as a fraudulent transfer or conveyance, under section 548 of the

Bankruptcy Code and applicable New York fraudulent conveyance law, a $400,000 payment

made by the Company to Ares in connection with the 2018 Recap. The Complaint alleges that

the payment was made to purchase Ares’ consent, as a Holder, to the Recap and its agreement to

deliver the consent of another Holder, with which it had influence.


12 US2008 15558340 6

31. The Complaint further alleges that the Debtors were insolvent when the payment

to Ares was made and that the Debtors did not receive reasonably equivalent value or fair

consideration in exchange for the payment. Notably, good faith is an element of fair

consideration under New York’s Uniform Fraudulent Conveyance Act. At a bare minimum, the

$400,000 payment to Ares was neither made nor received in good faith. The Claim against Ares

is a colorable claim.

32. The third category of claims asserted in the Complaint is against the Audax Debt

Funds.4 This claim seeks to avoid, under section 547 of the Bankruptcy Code, approximately

$4.1 million of insider preference payments made to the Audax Debt Funds in connection with

the 2018 Recap (which occurred within one year before the Petition Date) and to recover those

payments or their value from the Audax Debt Funds under section 550 of the Bankruptcy Code.

The Audax Debt Funds were Holders of Pre-Recap First Lien Debt. As part of the 2018 Recap,

Holders of Pre-Recap First Lien Debt that consented to the 2018 Recap were entitled to a pro-

rata share of a $50 Million Pay Down of that debt. The Audax Debt Funds received

approximately $4.1 million (the “Audax Transfers”) as part of the $50 Million Pay Down on this

antecedent debt. The Complaint alleges that the Debtors were insolvent when the Audax

Transfers were made and that these payments enabled the Audax Debt Funds to receive more

than they would receive in a chapter 7 case of the Company if these payments had not been

made.

4 A claim is also asserted in the Complaint against Audax Management (NY) to the extent, if any, it was an initial transferee of the transfers sought to be avoided as to the Audax Debt Funds or an entity for whose benefit the transfers were made, or an immediate or mediate transferee of those transfers.


13 US2008 15558340 6

33. The Audax Debt Funds are insiders of the Debtors on account of their close

relationship with Audax Management Company, LLC5 (“AMC”) and/or private equity funds it

manages (collectively, with AMC, “Audax Sponsor”) and the difference in treatment received by

the Audax Debt Funds because of that relationship. Audax Sponsor was and is an equity sponsor

of the Debtors’ ultimate parent, Debtor FC Pioneer. At all times relevant to the Claim against

the Audax Debt Funds, Audax Sponsor controlled a seat on FC Pioneer’s governing board, and

one of its senior employees occupied that seat as a representative of Audax Sponsor. On

information and belief, that employee also served as a managing agent of FC Pioneer. On

information and belief, Audax Sponsor shared confidential information about the Debtors with

its affiliate, Audax Management (NY). Audax Management (NY) represented the interests of

the Audax Debt Funds in their respective capacities as Holders, and had the authority to consent,

on their behalf, to the 2018 Recap.

34. Audax Sponsor is an insider of the Debtors because Audax Sponsor would be

deemed a director and/or managing agent of the Debtors under the deputization doctrine, as

articulated in Feder v. Martin Marietta Corp., 406 F.2d 260 (2d Cir. 1969). Furthermore,

regardless of whether Audax Sponsor owned with power to vote 20% or more of the outstanding

voting securities of FC Pioneer, it had the same access to confidential information about the

Company as if it were a 20% owner.

35. On April 30, 2018, the date on which the Audax Transfers were made, Audax

Sponsor and Audax Management (NY), which managed the Audax Debt Funds, operated

together as a single advisory business and generally shared common owners, officers, partners,

5 Audax Management Company, LLC is an entity different from Audax Management (NY), though they are closely affiliated. See Objection of Audax Management Company, LLC to the Existing First Lien Agent’s Motion for Entry of an Order Authorizing Document Discovery Pursuant to Bankruptcy Rule 2004, filed March 14, 2019 [ECF No. 200] at 1 n. 2.


14 US2008 15558340 6

employees, consultants and other persons occupying similar positions. Audax Sponsor arranged

for employees of Audax Management (NY), who managed the Audax Debt Funds, to meet with

the Debtors’ investment banker to receive information about the contemplated recapitalization

transaction, on information and belief, well before information about the contemplated

transaction was provided to the other Holders (other than Silver Point). Moreover, the Audax

Debt Funds, unlike other Holders that desired early access to information, were not required to

sign nondisclosure agreements to obtain information about the contemplated transaction.

36. In short, because of, inter alia, the closeness of the Audax Debt Funds’

relationship with Audax Sponsor, which resembled the relationship between a director and its

relative (see 11 U.S.C. § 101(31)(B)(vi)), the Audax Debt Funds were treated by the Debtors as

an insider would be treated; i.e., more favorably than the non-insider Holders other than Silver

Point. These facts establish, at a minimum, a colorable claim that the Audax Debt Funds were

insiders of the Debtors and, therefore, subject to the one-year reach-back period under section

547(b) of the Bankruptcy Code. Accordingly, the Complaint alleges colorable preference claims

against the Audax Debt Funds and against Audax Management (NY) to the extent, if any, it was

the initial transferee of the Audax Transfers or an entity for whose benefit those transfers were

made, or an immediate or mediate transferee of those transfers.

37. In sum, the Committee has set forth in the Complaint colorable Claims and should

be granted standing to assert and prosecute such Claims.

C. The Debtors Waived their Right to Bring the Claims Constituting Unjustifiable Refusal

38. The second factor in determining whether to grant the Committee standing is

whether the Debtors unjustifiably failed to bring the Claims. Here, the Committee asserts that


15 US2008 15558340 6

that factor is per se satisfied because the Debtors waived their right to bring the Claims pursuant

to the provisions of the Final DIP Financing Order.

39. The Final DIP Financing Order includes stipulations and releases by the Debtors

that prevent the Debtors from asserting the Claims. For example, the Final DIP Financing Order

provides that the Debtors release the Prepetition Secured Parties and their respective

Representatives from any and all claims related to the relevant loan agreements, the obligations

owing thereunder, the negotiation thereof, and the transactions reflected thereby. [ECF No. 166

at ¶5(j)]. Subject to a challenge as set forth in the Final DIP Financing Order, the Debtors have

released the Claims against the Defendants.

40. In addition, the Final DIP Financing Order contains various stipulations of the

Debtors as to the validity, extent and priority of the Silver Point Defendants’ liens and claims.

[Id. at ¶5]. These stipulations contradict the Claims, and effectively prevent the Debtors from

asserting the Claims.

41. Nevertheless, the Committee sent the Demand Letter to the Debtors. In it, the

Committee demanded that the Debtors’ assert the Claims. The Debtors have responded that they

do not intend to assert the Claims.

42. The Debtors waiver of such Claims, and refusal to bring such Claims, constitutes

the Debtors’ unjustifiable failure to bring such Claims, as the Claims are likely to benefit the

Debtors’ estates, after taking account of any associated costs or delays. The Committee has

satisfied the second factor of the test to grant the Committee standing to bring such Claims.


43. The Committee reserves its right to seek authority to commence and prosecute

other claims and/or causes of action against the Defendants on behalf of the Debtors’ estates.


16 US2008 15558340 6

NOTICE

44. This Motion was served on: (i) the Office of the United States Trustee for the

Southern District of New York; (ii) the Debtors; (iii) counsel to the Debtors; (iv) counsel to the

administrative agent under the Debtors’ Prepetition Priority First Lien Facility and DIP Facility;

(v) counsel to the administrative agent under the Debtors’ Prepetition First Lien Facility; (vi)

counsel to counsel to the administrative agent under the Debtors’ Prepetition Second Lien

Facility; (vii) counsel to the investor representative under the Tranched PIK Notes; (viii) counsel

to the investor representative under the Original PIK Note Facility; (ix) the U.S. Attorney for the

Southern District of New York; (x) the Internal Revenue Service; (xi) known counsel to the

named Defendants; and (xii) all parties entitled to notice pursuant to Bankruptcy Rule 2002.

NO PRIOR REQUEST

45. No prior request for the relief sought in this Motion has been made to this or any

other court in connection with these chapter 11 cases.

[Remainder of Page Intentionally Left Blank]


17 US2008 15558340 6

CONCLUSION

WHEREFORE, the Committee respectfully requests that the Court enter an order: (i)

substantially in the form attached hereto as Exhibit B, granting the Committee standing to

commence and prosecute the Claims on behalf of the Debtors’ estate; and (ii) grant such

additional relief as the Court may deem just, proper and equitable

Dated: June 3, 2019 /s/ David M. Posner

KILPATRICK TOWNSEND & STOCKTON LLP David M. Posner, Esq. Gianfranco Finizio, Esq. Kelly Moynihan, Esq. The Grace Building 1114 Avenue of the Americas New York, New York 10036-7703 Telephone: (212) 775-8700 Facsimile: (212) 775-8800 Email: [email protected] [email protected] [email protected]

Counsel to the Official Committee of Unsecured Creditors of Trident Holding Company, LLC, et al.


In re: Le Tote, Inc., et al.

The Official Committee of Unsecured Creditors’ Omnibus (I) Objection to Debtors’ Motion for Entry of an Order

(A) Authorizing and Approving the HBC Settlement by and Among The Debtors and the HBC Secured Parties and (B) Granting Related

Relief and (II) Reply in Support of Motion for Entry of an Order Authorizing the Committee to Prosecute Certain Claims,

Challenges, and Causes of Action Related to The HBC Secured Parties

COOLEY LLP COOLEY LLP Cullen D. Speckhart (VSB 79096) Jay R. Indyke (admitted pro hac vice) Dana J. Moss (VSB 80095) Ian Shapiro (admitted pro hac vice) 1299 Pennsylvania Avenue, NW, Suite 700 Michael Klein (admitted pro hac vice) Washington, DC 20004-2400 Evan Lazerowitz (admitted pro hac vice) Telephone: (202) 842-7800 Paul Springer (admitted pro hac vice) Facsimile: (202) 842-7899 55 Hudson Yards New York, NY 10001 Telephone: (212) 479-6000 Facsimile: (212) 479-6275 Counsel to the Official Committee of Unsecured Creditors of Le Tote, Inc., et al.


FOR THE EASTERN DISTRICT OF VIRGINIA RICHMOND DIVISION

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - X

In re:

LE TOTE, INC., et al.1

Debtors.

: : : :

Chapter 11

Case No. 20-33332 (KLP)


- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - X

THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS’ OMNIBUS (I) OBJECTION TO DEBTORS’ MOTION FOR ENTRY OF AN ORDER

(A) AUTHORIZING AND APPROVING THE HBC SETTLEMENT BY AND AMONG THE DEBTORS AND THE HBC SECURED PARTIES AND (B) GRANTING RELATED

RELIEF AND (II) REPLY IN SUPPORT OF MOTION FOR ENTRY OF AN ORDER AUTHORIZING THE COMMITTEE TO PROSECUTE CERTAIN CLAIMS,

CHALLENGES, AND CAUSES OF ACTION RELATED TO THE HBC SECURED PARTIES

1 The Debtors in these chapter 11 cases, along with the last four digits of each Debtor’s federal tax identification number, are set forth in the Debtors’ Motion for Entry of an Order (I) Directing Joint Administration of Chapter 11 Cases and (II) Granting Related Relief filed August 2, 2020 [Docket No. 3]. The location of the Debtors’ service address is 250 Vesey Street, 22nd Floor, New York, New York 10281.

