MIKE K. NAKAGAWA, Bankruptcy Judge.
On October 5, 2016, the court heard the Emergency Motion to Extend Time in Which to File an Amended Plan of Reorganization and Disclosure Statement ("Emergency Motion"). The appearances of counsel were noted on the record. After arguments were presented, the matter was taken under submission.
On September 9, 2011, a voluntary Chapter 11 proceeding was commenced by Kerensa Investment Fund 1, LLC ("Kerensa 1"), denominated Case No. 11-24352-MKN.
On October 25, 2012, Submarina filed a voluntary Chapter 11 petition for reorganization. (Submarina ECF No. 1). The bankruptcy petition is also signed by Rosenthal as the president and chief executive officer of Submarina. According to the List of Equity Security Holders, the voting common stock of Submarina is held by: Kerensa 1 (2,198,958 shares), Robert Pina (532,500 shares), Zeller (169,926 shares) and Rosenthal (19,064 shares). (Submarina ECF No. 11).
On December 24, 2012, Submarina filed a motion to assume and reject certain franchise agreements and executory contracts ("Assumption Motion"). (Submarina ECF No. 36).
On March 27, 2013, Submarina commenced Adversary Proceeding No. 13-01051-MKN ("First Adversary"), against numerous franchisees seeking damages for breach of the individual franchise agreements with each named defendant. The adversary complaint asserted that the named defendants failed to pay royalties and certain fees related to marketing and promotion of the Submarina brand.
On July 24, 2013, an order was entered granting Submarina's motion to obtain postpetition, debtor in possession financing ("DIP Loan") not to exceed $450,000, from an entity known as Kerensa Investment Fund 2, LLC ("Kerensa 2"). (Submarina ECF No. 192). Kerensa 2 is owned and managed by Rosenthal.
On September 12, 2013, an order was entered requiring the Submarina and Kerensa 1 reorganization proceedings to be jointly administered, with the Submarina proceeding designated as the lead case.
On January 13, 14, 16, and 17, 2014, a combined trial was conducted encompassing factual and legal issues arising in connection with the Assumption Motion and the First Adversary.
On March 24, 2016, Submarina filed in the First Adversary an Ex-Parte Motion for Preliminary Injunction on an Order Shortening Time (AECF No. 218) without filing a request for an order shortening time as required by Local Rules 9014(a)(2) and 9006(a).
On March 29, 2016, the clerk of the court issued a notice informing Submarina that the ex parte motion had an incorrect case caption as well as incorrect defendant names.
On March 30, 2016, Submarina filed an Amended Ex-Parte Motion for Preliminary Injunction on an Order Shortening Time ("PIJ Motion") (AECF No. 222), but again did not file a request for order shortening time.
On April 11, 2016, Submarina finally filed a request for order shortening time to hear its PIJ Motion. (AECF No. 225).
On April 13, 2016, a Motion to Convert ("Conversion Motion") was filed by SD Subros, Inc., Subros, Inc., EDRC LLC, J&C Mason Inc., JTJM Inc., J & J Subs Inc., Masquerade, Inc., JTW Area Developers Inc., Vonnie Audibert and Paul Simmons ("Subros Parties"). (Submarina ECF No. 426). Some of the moving parties were also named as defendants in the First Adversary. All of the moving parties sought to convert the Chapter 11 proceeding to a Chapter 7 liquidation proceeding whereupon a bankruptcy trustee would be appointed. The Conversion Motion was noticed to be heard on May 18, 2016.
On April 14, 2016, an order was entered scheduling the PIJ Motion to be heard on April 28, 2016. (AECF No. 226). On April 15, 2016, Submarina finally served its motion on the entities for which it sought injunctive relief. (AECF No. 228).
On April 15, 2016, an order was entered granting the Assumption Motion. (Submarina ECF No. 433). On the same date, a judgment was entered in the First Adversary awarding damages against numerous defaulting franchisees in favor of Submarina. (AECF No. 230). Contemporaneously with that order and the judgment, a combined memorandum decision was entered setting forth the court's findings of fact and conclusions of law with respect to both matters ("Trial Decision"). (Submarina ECF No. 432 and AECF No. 229).
On April 28, 2016, counsel for Submarina and the Subros Parties (and perhaps others) appeared before the court in connection with Submarina's PIJ Motion. Counsel requested that a settlement conference be scheduled in light of the judgment entered in the First Adversary. The hearing on the PIJ Motion was continued to May 18, 2016, i.e., the same date as the hearing on the Conversion Motion.