Case 20-33332-KLP Doc 844 Filed 01/26/21 Entered 01/26/21 16:35:09 Desc MainDocument Page 1 of 47

TABLE OF CONTENTS

Page

i

PRELIMINARY STATEMENT .................................................................................................... 1 BACKGROUND ............................................................................................................................ 6

A. General Background ............................................................................................... 6 B. Committee’s Standing Motion and Complaint Against the HBC Parties ............... 6 C. The Restructuring Committee’s Assessment of Claims Against HBC ................... 8 D. Negotiations Over the HBC Settlement ................................................................ 10 E. The HBC Settlement ............................................................................................. 11

ARGUMENT ................................................................................................................................ 12 I. THE 9019 MOTION SHOULD BE DENIED.................................................................. 12

A. The 9019 Motion Should be Subject to Heightened Scrutiny. ............................. 14 B. The HBC Settlement Fails to Satisfy the Four Factor Test Used in the

Fourth Circuit to Scrutinize Proposed Settlements. .............................................. 17 i. Probability of Success in Litigation. ......................................................... 17

1. Claims Deemed Colorable by Restructuring Committee.............. 17 2. Claims Deemed Not Colorable by Restructuring Committee. ...... 20

(a) The Acquisition as a Constructive Fraudulent Transfer. ............................................................................ 21

(b) Lien Challenges. ............................................................... 28 (c) Additional Claims. ............................................................ 30

3. The HBC Settlement Settles the HBC Causes of Action for Insufficient Consideration. ............................................................ 31

ii. No Evidence of Collection Difficulties. .................................................... 33 iii. The Litigation Involved is Not Prohibitively Expensive or Complex. ..... 34 iv. Paramount Interest of Creditors Supports Denial of 9019 Motion. .......... 34

II. THE STANDING MOTION SHOULD BE GRANTED ................................................. 35 A. The Fourth Circuit Does Not Prohibit Granting Standing to the Committee. ...... 36 B. The Committee Has Demonstrated that Standing is Warranted. .......................... 38

i. The Committee Has Asserted Colorable Claims that Would Benefit the Estates. ................................................................................................ 38

ii. The Debtors Unjustifiably Refuse to Pursue Colorable Claims. .............. 39

CONCLUSION ............................................................................................................................. 40 RESERVATION OF RIGHTS ..................................................................................................... 41


TABLE OF AUTHORITIES

Page(s)

ii

Cases

Adelphia Commc’ns Corp. v. Bank of Am., N.A. (In re Adelphia Commc’ns Corp.), 330 B.R. 364 (Bankr. S.D.N.Y. 2005) .....................................................................................40

Airocare, Inc. v. Chambers (In re Airocare), No. 10-14519-RGM, 2011 Bankr. LEXIS 1324 (Bankr. E.D. Va. April 1, 2011) ........................................................................................................................................37

In re Alpha Nat. Res. Inc., 544 B.R. 848 (Bankr. E.D. Va. 2016) ......................................................................................17

In re Applied Theory Corp., 493 F.3d 82 (2d Cir. 2007).......................................................................................................36

Brandt v. Trivest II, Inc. (In re Plassein Int’l. Corp.), 405 B.R. 402 (Bankr. D. Del. 2009) ........................................................................................22

Brown v. Chesnut (In re Chesnut), 400 B.R. 74 (N.D. Tex. 2009), aff'd, 356 F. App’x 732 (5th Cir. Dec. 17, 2009) ........................................................................................................................................40

Charys Liquidating Trust v. McMahan Sec. Co., L.P. (In re Charys Holding Co.), 443 B.R. 628 (Bankr. D. Del. 2010) ..................................................................................22, 39

In re Chemtura Corp., 439 B.R. 561 (Bankr. S.D.N.Y. 2010) .....................................................................................23

Conn. Gen. Life Ins. Co. v. United Cos. Fin. Corp. (In re Foster Mortgage Corp.), 68 F.3d 914 (5th Cir. 1995) .....................................................................................................34

In re CS Mining, LLC, 574 B.R. 259 (Bankr. D. Utah 2017) .......................................................................................14

Emerald Capital Advisors Corp. v. Bayerische Moteren Werke Aktiengesellschaft (In re Fah Liquidating Corp.), 572 B.R. 117 (Bankr. D. Del. 2017) ........................................................................................31

Fairchild Dornier GMBH v. Off. Comm. of Unsecured Creditors (In re Dornier Aviation (N. Am.), Inc.), 453 F.3d 225 (4th Cir. 2006) .............................................................................................17, 18


TABLE OF AUTHORITIES (Continued)

Page(s)

iii

In re Frye, 216 B.R. 166 (Bankr. E.D. Va. 1997) ................................................................................13, 17

Geltzer v. Original Soupman Inc. (In re Soup Kitchen Int’l, Inc.), 506 B.R. 29 (Bankr. E.D.N.Y. 2014) .......................................................................................22

In re Gordon Props., LLC, 515 B.R. 454 (Bankr. E.D. Va. 2013) ......................................................................................13

Halperin v. Moreno (In re Green Field Energy Servs.), Nos. 13-12783 (KG), 15-50262 (KG), 2015 Bankr. LEXIS 2914 (Bankr. D. Del. Aug. 31, 2015)..................................................................................................................31

Helms v. Certified Packaging Corp., 551 F.3d 675 (7th Cir. 2008) ...................................................................................................29

Kipperman v. Onex Corp., 411 B.R. 805 (N.D. Ga. 2009) .................................................................................................22

Lehman Cap. v. Official Comm. of Unsecured Creditors of Fas Mart Convenience Stores, Inc. (In re Fas Mart Convenience Stores, Inc.), No. 3:03-CV-359, 2003 WL 22048024 (E.D. Va. 2003) ........................................................37

In re Loudoun Heights, LLC, No. 13-15588-BFK, 2014 Bankr. LEXIS 2805 (Bankr. E.D. Va. June 26, 2014) ........................................................................................................................................14

In re Matco Elecs. Grp., Inc., 287 B.R. 68 (Bankr. N.D.N.Y. 2002) ......................................................................................35

Matson v. Alpert (In re LandAmerica Fin. Grp., Inc.), 470 B.R. 759 (Bankr. E.D. Va. 2012) ......................................................................................18

Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548 (3d Cir. 2003).....................................................................................................36

Pereira v. WWRD US, LLC (In re Waterford Wedgwood USA, Inc.), 500 B.R. 371 (Bankr. S.D.N.Y. 2013) .....................................................................................22

Protective Comm. for Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 U.S. 414 (1968) ...........................................................................................................13, 14

PW Enters., Inc. v. North Dakota (In re Racing Services, Inc.), 363 B.R. 911 (B.A.P. 8th Cir. 2007)........................................................................................37


TABLE OF AUTHORITIES (Continued)

Page(s)

iv

Reynolds v. Comm’r of Internal Rev., 861 F.2d 469 (6thCir. 1988) ....................................................................................................13

In re S. Peru Copper Corp. S’holder Derivative Litig., 30 A.3d 60 (Del. Ch. 2011), revised and superseded, 52 A.3d 761 (Del. Ch. 2011), aff’d Americas Mining Corp. v. Theriault, 51 A.3d 1213 (Del. 2012) .........................16

Schlossberg v. Abell (In re Abell), 549 B.R. 631 (Bankr. D. Md. 2016) ..................................................................................23, 24

Scott v. Nat’l Century. Fin. Enters., Inc. (In re Baltimore Emergency Servs. II, Corp.), 432 F.3d 557 (4th Cir. 2005) ...................................................................................................37

SunTrust Bank v. Matson (In re CHN Constr., LLC), 531 B.R. 126 (Bankr. E.D. Va. 2015) ..........................................................................37, 38, 40

Statutes

11 U.S.C. § 544(b) ....................................................................................................................................22 § 547(b)(3) ...............................................................................................................................19 § 548(a)(1)(B) ..........................................................................................................................22

Bankruptcy Code ................................................................................................................... passim

Uniform Commercial Code ......................................................................................................29, 30

Other Authorities

Federal Rule of Bankruptcy Procedure 9019 ......................................................................... passim

Federal Rule of Civil Procedure 12(b)(6) ........................................................................................6


1

The Official Committee of Unsecured Creditors (the “Committee”) of Le Tote, Inc., et

al., as debtors and debtors-in-possession (the “Debtors”), by and through its counsel Cooley

LLP, hereby submits this omnibus (i) objection (this “Objection”) to the Debtors’ (I) Motion for

Entry of an Order (A) Authorizing and Approving the HBC Settlement By and Among the

Debtors and the HBC Secured Parties and (B) Granting Related Relief and (II) Objection to the

Motion of the Official Committee of Unsecured Creditors for Entry of an Order Authorizing the

Committee to Prosecute Certain Claims, Challenges, and Causes of Action Related to the HBC

Secure Parties [Docket No. 796] (the “9019 Motion”) and (ii) reply in support of its Standing

Motion (this “Reply”).1 In support thereof, the Committee respectfully states as follows:


Through the 9019 Motion, the Debtors (i) seek to compromise certain valuable estate

claims against HBC that the Debtors and their special committee of independent directors (the

“Restructuring Committee”) admit are colorable for insufficient consideration and (ii) cast aside

other valuable estate claims for no consideration at all. This untoward combination creates a

proposed settlement that falls well below the lowest range of reasonableness. If litigated, the

claims against HBC not only could result in HBC’s purported secured debt being recharacterized

as equity, but could require HBC to provide affirmative payments to the Debtors’ estates.

Instead of prosecuting those claims for the benefit of the estates, however, the Debtors entered

into a lopsided settlement that, if approved, would result in HBC receiving substantially higher

recoveries than unsecured creditors, and places all of the risk of lower-than-expected liquidation

proceeds on unsecured creditors.

1 On December 17, 2020, the Committee filed a proposed adversary complaint against certain of the HBC Parties (the “Complaint”) attached to the Motion of the Official Committee of Unsecured Creditors for Entry of an Order Authorizing the Committee to Prosecute Certain Claims, Challenges, and Cause of Action Relating to the HBC


2

The settlement should be subject to close scrutiny by this Court based on the Debtors’

irreconcilable conflicts with HBC and the Debtors’ own implicit biases. Not only are the

Debtors beholden to HBC for operational support and rent payments, the Debtors’ board of

directors approved the acquisition of Lord & Taylor LLC (“Lord & Taylor” or “L&T”) by Le

Tote in 2019 (the “Acquisition”), which is now at issue in these cases, and the Plan seeks

releases for these individuals to absolve them of any liability stemming from their approval of

the disastrous Acquisition. Under that close scrutiny, it is even clearer that the settlement should

not be approved because it ascribes insufficient value to actionable claims and ignores other

material claims that the Committee determined are colorable. The Court should instead grant the

Committee standing to pursue the estate’s claims against HBC, as set forth in the Committee’s

Standing Motion and Complaint.

The estates’ claims against HBC arise out of the Debtors’ imprudent Acquisition of the

Lord & Taylor business through a transaction that was so one-sided in favor of HBC that it

rendered the Debtors unable to continue operating as a viable going concern, constituting a

constructively fraudulent transfer. The sole party to benefit from the Acquisition was HBC,

which initially hatched the plan for the Acquisition as a loss-mitigation strategy. The Lord &

Taylor business was a money-losing operation that HBC was desperate to shed. The Acquisition

was structured to permit HBC to “recover” as much of its “sunk” costs in Lord & Taylor as

possible and to cover part of its own overhead costs and obligations that existed regardless of the

ongoing operation of Lord & Taylor. The Acquisition was also designed to make the transaction

so complex as to give HBC effective control over the operations and destiny of the business due

to Le Tote’s reliance on HBC to physically operate the Lord & Taylor business.

Secured Parties [Docket No. 694] (the “Standing Motion”). Capitalized terms used but not otherwise defined herein have the meanings ascribed to them in the Complaint.


3

Le Tote was the only buyer that HBC could entice to acquire the money-losing Lord &

Taylor business, and Le Tote assumed hundreds of millions of dollars in liabilities in connection

with the Acquisition. HBC also planned for the Debtors’ inevitable bankruptcy filing by

exercising significant control over the Debtors as one of their equity holders, alleged secured

lender, and integral service provider. The Debtors’ business quickly cratered following the

Acquisition, even before the COVID-19 pandemic took shape, which was not surprising given

that the Debtors lacked a viable plan or the necessary capital to operate the Lord & Taylor

business. These bankruptcy filings were the foreseeable consequence of the Acquisition, and the

Debtors’ unsecured creditors were directly harmed by the Acquisition and its resulting costs to

the business.

The Debtors and Committee agree that the majority of prospective estate claims against

HBC are colorable. Nonetheless, the HBC Settlement2 does not reflect the substantial value that

could be unlocked if the claims are successful, and provides for HBC to receive the first $8

million of distributable proceeds on account of its purportedly secured debt, with the estates only

set to receive $3 million (if any) before the remaining proceeds (if any) are split 50-50 among

HBC and the estates. In other words, if liquidation sales do not perform as expected, there may

never be any distributable proceeds available to satisfy general unsecured claims. The HBC

Settlement also allows HBC to receive the proceeds of assets on which HBC does not hold valid

liens, including commercial tort claims, trailers, and the proceeds from the sale of augmented

inventory. That outcome does not accurately reflect the risk faced by HBC that its purportedly

secured debt could be recharacterized as equity and only paid after all unsecured claims are

2 See Exhibit D to the Disclosure Statement (as defined below) (the “HBC Settlement”).


4

satisfied in full. Nor does it account for the $26.6 million in preferential transfers that HBC

received on account of the prepayment of the Inventory Note.

When viewed under the totality of circumstances, this Court should conclude that the

HBC Settlement falls below the lowest point on the range of reasonableness in light of the

compelling nature of the estate’s claims against HBC. The value of the consideration provided

by HBC under the HBC Settlement is simply not proportionate to the value of the estates’ claims

against HBC proposed to be released.

Moreover, in negotiating the HBC Settlement, the Debtors refused to include additional

colorable claims that could significantly increase HBC’s liabilities to the estates. The major

point of disagreement between the Debtors and the Committee relates to the Committee’s view

that the estates possess colorable claims to avoid the entire Acquisition as a fraudulent transfer,

which would result in HBC becoming liable to the estates for the $151 million in consideration

that was transferred to it. The Committee has alleged that the Debtors did not receive reasonably

equivalent value in exchange for the Lord & Taylor business because it acquired massive

liabilities that dwarfed the value of the assets received. The Debtors have concluded otherwise,

but, in so doing, overlook critical case law and entirely ignore or mischaracterize significant

assumed liabilities incurred under the terms of the Acquisition.

Rather than seriously consider the Committee’s views on how the Acquisition could be

successfully challenged as a fraudulent transfer, the Debtors instead dedicated substantial time to

refuting the fraudulent transfer claims and refused to even advance the claims in negotiations

with HBC. Basic negotiating strategy would dictate at least using the claims as leverage to shape

a more favorable settlement. While the Committee is disappointed that the Debtors do not

recognize the colorability of those claims, it is not surprising that the Debtors have been fixated


5

on their efforts to demonstrate those claims lack merit. The Debtors were always unlikely to

pursue claims that would highlight the conduct and knowledge of the Debtors’ management in

entering into the Acquisition. Indeed, such conduct and knowledge could even give rise to

claims against the Debtors’ directors and officers for breach of fiduciary duty. In the end, the

Debtors sacrificed critical colorable claims for no value and the overall package of value

associated with the HBC Settlement tilted even further down the scale, below the lowest point on

the range of reasonableness.

Regardless of any level of independence enjoyed by the Restructuring Committee in

conducting its investigation, the Debtors’ ultimate negotiators and decision makers were either

biased or conflicted and the HBC Settlement is not the product of truly arms’-length negotiations

by disinterested stewards of the estates. The Debtors’ biases, including their operational reliance

on HBC, mandate application of the close scrutiny standard. Applying that standard, the HBC

Settlement does not pass muster. The HBC Settlement is the product of negotiations among

insiders who cannot be expected to advance the interests of the unsecured creditors who are the

main beneficiaries of the estate’s claims against HBC.

In denying the 9019 Motion, the Court should also grant the Committee standing to

pursue the claims against HBC. The Debtors’ arguments that the Committee has failed to

demonstrate colorable claims in the Standing Motion are without merit. In advancing those

arguments, the Debtors attempt to apply a heightened standard of colorability to the Committee’s

claims, where the Committee would somehow be required to fully prove claims during a

condensed schedule that does not allow the Committee to conduct full merits discovery. But that

is not the law, nor should the Court consider the Debtors’ improper introduction of evidence that

implicates issues of expert evidence that likely can only be resolved at trial. Applying the


6

appropriate standard, which is akin to the standard under Federal Rule of Civil Procedure

12(b)(6), the Committee’s claims would all, at a minimum, survive a motion to dismiss.

Nevertheless, the Debtors unjustifiably refused to bring (or even use as leverage in

negotiations) certain colorable claims included in the Complaint. With the Debtors failing to

maximize value for the estates, the Committee, having conducted its own investigation, remains

well positioned to protect creditors’ rights to a full and fair prosecution of the claims, challenges,

and causes of action against the HBC Parties. For the reasons explained herein, the Debtors

cannot be expected to get the settlement right with a second try at negotiations with HBC.

BACKGROUND

A. General Background

1. On August 2, 2020 (the “Petition Date”), each of the Debtors filed a voluntary

petition with this Court for relief under chapter 11 of the Bankruptcy Code. The Debtors are

operating their businesses and managing their properties as debtors-in-possession pursuant to

sections 1107(a) and 1108 of the Bankruptcy Code. No trustee or examiner has been appointed

in these cases by the Office of the United States Trustee for the Eastern District of Virginia (the

“U.S. Trustee”).

2. On August 12, 2020, the U.S. Trustee appointed the Committee, consisting of the

following three members: (i) The CIT Group/Commercial Services, Inc., (ii) G-III Leather

Fashions, Inc., and (iii) Liquidity Capital II, L.P. See Notice of Appointment of Unsecured

Creditors’ Committee [Docket No. 117].

B. Committee’s Standing Motion and Complaint Against the HBC Parties

3. On December 17, 2020, the Committee filed the Standing Motion and Complaint.

The Complaint contains an extensive discussion of the factual circumstances surrounding the

Acquisition, the terms of the APA entered into in connection therewith, and the resulting


7

aftermath that plunged Le Tote into a severe liquidity crisis within three months after closing the

Acquisition. The Complaint is the product of a preliminary investigation, conducted by the

Committee in collaboration with the Restructuring Committee, into certain potential claims and

causes of action held by the Debtors’ estates against the HBC Parties.

4. After extensive review and investigation, the Committee has determined that the

HBC Parties are subject to the following claims, challenges, and causes of action, among others:

• constructive fraudulent transfer claims based on the Acquisition;

• a recharacterization and avoidance action with respect to the prepayment of an inventory note, in aggregate principal amount of approximately $26.6 million, initially owed to HBC US Propco to partially finance the Acquisition and acquired inventory in connection therewith (the “Inventory Note”);

• recharacterization and equitable subordination claims with respect to the validity and priority of the Seller Note;

• claims with respect to breaches of the TSA; and

• an avoidance action with respect to setoffs under the Omnibus Agreement Term Sheet (the “Omnibus Term Sheet”) dated April 10, 2020, which, among other things, offset amounts owed under the TSA against amounts owed by certain HBC Parties to the Debtors, and also restructured go-forward services under the Transition Services Agreement.

5. The Committee also conducted a comprehensive lien review for each of the

Debtors’ purportedly secured lenders, including Wells Fargo, Carlyle, and HBC. Following that

review, the Committee determined that the HBC Parties do not have a perfected or otherwise

enforceable security interest in, the following assets of the Debtors or the proceeds thereof:

• commercial tort claims held by the Debtors;

• the Debtors’ accounts receivable generated as a result of the “Additional Agent Goods Fee” provided by Hilco Merchant Resources, LLC and Gordon Brothers Retail Partners, LLC in their


8

capacities as consultants pursuant to that certain Letter Agreement Governing Inventory Disposition dated as of April 17, 2020; and

• the Debtors’ trailers.3

6. In the event that some or all of the above claims, challenges, and causes of action

are successfully prosecuted, the HBC Parties would not only lose their alleged secured positions,

but they could also lose their unsecured positions and be required to affirmatively pay significant

monetary damages to the Debtors’ estates. In addition, the terms and conditions imposed upon

the Debtors by the HBC Parties with respect to the Debtors’ use of cash collateral would likely

need to be revisited to account for the HBC Parties’ no longer carrying status as the sole

remaining secured lender under the New Cash Collateral Order.4

C. The Restructuring Committee’s Assessment of Claims Against HBC

7. As noted in the 9019 Motion, the Restructuring Committee conducted an

investigation focused on whether the Debtors had cognizable claims against the HBC Parties

arising from the following transactions and occurrences: “(a) the Acquisition; (b) the Debtors’

prepayment of the Inventory Note; (c) the Debtors’ issuance of the Seller Note, particularly

whether there is a factual basis for the Seller Note to be recharacterized as equity, or equitably

subordinated; (d) the [HBC Parties’] post-closing obligation to pay rent for the Lord & Taylor

3 In light of the Debtors’ arguments raised in their 9019 Motion, in the event the Committee is granted standing to prosecute the Complaint, the Committee intends to remove from Counts 11 and 12 of the Complaint the challenges to HBC’s liens over (i) money or currency held by any of the Debtors as of the Petition Date in any of the Debtors’ bank accounts and (ii) the Debtors’ copyrights, as the latter is likely moot following the sale of substantially all of the Debtors’ assets to Saadia Group LLC. 4 On August 28, 2020, the Court entered its Final Order (I) Authorizing Use of Cash Collateral and Affording Adequate Protection; (II) Modifying the Automatic Stay; and (III) Granting Related Relief [Docket No. 268] (the “Initial Cash Collateral Order”). Following the Debtors’ pay down of the obligations owed to Wells Fargo and Carlyle, on December 21, 2020, the Court entered its Second Agreed Order (I) Authorizing Use of Cash Collateral and Affording Adequate Protection; (II) Modifying the Automatic Stay; and (III) Granting Related Relief [Docket No. 714] (the “New Cash Collateral Order”).


9

stores; and (e) the services provided by the [HBC Parties] to Le Tote under the [TSA] and the

Omnibus [Term Sheet].” See 9019 Motion at ⁋ 36.

8. Just as the Committee’s investigation bore fruit, the Restructuring Committee

similarly concluded that the Debtors possessed colorable claims against the HBC Parties related

to, among other things, (i) avoidance of the Inventory Note prepayment as a preference,

(ii) recharacterization of the Seller Note, and (iii) equitable subordination based on the HBC

Parties’ unfair conduct following the Acquisition, such as overcharging the Debtors for TSA

services. Indeed, the Restructuring Committee agrees that several of the Counts included in the

Complaint implicate colorable claims.

9. The chart below identifies which Counts in the Committee’s Complaint relate to

claims found to be colorable by the Restructuring Committee. The chart also contains brief

descriptions of the benefits provided to the Debtors’ estates and unsecured creditors in the event

each Count were to be successfully litigated against the HBC Parties.

Counts Description of Cause of Action

Restructuring Committee Found

Colorable?

Potential Benefits to the Debtors’ Estates and Unsecured Creditors

1-2, 5-6

Avoidance of the Transaction as a Fraudulent

Transfer No Return of approximately $151

million to the Debtors’ estates

3 Recharacterization of Seller Note as Equity Yes

Removing approximately $30 million of secured claims from the waterfall of distributable

proceeds

4 Recharacterization of Inventory Note as Equity No

Support a fraudulent transfer claim to avoid the prepayment

of the Inventory Note as an equity distribution

7 Preference Yes Return of approximately $26.6 million to the Debtors’ estates

8 Unjust Enrichment No Monetary judgement against HBC Parties

9 Breach of Contract Yes Monetary judgement against HBC Parties


10

10 Indemnification Yes Coverage for any costs incurred

by HBC Parties’ breaches of APA and TSA

11-12 Lien Challenges No HBC Parties lose secured status in whole or in part

13

Objections to Proofs of Claim and Requests for

Allowance of Administrative Expenses

No Eliminating claims against the Debtors’ estates

14 Equitable Subordination Yes

Lowering HBC Parties’ priority in the waterfall of distributable

proceeds below unsecured creditors

D. Negotiations Over the HBC Settlement

10. From the outset of its investigation, the Committee participated in regular

communications with the Debtors and the Restructuring Committee regarding potential

settlement constructs, and the Debtors suggested that the Committee communicate through them

in making proposals to HBC. None of the term sheets exchanged between the Debtors and HBC

met the Committee’s satisfaction in delivering value to general unsecured creditors. With the

Debtors’ permission, the Committee made its first formal settlement offer directly to HBC on

December 4, 2020. That settlement offer, conveyed in a structure that was similar to the

construct being negotiated between the Debtors and HBC at the Debtors’ request, was carefully

crafted and intended to serve as a framework for further discussions of how the settlement being

discussed by the Debtors and HBC could be improved. That settlement offer was dismissed by

HBC on December 8, 2020 without a counter. HBC effectively conveyed to the Committee that

its opening offer was outside of the goal posts governing discussions between the Debtors and

HBC and that they would continue discussions only with the Debtors. Unsurprisingly, the

Debtors and HBC agreed to the terms of the HBC Settlement just days later. When counsel for

the Committee subsequently reiterated its request that HBC provide a counter, counsel for HBC


11

instructed that the Committee should simply “get on board” with the settlement reached with the

Debtors.

11. The Committee demanded that the Debtors assert all of the estates’ claims against

HBC by email dated December 10, 2020, but the Debtors declined and instead informed the

Committee on December 11, 2020, that they had reached a settlement in principle with HBC.

On December 17, 2020, after reviewing the final terms of the HBC Settlement, the Committee

filed the Standing Motion seeking to prosecute the Complaint against HBC. The Standing

Motion seeks this Court’s permission to pursue the Counts in the Complaint, as the Debtors’

pursuit of the indefensible HBC Settlement should disqualify them from getting another

opportunity to adequately represent the estates’ interests.

E. The HBC Settlement

12. The HBC Settlement, which has been hardwired into the Debtors’ proposed Plan,

includes the following components (all terms used in this paragraph shall have the meanings

ascribed to them in the Disclosure Statement):5

• After payment of administrative and priority claims and the TSA Shortfall Claim (approximately $1.48 million) to the HBC Parties, the HBC Parties then also receive the first $8 million of distributable proceeds from the Debtors’ estates on account of the Seller Note.

• Following the payments of approximately $9.48 million to the HBC Parties, the Debtors’ estates receive the next $3 million before the HBC Parties then rejoin in a 50/50 split with the Debtors’ estates for any remaining distributable proceeds until the Seller Note claims are satisfied.

• Other than with respect to mutual indemnification obligations

already existing under the APA, the HBC Parties, for

5 On December 21, 2020, the Debtors filed the Amended Joint Chapter 11 Plan of Le Tote, Inc. and Its Debtor Affiliates (the “Plan”) [Docket No. 709] and the Disclosure Statement for the Amended Joint Chapter 11 Plan of Le Tote, Inc. and Its Debtor Affiliates (the “Disclosure Statement“) [Docket No. 710].


12

themselves and their affiliates (including current and former directors, officers, employees, agents, attorneys, and other related parties) receive general releases, including, without limitation, with respect to preference, breach of contract, fraudulent transfer, recharacterization, subordination, and other claims under investigation by the Restructuring Committee and the Committee.

• Despite never having filed a UCC-1 that describes in detail the

Urban Outfitters litigation, the HBC Parties receive 50% of any Urban Outfitters litigation proceeds following an initial $1 million payment to the Debtors’ estates on account of the UO Claim.

• The Debtors will assume and assign two master leases (the “Master Leases”) where the HBS Landlords serve as landlords to a designee of the HBC Parties.

ARGUMENT

I. THE 9019 MOTION SHOULD BE DENIED

13. Despite admitting that the estates possess colorable and compelling claims

identified by their own Restructuring Committee, the Debtors are nonetheless seeking approval

of a settlement that is disproportionately favorable to HBC at the expense of the estates. At

bottom, the HBC Settlement falls well below the lowest point on the range of reasonableness

because of the gross mismatch between the “consideration” being provided by HBC, and the

value of the claims against HBC that are proposed to be released.

14. Among other glaring deficiencies, the settlement does not require the HBC Parties

to provide any affirmative consideration to the estates, affords the HBC Parties secured claims,

awards the HBC Parties liens on unencumbered assets, and grants the HBC Parties a recovery

percentage that is approximately four times higher than that of general unsecured creditors.6 In

addition, while the Debtors attempt to ascribe substantial value to the assumption and assignment


13

of the Master Leases, they ignore that the associated rent claims that will be avoided were always

HBC’s sole responsibility under the APA. Accordingly, the Court should not find that aspect of

the settlement to provide any material value. The HBC Settlement is also improperly designed to

shield the Debtors’ insiders, including their directors and officers, from the possibility of facing

any investigation into their conduct with respect to the Acquisition.

15. Federal Rule of Bankruptcy Procedure 9019 (“Rule 9019”) authorizes the Court

to approve a compromise or settlement proposed by the Debtors. Fed. R. Bankr. P. 9019(a).

However, the proposed settlement must be fair and equitable and in the best interest of the

estates. See Protective Comm. for Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson,

390 U.S. 414, 424 (1968) (“The fact that courts do not ordinarily scrutinize the merits of

compromises involved in suits between individual litigants cannot affect the duty of a

bankruptcy court to determine that a proposed compromise forming part of a reorganization plan

is fair and equitable.”); In re Frye, 216 B.R. 166, 174 (Bankr. E.D. Va. 1997) (“In order to

approve a compromise, this court must look at various factors and determine whether the

compromise is in the best interest of the estate and whether it is fair and equitable.”). This test is

conjunctive, and the Debtors bear the burden to demonstrate that the test is met. In re Gordon

Props., LLC, 515 B.R. 454, 465 (Bankr. E.D. Va. 2013); In re Frye, 216 B.R. at 174 (the

proponent of the compromise “has the burden of persuading the court that the compromise is fair

and equitable and should be approved”).

16. When considering a proposed settlement, “[t]he court is not permitted to act as a

mere rubber stamp or to rely on the [proponent’s] word that the [settlement] is reasonable.”

Gordon Props., 515 B.R. at 465 (quoting Reynolds v. Comm’r of Internal Rev., 861 F.2d 469,

6 According to the Disclosure Statement, holders of general unsecured claims will receive approximately 8% of the value of their general unsecured claims, while the HBC Parties receive approximately 32% of the value of their


14

473 (6thCir. 1988)) (internal quotation marks omitted). Rather, the Court must apprise itself of

the “facts necessary for an intelligent and objective opinion of the probabilities of ultimate

success should the claim be litigated.” TMT Trailer, 390 U.S. at 424.

17. Analyzing the HBC Settlement in its totality, the Debtors cannot demonstrate that

the settlement is fair and equitable under the circumstances. In failing to satisfy their burden, the

Debtors do not even provide the Court with a claim-by-claim valuation, explaining how much

value they ascribed to each individual claim in the context of negotiating the package of

consideration embodied in the HBC Settlement. Nevertheless, it is apparent that certain

colorable claims were undervalued and other colorable claims were ascribed no value at all. The

9019 Motion should be denied.

A. The 9019 Motion Should be Subject to Heightened Scrutiny.

18. The Debtors’ decision to enter into the HBC Settlement must be closely

scrutinized given that the Debtors are subject to irreconcilable conflicts of interest with respect to

both the HBC Parties and the claims proposed to be settled. See In re Loudoun Heights, LLC,

No. 13-15588-BFK, 2014 Bankr. LEXIS 2805, at *41 (Bankr. E.D. Va. June 26, 2014) (holding

that a debtor’s settlement with insiders must be “heavily scrutinized by the Court.”); see also In

re CS Mining, LLC, 574 B.R. 259, 275 (Bankr. D. Utah 2017) (denying 9019 motion where

proposed settlement would benefit an insider and applying a standard of “closer scrutiny”).

19. First, the Debtors rely on the HBC Parties to provide operational support and to

honor their obligations to pay rent under the APA for certain of the Debtors’ leased locations.

See 9019 Motion at ¶¶ 20-21. As the Debtors admit, without the TSA Services, the Debtors

would likely be unable to conduct store closing sales and would need to find an alternative

claims under the Seller Note. See Disclosure Statement, Article II.D.


15

service provider. See id., ¶ 49. The HBC Parties also hold equity in the Debtors, previously held

seats on the Debtors’ board of directors, and now purport to exercise control over the Debtors’

cash collateral as their fulcrum secured lender under the New Cash Collateral Order. See id.,

¶ 89. In other words, at all relevant times during negotiations, the Debtors were beholden to the

HBC Parties, who were undoubtedly both a statutory and non-statutory insider. The Debtors,

through the HBC Settlement, elected not to bite the hand that feeds them.

20. Second, the Debtors’ own insiders, including its directors and officers, are biased

because they could be susceptible to breach of fiduciary duty claims in the event the Acquisition

is successfully challenged as a constructive fraudulent transfer.7 The litigation of that claim will

necessarily involve discovery into the knowledge and conduct of the Debtors’ insiders in

entering into the Acquisition. Among other things, the reasonableness of the Debtors’ financial

projections, and the Debtors’ conclusion that they allegedly received reasonably equivalent value

in exchange for paying over $151 million in consideration, will be placed at issue. The Debtors’

management team cannot be expected to cast aside their self-interest and agree that a transaction

they entered into would be so one-sided so as to lack reasonably equivalent value.8 But,

avoiding embarrassing litigation and protecting directors and officers from potential liabilities

are not reasonable justifications for settling valuable estate claims for insufficient consideration.

7 Based on the Disclosure Statement, it does not appear that the Restructuring Committee conducted an investigation into, or reached any conclusions regarding whether, the Debtors hold actionable claims against their directors and officers or other insiders in connection with, among other things, the directors’ and officers’ decision to approve the Acquisition. The Committee expressly reserves the right to pursue such claims, which are currently proposed to be released under the Plan in exchange for no consideration and without any description of such claims in the Disclosure Statement. 8 Additionally, Debtors’ current counsel also advised the Debtors with respect to the Acquisition, and, as a result, may be similarly colored with a level of reluctance to pursue a fraudulent transfer claim. The 9019 Motion states that the “decision of the Restructuring Committee to hire independent counsel was informed in part by the fact that the Debtors’ restructuring counsel Kirkland & Ellis LLP had represented Le Tote in connection with the Acquisition.” See 9019 Motion at ¶ 31 n.4.


16

21. Third, the involvement of the Restructuring Committee did not cleanse the

Debtors of any conflicts of interest. In the 9019 Motion, the Debtors dismiss out of hand the

Committee’s assertion that the Restructuring Committee was “independent” in name only, and

both its investigation and decision-making were tainted by the involvement of the Debtors. See

9019 Motion, ¶ 101. The 9019 Motion makes clear, however, that the Committee’s concerns

about the relationship between the Debtors and Restructuring Committee are valid. As detailed

in Exhibit C to the 9019 Motion, Debtors’ counsel was intimately involved in substantially every

aspect of the Restructuring Committee’s investigation, including interviews of the Debtors’

employees, discussions regarding potential estate causes of action, communications with the

HBC Parties, and the drafting of the HBC Settlement. See 9019 Motion, Ex. C. In addition, the

Debtors’ board of directors voted to approve the HBC Settlement, demonstrating that

management’s grant of authority to the Restructuring Committee was ultimately subject to

important limitations. See id., p. 12. Because the Debtors’ board of directors retained ultimate

decision-making and negotiating authority, the Debtors remained subject to irreconcilable

conflicts of interest in their dealings with the HBC Parties.9

22. The Debtors’ conflicts of interest and biases, both with respect to the control

exerted by the HBC Parties over the Debtors, and the existence of potential director and officer

claims, weigh heavily in favor of denial of the 9019 Motion.

9 See, e.g., In re S. Peru Copper Corp. S’holder Derivative Litig., 30 A.3d 60 (Del. Ch. 2011), revised and superseded, 52 A.3d 761 (Del. Ch. 2011) (criticizing the role of a special committee in reviewing a merger proposal from a controlling stockholder and stating that the special committee’s “‘approach to negotiations was stilted and influenced by its uncertainty about whether it was actually empowered to negotiate’” and that the special committee “‘from inception . . . fell victim to a controlled mindset and allowed [its controlling stockholder] to dictate the terms and structure of the [m]erger.’”), aff’d Americas Mining Corp. v. Theriault, 51 A.3d 1213, 1245 (Del. 2012).


17

B. The HBC Settlement Fails to Satisfy the Four Factor Test Used in the Fourth Circuit to Scrutinize Proposed Settlements.

23. Courts in the Fourth Circuit consider four factors when determining whether a

settlement under Bankruptcy Rule 9019 should be approved: “(i) the probability of success in

litigation; (ii) the potential difficulties in any collection; (iii) the complexity of the litigation and

the expense, inconvenience, and delay necessarily attending it; and (iv) the paramount interest of

the creditors.” In re Alpha Nat. Res. Inc., 544 B.R. 848, 857 (Bankr. E.D. Va. 2016) (citing In re

Frye, 216 B.R. at 174).

24. The Debtors have not met their burden to demonstrate that each of these factors

supports approval of the HBC Settlement.

i. Probability of Success in Litigation.

1. Claims Deemed Colorable by Restructuring Committee.

25. The Restructuring Committee identified a number of causes of action against the

HBC Parties that are colorable, including: (i) recharacterization of the Seller Note as an equity

interest; (ii) equitable subordination of the claims of the HBC Parties; (iii) avoidance of the

prepayment of the Inventory Note as a preference; (iv) breach of contract or indemnification to

the extent of any losses related to the HBC Parties’ failure to pay the rent owed under the APA,

and (v) breach of the TSA. See 9019 Motion at ⁋⁋ 61 & 78. The Committee agrees that these

claims are colorable, has asserted them in its Complaint, and contends that those claims will be

litigated with a real probability of success. Thus, there is no genuine dispute that the estates have

a likelihood of success on many of the claims proposed to be released under the HBC Settlement.

26. First, as the Restructuring Committee acknowledges, the Seller Note bears almost

all of the indicia of equity under the Fourth Circuit’s eleven-factor test to assess whether a

transaction should be classified as debt or equity. See Fairchild Dornier GMBH v. Off. Comm.


18

of Unsecured Creditors (In re Dornier Aviation (N. Am.), Inc.), 453 F.3d 225 (4th Cir. 2006);

9019 Motion at ⁋⁋ 63 – 66. The Restructuring Committee appears to believe that this claim

would be likely to succeed on the merits, but the Debtors instead elected to forego litigation

based on the unfavorable terms included in the HBC Settlement. However, the HBC Settlement

improperly recognizes the HBC Parties as a secured creditor and grants them the lions’ share of

the estates’ remaining distributable value, despite the significant risk that their claim will be

recharacterized as equity, placing them below unsecured creditors in the waterfall.

27. Second, the Restructuring Committee also acknowledges that a “claim to

equitably subordinate the HBC Secured Parties’ claims pursuant to section 510(c) of the

Bankruptcy Code is likely colorable in that factual allegations can be made that would likely

survive a motion to dismiss.” See 9019 Motion at ⁋ 68. Because the HBC Parties are insiders,

the Debtors’ estates would only need to show “‘some unfair conduct, and a degree of culpability,

on the part of the insider.’” See Matson v. Alpert (In re LandAmerica Fin. Grp., Inc.), 470 B.R.

759, 806 (Bankr. E.D. Va. 2012). The Restructuring Committee has identified several unfair acts

committed by the HBC Parties, including intentionally not paying rent as required by the APA

and making $18 million in payments on behalf of the HBC Parties through Lord & Taylor bank

accounts. See 9019 Motion at ⁋ 71. Nonetheless, the Restructuring Committee has invented

defenses for the HBC Parties out of whole cloth, conjecturing that the Debtors would be unlikely

to prevail at trial on such an equitable subordination claim. However, the Restructuring

Committee’s admission that this claim could survive a motion to dismiss is significant and

evinces that this claim has value that is being dismissed as part of the HBC Settlement.

28. Third, avoiding the Inventory Note as a preference is straightforward and the

Restructuring Committee shares the Committee’s assessment that the prima facie elements of a


19

preference under section 547 of the Bankruptcy Code are clearly met. See 9019 Motion at ⁋ 73.

However, the Debtors again conjecture as to the strength of potential defenses the HBC Parties

may raise and would then hold the burden of proving. See 9019 Motion at ⁋⁋ 74 – 77. As a

threshold matter, HBC was likely undersecured at the time of the prepayment, as it held a third-

lien position and is not projected to be paid in full now. Not only would this make it difficult for

HBC to support the “contemporaneous exchange for new value” defense, but any “release” of

purported collateral by HBC at the time would be illusory.10 The Inventory Note preference

payment was made to an insider within one year of the Petition Date and there is no real dispute

between the Restructuring Committee and the Committee that Le Tote was insolvent at the time.

See 11 U.S.C. § 547(b)(3). Also, as discussed below, the Committee has identified colorable

claims to recharacterize the Inventory Note. The Restructuring Committee’s acknowledgments

that (i) the Debtors could meet the prima facie elements of this claim and (ii) the HBC Parties

would have to undertake expensive litigation in raising affirmative defenses where they bear the

burden of proof suggest that this claim has value not being matched by the insufficient

consideration in the HBC Settlement.

29. Fourth, it is undisputed that the HBC Parties failed to pay rent on Le Tote’s behalf

as required under the APA. The Committee agrees with the Debtors that Le Tote could assert a

breach of contract claim, or a related indemnification claim, against the HBC Secured Parties to

the extent Le Tote suffered any damages related to the HBC Secured Parties’ failure to pay the

rent obligations owed under the APA. See 9019 Motion at ⁋ 79; APA § 9.02(a)(ii). The Debtors

10 The Debtors’ own cited case law acknowledges that two of the HBC Parties’ defenses would be futile if the HBC Parties were undersecured at the time of the Inventory Note prepayment. See 9019 Motion at ⁋ 74 (Le Tote would be able to collect on the preference claim “to the extent the HBC [Parties] would have been undersecured in a hypothetical chapter 7 case as of the Petition Date.”); 9019 Motion at ⁋ 75 (“If the HBC [Parties] were oversecured at the time of the Inventory Note Transfer, then the release of the liens provided dollar-for-dollar value to Le Tote in exchange for the Inventory Note Transfer, and the HBC [Parties’] preference liability would be eliminated” under the contemporaneous exchange for new value defense.”)


20

believe that any litigation for breach of contract or indemnification would succeed, but

incorrectly argue that the HBC Settlement provides a “far better outcome than even a total

litigation win.” See 9019 Motion at ¶ 78. In any event, this issue is soon to be moot. The HBC

Parties, likely in recognition of their inevitable liability in the event litigation were to commence,

have agreed to assume the Master Leases outside the context of the HBC Settlement and prior to

a ruling on the 9019 Motion. The Court should not find HBC’s choice to willingly comply with

its Rent Payment Obligations under the APA as somehow providing material value under the

HBC Settlement.

30. Fifth, the Restructuring Committee concluded that the Debtors have colorable

claims against the HBC Parties for breaching the TSA by (i) overcharging for services rendered

and (ii) breaching the standard of care with which HBC operated the Lord & Taylor stores during

the year prior to the closing of the Acquisition. See 9019 Motion at ⁋⁋ 82 – 84. Again, the

Debtors believe that any litigation brought against the HBC Parties for breaching the TSA would

ultimately succeed but elected to forego litigating this claim in order to secure discounted go-

forward TSA services under the HBC Settlement.

31. In sum, there are several claims where the Restructuring Committee and the

Committee share their assessment that these claims are colorable and likely to succeed if

litigated. For these claims, the first factor of the Fourth’s Circuit test is met.

2. Claims Deemed Not Colorable by Restructuring Committee.

32. In conjunction with acknowledging the existence of the above-mentioned

colorable claims, the Debtors also decided that certain claims were not colorable and declined to

even advance those claims in settlement discussions with the HBC Parties. The Committee has a

different assessment of these claims and believes they are both colorable and compelling as set


21

forth herein. They should have been used as leverage in negotiations with HBC. The Debtors’

decision to completely cast these claims aside supports denial of the 9019 Motion because it

(i) demonstrates that the HBC Settlement settles the estates’ claims for insufficient value when

considering potential recoveries on these claims; and (ii) highlights the impact of the Debtors’

conflicts of interest and biases in determining that fraudulent transfer claims are not colorable.

The Restructuring Committee and the Committee can have intellectually honest disagreements

about the colorability of these claims, but the Committee remains puzzled as to why these claims

would be ascribed zero value and not even accounted for to some degree in the consideration

given by the HBC Parties for their releases under the HBC Settlement.

(a) The Acquisition as a Constructive Fraudulent Transfer.

33. The Committee has alleged colorable claims to avoid the entire $151 million in

consideration transferred by the Debtors to HBC in connection with the Acquisition. The

Debtors contend that the Committee cannot support its allegation that the Debtors received less

than reasonably equivalent value in connection with the Acquisition, but notably do not raise any

issues with the other elements of a fraudulent transfer claim, including with respect to the

Debtors’ financial condition at the time of the Acquisition. The Debtors’ reasonably equivalent

value analysis, however, is flawed in that it ignores significant liabilities (such as the secured

debt Le Tote incurred to finance the Acquisition and over a decade of lease obligations) and

overvalues certain assets (such as the three year Rent Payment Obligation and certain leases).

When the Court views the Acquisition under the totality of the circumstances, it is clear that the

Committee has alleged colorable fraudulent transfer claims.

34. The elements of a constructively fraudulent transfer (although stated somewhat

differently under various state laws) are that the debtor: (i) received less than reasonably


22

equivalent value in exchange for the transfer or obligation; and (ii) the transfer or obligation

occurs under financial circumstances in which the debtor is rendered insolvent, inadequately

capitalized, or unable to pay its debts as they mature. See 11 U.S.C. § 548(a)(1)(B); see also

Kipperman v. Onex Corp., 411 B.R. 805 (N.D. Ga. 2009) (outlining the prima facie case under

section 548 of the Bankruptcy Code).11

35. While the Bankruptcy Code does not define “reasonably equivalent,” courts

generally look to the totality of the circumstances surrounding the transfer in question. See

Brandt v. Trivest II, Inc. (In re Plassein Int’l. Corp.), 405 B.R. 402, 411-12 (Bankr. D. Del.

2009); see also Pereira v. WWRD US, LLC (In re Waterford Wedgwood USA, Inc.), 500 B.R.

371, 381 (Bankr. S.D.N.Y. 2013). The “totality of the circumstances” inquiry generally involves

three factors: (1) whether the transaction is at arm’s length; (2) whether the transferee acted in

good faith; and (3) the degree of difference between the fair market value of the assets

transferred and the price paid. In re Waterford Wedgwood USA, Inc., 500 B.R. at 381.

“[R]easonably equivalent value is a fact intensive determination that typically requires testing

through the discovery process.” Charys Liquidating Trust v. McMahan Sec. Co., L.P. (In re

Charys Holding Co.), 443 B.R. 628, 638 (Bankr. D. Del. 2010).

36. The crux of the dispute between the Debtors and the Committee as to this claim is

whether Le Tote received reasonably equivalent value in exchange for paying HBC somewhere

between approximately $151 million and $176 million. 9019 Motion, ¶ 119.12 In exchange, the

11 The Bankruptcy Code incorporates state fraudulent conveyance laws by allowing a trustee to avoid any transfer voidable under applicable state law. See 11 U.S.C. § 544(b). 12 For the purposes of this Objection, the Committee accepts as true the Debtors’ calculations as to reasonably equivalent value, with certain modifications. The Committee does not need expert testimony on this point given that a Court assesses the colorability of the claims without holding a “mini-trial.” See Geltzer v. Original Soupman Inc. (In re Soup Kitchen Int’l, Inc.), 506 B.R. 29, 42 (Bankr. E.D.N.Y. 2014) (“While trial of the Trustee Action would undoubtedly involve analysis of the parties’ competing valuations, which, to be meaningful, would require expert testimony, it is neither necessary nor appropriate to engage in this type of litigation in the context of a Rule 9019


23

Debtors allege that they received assets from HBC that have an estimated value of between

approximately $350 million and $447 million. See 9019 Motion at ⁋⁋ 120 & 133. Those assets

received include:

• Inventory valued at a minimum of $211 million;

• $13.4 million of other current assets;

• $900,000 in store cash;

• Intangible assets worth at least $4 million;

• $1.5 million in personal property; and

• The Rent Payment Obligation for a three-year period.

37. The Committee does not fundamentally disagree with the Debtors’ analysis.

However, the critical flaw in the Debtors’ analysis of reasonably equivalent value is that they

attempt to assess reasonably equivalent value without accounting for the total liabilities incurred

in the Acquisition. Reasonably equivalent value is not assessed in a vacuum. Rather, reasonably

equivalent value is assessed holistically, examining all liabilities and assets involved in a

predicate transaction. Where both assets and liabilities are exchanged as part of a larger

transaction, the “collapsing doctrine” applies and requires a court to reduce reasonably

equivalent value where a transferee assumes liabilities. See Schlossberg v. Abell (In re Abell),

549 B.R. 631, 662 (Bankr. D. Md. 2016) (holding that “[a]lthough the Fourth Circuit has not

addressed the collapsing transaction doctrine, this district adopted the following test, which

requires a court to consider whether: (1) [a]ll of the parties involved had knowledge of the

motion.); In re Chemtura Corp., 439 B.R. 561, 594 (Bankr. S.D.N.Y. 2010) (“It is not necessary for the court to conduct a ‘mini-trial’ of the facts or the merits underlying the dispute. Rather, the court only need be apprised of those facts that are necessary to enable it to evaluate the settlement and to make a considered and independent judgment about the settlement.”). Moreover, the Committee’s modifications to the Debtors’ analysis can be considered by the Court because they implicate issues of law, i.e., whether certain assets and liabilities should be considered in the first place.


24

multiple transactions; (2) [e]ach transaction would not have occurred on its own; and (3) [e]ach

transaction was dependent or conditioned on other transactions.”). When the Acquisition’s

component parts are collapsed and viewed as a single integrated transaction, it is clear that Le

Tote did not receive reasonably equivalent value.

38. For example, Le Tote incurred $130 million in liabilities under two secured loan

facilities, an amount that the Debtors completely ignore in their reasonably equivalent value

analysis. HBC not only had knowledge of Le Tote’s dependence on these two loans in order to

secure the funding required to consummate the transaction, HBC made it a condition precedent

to their closing under the APA that Le Tote obtain these two loans. See Complaint at ⁋ 45.

Indeed, unless Le Tote obtained the $130 million debt financing commitment, HBC held the

right to terminate the APA and receive a $2 million termination fee. Id. Under the

circumstances, the Schlossberg test has been met and if the Court were to apply the collapsing

doctrine, it could include the liabilities associated with the $130 million of secured debt in its

reasonably equivalent value analysis. This point is completed ignored by the Debtors’ analysis.

39. Most significantly, however, as part of the Acquisition, Le Tote agreed to assume

rent payment obligations that exceeded $100 million a year under leases with up to 15-year

remaining terms, additional rent obligations not covered by the Rent Payment Obligation, and

TSA payments. The Debtors do not account for the long-term lease liabilities, and instead

include the leases as assets in their calculation of value. See 9019 Motion at ¶ 121. This is

improper for several reasons.

40. First, the Debtors do not set forth any basis for their valuation of the Debtors’

leasehold interests, and it should not be considered by the Court without an opportunity to be

vetted, which would be procedurally improper at this stage of the proceedings regardless. In


25

addition, and again without any support, the Debtors appear to rely on BRG analysis to proffer

that certain of the Debtors’ leases were above or below market. See 9019 Motion at ⁋ 121. BRG

is not a real estate appraiser. BRG is not qualified to offer an opinion on this subject nor was

appraising real estate included in their services to be provided under their retention terms in these

cases. For these reasons, the Court should exclude BRG’s opinions on this subject.

41. Second, any value that the Debtors’ leasehold interests may have had should be

assessed at zero because the Debtors lacked the liquidity necessary to pay over $100 million in

rent obligations per year. The Debtors do not dispute this point, but apparently rely upon certain

put options in the APA to estimate that the Debtors’ lease liabilities would be substantially

lower. See 9019 Motion, ¶ 121. However, that incorrectly presupposes that the Debtors could

have exercised those options in the first place. It is uncontroverted that the Debtors were in

default under the TSA and APA for failing to make TSA payments as early as February and

March 2020. See First Day Declaration13 at ⁋ 52; Complaint at ⁋ 64. HBC could have taken the

position that the Debtors’ default renders them unable to exercise their contractual put rights.

See APA at § 10.02.14 HBC could also have argued that it was not responsible for paying rent,

rendering the Rent Payment Obligation a valueless asset. Id.15

42. At the time of the Acquisition, Le Tote was also effectively agreeing to assume

the losses that Lord & Taylor would generate on a monthly basis. Le Tote would have to sustain

these losses for several months, if not longer, while it hoped to realize sufficient synergies to

13 On the Petition Date, the Debtors submitted the Declaration of Ed Kramer, Chief Restructuring Officer of Le Tote, Inc., in Support of Chapter 11 Petitions and First Day Motions [Docket No. 15] (the “First Day Declaration”). 14 Even if Le Tote was permitted to exercise its put rights for specific locations, the APA requires the Debtors to continue paying some level of consideration related to the properties for up to 9 months following notice of the intent to put. See APA at § 6.05. Indeed, the Committee believes the Debtors elected not to exercise put options at the outset of these cases either because they were unable to do so under the APA or deemed doing so prohibitively expensive under the circumstances. 15 Indeed, HBC eventually ceased paying rent, allegedly due to the COVID-19 pandemic. See Complaint at ⁋ 79.


26

potentially swing back to profitability. See Complaint at ⁋ 103. It would have been entirely

reasonable for a market participant to deduce that the Debtors would (i) quickly default under the

operative leases or TSA obligations, (ii) lose any benefits of the three-year Rent Payment

Obligation, and (iii) retain obligations for hundreds of millions of dollars in rent obligations that

could not be put back to HBC. The Debtors’ analysis ignores this potential outcome by

interjecting hindsight knowledge of HBC’s willingness to negotiate around the TSA and APA

defaults. Once rent obligations are appropriately included as liabilities under the Debtors’

reasonably equivalent value analysis, those liabilities alone dwarf the estimated value that the

Debtors calculate they received as part of the Acquisition.

43. The Debtors also argue that (i) assets are generally valued at their going concern

or fair market price unless a business is on its “deathbed” at the time of the transaction in

question and (ii) a commercial enterprise is a going concern if it is actively engaged in business

with the expectation of indefinite continuance. See 9019 Motion at ⁋ 128. However, at the time

of the Acquisition, it was far from certain that the combined Lord & Taylor and Le Tote business

could generate sufficient revenue to exceed the cost of conducting business.16 We now know it

did not. Even without the benefit of hindsight, the combined company would have been required

to (i) realize significant buyer-specific synergies to reach positive cash flow and (ii) roll out the

infrastructure required to alleviate the Debtors’ reliance on TSA services and independently

support the full operations of the combined business within a year, both of which were lofty, and

both of which would only be feasible with HBC paying the rent.

44. After properly accounting for assumed liabilities and excluding the asset value of

the leases, Le Tote did not receive reasonably equivalent value as shown in the chart below:


27

Debtors' Analysis of Value Transferred / Received Summary ($000s)

Low

High

Debtor's

Debtor's

Analysis

Adjusted

Analysis

Adjusted

Total Value Transferred [A]

151,000

151,000

176,000

176,000

Value Received

Total Assets Received

Closing store cash

900

900

900

900

Inventories

211,300

211,300

265,000

265,000 Other current assets

13,400

13,400 13,400

13,400

Trade name value

4,000

4,000 5,000

5,000 Personal property, incl. trucks/trailers

1,500

1,500 2,500

2,500

Other Property

0

0 10,000

10,000 Free rent

177,200

0

196,300

0

Net below (above) market leasehold interests 42,400

0

46,300

0

Total Assets Received

450,700

231,100 539,400

296,800

Total Liabilities Assumed

Other current liabilities

(36,300)

(36,300)

(36,300)

(36,300)

Gift card & loyalty program payables

(15,800)

(15,800)

(15,800)

(15,800) Vendor purchase commitments

(6,300)

(6,300)

(6,300)

(6,300)

Overpayments of TSA services

(48,100)

(48,100)

(39,400)

(39,400)

Total Liabilities Assumed

(106,500)

(106,500) (97,800)

(97,800)

Other

Omnibus closing adjustments

5,400

5,400

5,400

5,400

Total Net Value Received [B]

349,600

130,000

447,000

204,400

Net Value Received (Lost) [C] = [A] - [B]17

198,600

(21,000)

271,000

28,400

Secured debt (ABL & FILO)

(130,000)

(130,000)

Net Value Received (Lost) Including Secured Debt (151,000) (101,600)

16 Indeed, upon information and belief, the Debtors’ projections prepared as part of the Acquisition showed operating losses until fiscal year ended January 31, 2023 (the entirety of the free rent period). In addition, Lord & Taylor did not operate at a profit for several years prior to the Acquisition. 17 In addition, as set forth herein, the Debtors’ rent obligations should be recognized as liabilities, not assets. The Debtors’ annual rent obligations under the Master Leases exceeded $100 million per year, and the Debtors estimate that rejection damages under the Master Leases were in excess of $200 million. See 9019 Motion at ¶ 5. If those massive rent obligations are correctly accounted for as liabilities under the Debtors’ analysis, the net value received by the Debtors would be drastically lower under both the “high” and “low” values included in the 9019 Motion.


28

45. The Committee recognizes that it has a difference of opinion with the Debtors as

to this claim and faces the burden of proving the claim at trial. But the Committee vehemently

disagrees with the Debtors’ conclusion that this claim has zero value, and believes that the HBC

Settlement is defective because, among other things, it disregards HBC’s actual risk with respect

to this claim.

(b) Lien Challenges.

46. Consistent with the HBC Parties viewing their Seller Note as an equity infusion,

they did not properly perfect their security interest in the Debtors’ Trailers and Commercial Tort

Claims. See Complaint at ⁋⁋ 227 – 232. In addition, the Additional Agent Goods Fee is not part

of HBC’s collateral because it does not arise from the sale of any collateral upon which HBC has

a lien and section 552(b) would cut off any of HBC’s rights to Additional Agent Goods Fees

generated after the Petition Date. See Complaint at ⁋⁋ 233 – 238.

47. First, the Debtors agree with the Committee that the HBC Parties did not properly

perfect their interest in the Trailers through a filing with the applicable motor vehicle agencies.

However, the Debtors ascribe $200,000 worth of value to the trailers without any support for that

calculation. See 9019 Motion at ⁋ 161. The Committee believes that the value of the trailers

may be considerably greater, but the Debtors “decided to resolve this matter through the HBC

Settlement” without identifying what value was contributed by HBC to account for their

unperfected security interest in the Trailers. Id. There is no disputing that if this claim were to

be litigated, the Trailers would be deemed outside of HBC’s collateral package and the value of

the Trailers, whatever that may be, would be available for unsecured creditors.

48. Second, the Debtors’ argument that the HBC Parties’ liens extend to the UO

Claim are unavailing and rely upon untested theories of how to characterize commercial tort


29

claims. See 9019 Motion at ⁋ 159 -160. The Debtors also raise an inventive defense on behalf of

the HBC Parties that would only impact the breach of contract component of the Urban

Outfitters litigation, and not the unfair competition, unjust enrichment, or violations of trade

secrets components. Id. However, the Uniform Commercial Code is clear. A UCC-1 financing

statement filing is sufficient to perfect a security interest in commercial tort claims held by a

borrower only if such claims are described with specificity. See UCC § 9-108(a); Helms v.

Certified Packaging Corp., 551 F.3d 675, 681 (7th Cir. 2008) (holding that general a reference to

“‘all commercial tort claims’” was insufficient to create a security interest in a particular

commercial tort claim).18 Both of the Debtors’ other secured lenders, Wells Fargo and Carlyle,

filed stand-alone UCC-1s that were specifically devoted to describing the Urban Outfitters

litigation. Those UCC-1s included details on the litigation’s jurisdiction, case caption, and case

number. The HBC Parties never did this. At best, the HBC Parties would have an uphill battle

to prove some level of protection under section 544(a) of the Bankruptcy Code on grounds of

estoppel or otherwise convince a court that the UO Claim, because it is based on the misuse of

confidential information, is somehow the properly perfected proceeds of the Debtors’ intellectual

property. Each would be a difficult burden for the HBC Parties to meet. Nevertheless, the

Debtors ascribed this claim almost no value in the context of the HBC Settlement discussions,

which is wholly detached from the risk HBC faces in trying to stake a claim to this estate asset.

49. Third, without any case law, the Debtors attempt to dispel of the Committee’s

argument that the HBC Parties do not have a valid security interest in the Additional Agent

Goods Fee because the fee stems from a prepetition contract between the Debtors and Hilco. See

18 Simply listing “a commercial tort claim” as a collateral type is insufficient. UCC § 9-108(e)(1). The official comments to section 108 of the UCC indicate that a description such as “‘all tort claims arising out of the explosion of a debtor’s factory’” would suffice even if the “exact amount of the claim, the theory on which it may be based,


30

9019 Motion at 156. The Debtors’ defense of HBC misses the point. The initial contractual

arrangement between Hilco and the Debtors is very clearly that of a consignment and was

ordered as such in the order approving the assumption of the Hilco engagement agreement.

Given the commission-like nature of the Additional Agent Goods Fee, the Debtors generate

accounts receivable with each sale of the “additional goods” under the contract. Accounts

receivable are perfected by the filing of a UCC-1, which HBC satisfied with respect to

prepetition accounts receivable. However, because the “Additional Agent Goods Fee” is a

percentage of goods sold fee, and because accounts receivable are not generated until the point of

sale, regardless of the contractual nature of the consignment, the actual accounts receivable for

the Additional Agent Goods Fees are not generated until after the Petition Date, and are

therefore subject to cut off under section 552 of the Bankruptcy Code. Regardless of how the

Additional Agent Goods Fee is characterized by the Debtors, they ignore the applicability of

section 552 of the Bankruptcy Code and completely ignore the risk to HBC in the event a court

found the Committee’s characterization of the arrangement more compelling.

(c) Additional Claims.

50. The Committee also raises several complementary claims which the Restructuring

Committee did not find colorable, including with respect to (i) avoiding the TSA Payments as

preferences, (ii) recharacterizing the Inventory Note as equity, and (iii) unjust enrichment. The

Committee acknowledges that the success of certain of these claims is likely dependent on

proving some of the underlying facts associated with the more focal claims described above.

However, these claims still carry weight and should not be categorically ignored in assessing the

value to be forfeited by the estates under the HBC Settlement.

and the identity of the tortfeasor(s) are not described.” 9-108:1 [Rev] Official Code Comment, 11 Part I Anderson U.C.C. § 9-108:1 [Rev] (3d. ed.).


31

51. With respect to the Committee’s argument to avoid the TSA Payments, the prima

facie elements under section 547(b) of the Bankruptcy Code are present. In the event the

Committee successfully challenged the HBC Parties’ liens, HBC would be left with the burden

to prove a subsequent new value defense under section 547(c)(4) of the Bankruptcy Code where

they have already admitted to overcharging the Debtors for certain services under the TSA. At

best, the HBC Parties would have a partial new value defense.

52. With respect to recharacterization of the Inventory Note, the Debtors admit that

some features of the Inventory Note bear the indicia of an equity contribution. See 9019 Motion

at ⁋ 142. The Debtors’ own analysis recognizes that HBC bears risk on this claim and thus

cannot support the extreme conclusion of non-colorability.

53. With respect to unjust enrichment, the Debtors’ analysis of this claim presupposes

that the Acquisition fraudulent transfer claim lacks merit. Under the Debtors’ theory, the estates

would be left without any adequate remedy at law. Under those circumstances, however, the

Committee has alleged a colorable claim for unjust enrichment. See, e.g., Emerald Capital

Advisors Corp. v. Bayerische Moteren Werke Aktiengesellschaft (In re Fah Liquidating Corp.),

572 B.R. 117, 131 (Bankr. D. Del. 2017) (holding that a claim for unjust enrichment can survive

a motion to dismiss where it is plausible that the plaintiff’s other claims may fail and leave the

plaintiff without a remedy at law); Halperin v. Moreno (In re Green Field Energy Servs.), Nos.

13-12783 (KG), 15-50262 (KG), 2015 Bankr. LEXIS 2914, at *33 (Bankr. D. Del. Aug. 31,

2015) (same).

3. The HBC Settlement Settles the HBC Causes of Action for Insufficient Consideration.

54. Contrary to the Debtors’ assertions in the 9019 Motion, the HBC Settlement does

not fall above the lowest point on the range of reasonableness. The Debtors contend that the


32

HBC Settlement (i) provides certainty regarding resolution of the disputes, (ii) paves the way for

a chapter 11 plan, (iii) achieves a “significant” distribution to unsecured creditors, and

(iv) enables the Debtors to continue store-closing sales. The Debtors also raise a veiled notion of

conversion to chapter 7 if litigation is brought against the HBC Parties. However, these

arguments miss the larger point – valuable claims are being settled for well below their value.

Further convoluting the Court’s assessment of the 9019 Motion, the Debtors have declined to

ascribe identifiable value to each of the individual claims against the HBC Parties such that the

Court can compare those values against the value being provided under the HBC Settlement.

Creditors are left to guess as to which specific claims the Debtors undervalued (or did not value

at all) to conjure up the grossly insufficient package of consideration in the HBC Settlement.

55. As an initial matter, it is apparent that the Debtors categorically refused to even

introduce certain colorable claims as leverage in their negotiations with HBC. Among those

claims cast aside is a claim that has the potential to return over $150 million to the estates. In

addition, the Debtors attempt to sell the HBC Settlement as meritorious on the basis that HBC

will be waiving rejection damage claims. However, rent payments, lease assumptions, and

waivers of rejection damages have little value to the estates given that those obligations were

always HBC’s, regardless of whether it acknowledged that upfront or through litigation. Lastly,

even with respect to the colorable claims the Debtors did include as leverage in their negotiations

with the HBC Parties, the HBC Settlement is not superior to litigation outcomes because HBC

not only retains its status as a secured creditor, they actually expand their collateral base to assets

that were previously unencumbered, such as the UO Claim. Under the HBC Settlement,

unsecured creditors are left to hope that the Debtors’ liquidation sales are sufficient to clear an $8

million payment to HBC in order to then receive $3 million before then sharing with the HBC


33

Parties again. If the colorable claims against the HBC Parties for recharacterization or equitable

subordination went forward, it is likely that (i) general unsecured creditors would be entitled to

payment in full before the HBC Parties, or, at a minimum (ii) they would share in distributable

proceeds at a more evenly split allocation. The HBC Settlement is a raw deal for unsecured

creditors, gifts value to the HBC Parties, and sacrifices valuable estate claims for insufficient

consideration.

ii. No Evidence of Collection Difficulties.

56. The Debtors, without any evidentiary support, represent that they would “face

significant obstacles to collection” against the HBC Parties. See 9019 Motion at ⁋ 94. HBC has

regularly certified under its secured loans that it has sufficient liquidity to meet the rent

obligations owed under the APA. In addition, HBC is a massive retail company, with hundreds

of retail locations across the United States and Canada. Although the Debtors implicate that the

COVID-19 pandemic may have placed HBC in distress, many retailers have weathered the storm

to date and news of progress on vaccine development and distribution suggest better days are

ahead for retailers. The Debtors’ assertion that HBC would be unable to satisfy a potential

judgment is pure speculation, has no provable basis, and should not be accepted by the Court.

57. Moreover, this argument incorrectly assumes that HBC’s ability to pay is even a

necessary prerequisite for a favorable outcome to the estates. To the contrary, even if HBC were

unable to pay an affirmative judgment, the estates could still achieve superior outcomes to the

HBC Settlement by altering the nature of HBC’s claims against the estates. For example, if the

recharacterization and equitable subordination claims are successful, they would entirely

eliminate the HBC Parties’ rights to recover from the estates, providing greater recoveries to

general unsecured creditors without accounting for HBC’s ability to satisfy a judgment.

Accordingly, this factor weighs heavily against approving the HBC Settlement.


34

iii. The Litigation Involved is Not Prohibitively Expensive or Complex.

58. The Debtors do not set forth any cognizable evidence showing that the litigation

will be overly complex. Indeed, the Debtors acknowledge that for certain claims, such as the

Inventory Note preference claim, the prima facie elements are easily met and the predominate

portion of any litigation expenses would likely be borne by the HBC Parties in attempting to

prove affirmative defenses. Other claims, such as recharacterization and equitable subordination

have already been well developed in the context of the Restructuring Committee and

Committee’s investigations. These claims all involve well-settled law with few novel issues.

59. In order to justify their entry into the inadequate HBC Settlement, the Debtors

confess that their “most salient consideration” is that the HBC Parties’ are their “single

remaining secured creditor” and hold the keys to cash collateral. See 9019 Motion at ⁋ 89.

Secondarily, the Debtors also express concern that any litigation against the HBC Parties would

have “negative impacts to the Debtors’ business relationship” with the HBC Parties and

potentially jeopardize services contractually owed by HBC under the TSA. See 9019 Motion at ⁋

90. These are conflicts, not justifiable bases to forego engaging contingency counsel or seeking

litigation funding, which are commonly explored in these situations. Despite the Debtors’

misguided argument to the contrary, this factor does not carry weight to support the 9019

Motion.

iv. Paramount Interest of Creditors Supports Denial of 9019 Motion.

60. The Committee, having conducted an independent investigation of the facts and

circumstances supporting the Counts in the Complaint, does not believe the HBC Settlement

adequately protects creditors’ interests. The Committee’s opposition to the 9019 Motion

significantly weighs in favor of denying the motion. See Conn. Gen. Life Ins. Co. v. United Cos.

Fin. Corp. (In re Foster Mortgage Corp.), 68 F.3d 914, 918 (5th Cir. 1995) (finding that both


35

the bankruptcy court and district court erred in approving a settlement agreement under FRBP

9019 that “was reached between insiders without the participation of the creditors ... [thus] not

showing proper deference to the views of the creditors.”); In re Matco Elecs. Grp., Inc., 287 B.R.

68, 78 (Bankr. N.D.N.Y. 2002) (considering a committee’s exclusion from meaningful

settlement negotiations and disapproval of the resulting settlement as “‘red flags’” justifying

denial of a motion to approve under Rule 9019).

61. The HBC Settlement is not favorable to creditors and a chapter 7 liquidation is not

a likely outcome in the event litigation proceeds against the HBC Parties.19 As an initial matter,

the lien challenges against the HBC Parties, if successful at the outset, would free up material

value for the estates to use to fund litigation. Even if the lien challenges were not immediately

successful, the possibility of a contingency fee arrangement or litigation funding could be used to

support litigation. These tools are routinely used under similar circumstances.

62. Lastly, the recoveries promised to general unsecured creditors under the HBC

Settlement are misleading. General unsecured creditors bear all of the risk of lower-than-

expected liquidation sales which could lead to no or miniscule recoveries for general unsecured

creditors. Even if the Committee was only successful on one of the claims deemed colorable by

the Restructuring Committee, it would effectively knock the HBC Parties down the waterfall and

better position unsecured creditors, even accounting for any litigation risk.

II. THE STANDING MOTION SHOULD BE GRANTED

63. In addition to denying the 9019 Motion, the Court should grant the Committee’s

Standing Motion to ensure that the estates’ claims against HBC are prosecuted by an

unconflicted and unbiased estate representative. In response to the Standing Motion, the Debtors

19 In the immediate term, HBC has every incentive to continue supporting the Debtors’ operations and liquidation sales in order to receive TSA payments and maximize any recoveries on account of their purportedly secured claims.


36

argue that they are pursuing the colorable causes of action against the HBC Parties through the

HBC Settlement. See 9019 Motion at ⁋ 108. The Committee agrees that the pure act of “settling

does not mean the Debtors refused to pursue claims,” as the Debtors suggest. Id. at ⁋ 109.

However, when determining whether a different estate fiduciary should take the reins on

maximizing value for the estates’ stakeholders, the Debtors having attempted to settle colorable

claims for well below their value is effectively the same as refusing to pursue them.

64. Most importantly, however, the Debtors categorically refused to pursue certain

claims that are colorable. If the 9019 Motion is denied on the grounds described above, the

Committee should be given standing to pursue all colorable claims against the HBC Parties.

The Committee has already spent time and effort preparing the Complaint and investigating the

underlying facts included therein. The Committee stands ready to vigorously advance the

estates’ interests, something the Debtors have demonstrably failed to do.

A. The Fourth Circuit Does Not Prohibit Granting Standing to the Committee.

65. In an effort to subvert the Court from the substance of the issues, the Debtors

contend that, in the Fourth Circuit, it is “far from self-evident” that a creditor could ever be

granted derivative standing. See 9019 Objection at ⁋ 106. As the Committee set forth in its

Standing Motion, there is broad judicial consensus that a creditors’ committee can be granted

standing to pursue claims on behalf of a debtor’s estate. Indeed, the majority of circuit courts

addressing the issue have made it clear that bankruptcy courts may allow a party other than the

trustee or debtor-in-possession to pursue an estate’s causes of action. See, e.g., Official Comm.

of Unsecured Creditors of Cybergenics Corp. v. Chinery, 330 F.3d 548, 552 (3d Cir. 2003)

(holding that Hartford Underwriters did not prevent bankruptcy courts from authorizing

committees to bring fraudulent transfer claims); In re Applied Theory Corp., 493 F.3d 82, 85-86

(2d Cir. 2007) (reaffirming a “qualified right” for a creditors’ committee to sue on derivative


37

actions post-Hartford Underwriters, but affirming lack of standing where committee had not

obtained court approval to pursue claims and where claims would not benefit the estate); PW

Enters., Inc. v. North Dakota (In re Racing Services, Inc.), 363 B.R. 911, 916 (B.A.P. 8th Cir.

2007) (“Every circuit court which has addressed this issue since the Hartford Underwriters

opinion was decided has recognized the possibility of derivative standing to pursue avoidance

actions on behalf of a bankruptcy estate.”).

66. Although the Fourth Circuit has not definitively ruled on the issue of standing for

creditors’ committees,20 courts within the Fourth Circuit have consistently held that derivative

standing granted to an individual creditor or creditors’ committee is appropriate if (i) the movant

has alleged a colorable claim that would benefit the estate; (ii) the trustee has unjustifiably

refused to pursue the claim itself; and (iii) the movant has obtained permission from the

bankruptcy court to initiate the action on behalf of the estate. See, e.g., SunTrust Bank v. Matson

(In re CHN Constr., LLC), 531 B.R. 126, 132 (Bankr. E.D. Va. 2015) (acknowledging that courts

in the district looked to the following factors to determine whether a creditors’ committee is

entitled to derivative standing: “(1) the trustee had unreasonably refused to commence the

lawsuit on his own; and (2) the lawsuit was (a) in the best interest of the bankruptcy estate, and

(b) is necessary and beneficial to the fair and efficient resolution of the bankruptcy

proceedings.”); Airocare, Inc. v. Chambers (In re Airocare), No. 10-14519-RGM, 2011 Bankr.

LEXIS 1324, at *4-5 (Bankr. E.D. Va. April 1, 2011) (endorsing same factors); Lehman Cap. v.

Official Comm. of Unsecured Creditors of Fas Mart Convenience Stores, Inc. (In re Fas Mart

Convenience Stores, Inc.), No. 3:03-CV-359, 2003 WL 22048024 at *5 (E.D. Va. 2003) (holding

20 See Scott v. Nat’l Century. Fin. Enters., Inc. (In re Baltimore Emergency Servs. II, Corp.), 432 F.3d 557, 560 (4th Cir. 2005).


38

that a creditors’ committee may initiate an adversary proceeding to bring claims on behalf of an

estate after seeking leave from the court to do so).

B. The Committee Has Demonstrated that Standing is Warranted.

67. Given the Debtors’ flawed approach to resolving all of the claims and causes of

action against the HBC Parties, the elements of the SunTrust test are clearly met. If there were

ever circumstances under which a committee should be granted standing, those circumstances

are present here. The Debtors have settled claims they deemed to be colorable for insufficient

value, while ascribing zero value to other colorable claims – throwing them away under the

pressure of disqualifying conflicts and biases without bargaining for adequate consideration in

exchange. Meanwhile, the Committee remains prepared to step in immediately and make sure

that all colorable claims are pursued, either through litigation or negotiating an enhanced version

of the HBC Settlement.

i. The Committee Has Asserted Colorable Claims that Would Benefit the Estates.

68. There is no dispute between the Debtors and the Committee that the estates hold

viable claims against the HBC Parties. For purposes of the SunTrust analysis, the question

centers on how many colorable claims exist. The Committee has determined there are more

colorable claims than the Debtors have settled under the HBC Settlement, including claims that

were overlooked with respect to attacking the Acquisition as a constructive fraudulent transfer

and challenging the HBC Parties’ purported liens.

69. As a threshold matter, despite not disputing that a colorability analysis under a

standing motion only requires the Committee to prove that such claims could survive a motion to


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dismiss,21 the Debtors improperly introduce extensive charts (likely prepared by BRG) that

purport to demonstrate that the fraudulent transfer claim is not colorable. This is improper. It is

well-settled that fraudulent transfer claims, and in particular issues relating to insolvency and

reasonably equivalent value, implicate expert testimony and are typically resolvable only at a

trial. See In re Charys Holding, 443 B.R. at 638. Simply put, the Debtors cannot bypass a

motion to dismiss, fact discovery, expert discovery, and summary judgment and rely upon

conclusory charts that have not been subjected to the scrutiny associated with the pre-trial

process. The Court should refuse to consider the Debtors’ unsupported assertions in

Section IX.B.1 of the 9019 Motion. Instead, the Court should accept the well-plead allegations

in the Complaint as true, and conclude that the Committee has asserted fraudulent transfer claims

that easily survive a motion to dismiss.

70. As discussed in Section I.B.i.2 above, the Counts in the Complaint deemed not

colorable by the Debtors are likely to succeed on the merits, and, at a bare minimum, are

certainly sufficient at this stage in the Committee’s investigation to survive a motion to dismiss.

ii. The Debtors Unjustifiably Refuse to Pursue Colorable Claims.

71. The Debtors have unjustifiably refused to pursue colorable claims and instead

entered into the HBC Settlement. Most egregious is the Debtors’ decision to ascribe zero value

to the Acquisition fraudulent transfer claim. It confounds reason. It leaves the Committee to

presume that the Debtors’ conflicts and biases played a role in their analysis of the claims as

valueless.

21 See Standing Motion at ⁋⁋ 25 – 28 for a discussion of the appropriate standard for colorability under a standing analysis. The Committee need only establish the existence of a plausible claim and that the cause of action has value to the Debtors’ estates – a bar surpassed by the Complaint. Under either a “serious issues” test or a “motion to dismiss” test, the extensive factual allegations and Counts asserted by the Committee in the detailed Complaint far exceed the requirements of the colorability threshold.


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72. The requisite showing for “colorability” is a low threshold to satisfy. See, e.g.,

Adelphia Commc’ns Corp. v. Bank of Am., N.A. (In re Adelphia Commc’ns Corp.), 330 B.R. 364,

376 (Bankr. S.D.N.Y. 2005) (“Caselaw construing requirements for ‘colorable’ claims has made

it clear that the required showing is a relatively easy one to make”); cf., Brown v. Chesnut (In re

Chesnut), 400 B.R. 74, 82 (N.D. Tex. 2009), aff'd, 356 F. App’x 732 (5th Cir. Dec. 17, 2009)

(“‘colorable claim’” approximates “arguable claim”). Further, the standing motion stage of

proceedings does not exist to protect defendants and exists only to ensure that the proposed

litigation “will not be a hopeless fling.” In re Adelphia Commc’ns Corp., 330 B.R. at 386.

73. There are genuine disputes between the Debtors and the Committee over the

viability of the Acquisition fraudulent transfer claim and the lien challenges to HBC’s purported

liens. However, the Debtors have lost sight of the applicable standard for discarding claims in

this context. All of the Counts in the Complaint are adequately pled and would survive a motion

dismiss. With that backdrop, the Debtors cannot pick and choose certain Counts to include in the

negotiations over the HBC Settlement. They certainly cannot selectively exclude the Counts that

would open a door for fiduciary duty claims against their directors and officers at the expense of

the estates’ other stakeholders.22 Maximizing value for the estates must remain the paramount

goal, and, in light of the grossly inadequate consideration provided to the estates under the HBC

Settlement, the Debtors appear to have refused to pursue colorable claims in order to advance

other interests.

CONCLUSION

74. The HBC Settlement proposes to release valuable estate claims against the HBC

Parties without netting proportionate value in return. Whether this failure is a result of the

22 There is no dispute over the third factor of the SunTrust test, as the Committee has sought Court permission through its Standing Motion to pursue claims prior to initiating an adversary proceeding or filing the Complaint.


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Debtors miscalculating the value of these claims or the Debtors suffering from conflicts or

biases, the HBC Settlement does not satisfy the Rule 9019 standard. Instead of giving the

Debtors another turn at bat, the Court should grant the Committee standing to pursue the estates’

claims against HBC, as set forth in the Committee’s Complaint and Standing Motion.


This Objection and this Reply are submitted without prejudice to, and with a full

reservation of, the Committee’s rights to object to confirmation of the Plan or any other plan of

reorganization proposed in these cases on any and all grounds. The Committee also reserves all

rights to raise additional arguments and present evidence and testimony at the hearings on the

9019 Motion and the Standing Motion.


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WHEREFORE, the Committee respectfully requests entry of an order denying the 9019

Motion, granting the Standing Motion, and granting such other and further relief as the Court

deems just and proper.

Dated: January 26, 2021 Respectfully submitted, /s/ Cullen D. Speckhart COOLEY LLP COOLEY LLP Cullen D. Speckhart (VSB 79096) Jay R. Indyke (admitted pro hac vice) Dana J. Moss (VSB 80095) Ian Shapiro (admitted pro hac vice) 1299 Pennsylvania Avenue, NW, Suite 700 Michael Klein (admitted pro hac vice) Washington, DC 20004-2400 Evan Lazerowitz (admitted pro hac vice) Telephone: (202) 842-7800 Paul Springer (admitted pro hac vice) Facsimile: (202) 842-7899 55 Hudson Yards New York, NY 10001 Telephone: (212) 479-6000 Facsimile: (212) 479-6275 Counsel to the Official Committee of Unsecured Creditors of Le Tote, Inc., et al. 242352388


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