On April 29, 2016, at the request of the parties, an order was entered scheduling a settlement conference with respect to all disputes. (AECF No. 247).
On May 6, 2016, Submarina filed opposition to the Conversion Motion. (Submarina ECF No. 442).
On May 13, 2016, the Subros Parties filed their reply in support of the Conversion Motion. (Submarina ECF No. 445).
On May 16, 2016, a settlement conference was held without success.
On May 23, 2016, an order was entered denying the Conversion Motion ("Conversion Order"), but setting specific deadlines for Submarina to complete its reorganization. (Submarina ECF No. 449). That order required Submarina to file a joint plan of reorganization along with a proposed disclosure statement no later than June 23, 2016. The order further established a deadline of August 24, 2016, for Submarina to confirm a Chapter 11 plan.
On June 23, 2016, Submarina filed a proposed Chapter 11 plan ("Plan") along with a proposed disclosure statement in compliance with the Conversion Order.
On July 22, 2016, Submarina filed a First Amended Disclosure Statement (Submarina ECF No. 457) along with an ex parte motion to conditionally approve that disclosure statement ("Conditional Approval Motion"). (Submarina ECF No. 458).
On July 25, 2016, an order was entered denying the Conditional Approval Motion without prejudice to Submarina filing an ex parte request to extend the plan confirmation deadline set forth in the Conversion Order.
On August 2, 2016, an order was entered extending the confirmation deadline, conditionally approving the First Amended Disclosure Statement, and scheduling a combined hearing on final disclosure statement approval and plan confirmation for September 28, 2016. (Submarina ECF No. 476).
On August 10, 2016, Submarina commenced an additional adversary proceeding denominated Adversary No. 16-01095, naming a variety of existing and former franchisees, many of which were named as defendants in its previous adversary complaints ("Second Adversary"). Many of the defendants are parties who brought the Conversion Motion, or are parties that were the subject of the PIJ Motion that was never rescheduled for hearing.
On September 2, 2016, a Motion to Compel Arbitration ("Arbitration Motion") was filed by various defendants in the Second Adversary. (AECF No. 66). That motion sought to compel arbitration of the claims set forth in the Second Adversary proceeding under the arbitration clauses of the underlying franchise agreements. The Arbitration Motion was noted to be heard on October 5, 2016. (AECF No. 68). The Arbitration Motion was amended (AECF No. 70), but was noticed to be heard on the same date. (AECF No. 71).
On September 12, 2016, an objection to the First Amended Disclosure Statement was filed by the Subros Parties and perhaps others, many of whom are franchisees. (Submarina ECF No. 495). Those same parties also objected to confirmation of the proposed Plan. (Submarina ECF No. 496). Both of those objections were joined by creditor Zeller.
On September 20, 2016, Submarina filed opposition to the Arbitration Motion. (AECF No. 85).
On September 21, 2016, Submarina filed the instant Emergency Motion by which it now seeks to extend the time to file a proposed amended plan of reorganization and amended disclosure statement until ninety days after resolution of the Second Adversary. In other words, Submarina seeks relief from the confirmation bar date established by the Conversion Order for an indeterminate amount of time.
On September 23, 2016, an order shortening time was entered so that the Emergency Motion could be heard on September 28, 2016, along with the combined hearing on final approval of the First Amended Disclosure Statement and on confirmation of the Debtor's proposed Plan. (Submarina ECF No. 513).
On September 27, 2016, opposition to the Emergency Motion was filed by the Subros Parties, accompanied by the Declaration of Jeanette E. McPherson ("McPherson Declaration"). (Submarina ECF Nos. 516, 517). Joinder in that opposition was filed by creditor Zeller. (Submarina ECF No. 519).
On September 28, 2016, a reply in support of the Arbitration Motion was filed. (AECF No. 86).
On September 28, 2016, the Emergency Motion was continued to October 5, 2016, to be heard concurrently with the Arbitration Motion.
After the Emergency Motion and Arbitration Motion were heard on October 5, 2016, both matters were taken under submission.
The court having reviewed the Emergency Motion, the response filed by the Subros Parties, the joinder by Zeller, the previously filed Plan and First Amended Disclosure Statement, and the entire record in this proceeding, concludes that the Emergency Motion must be denied.
Submarina's proposed Plan consists of seven classes of claims or interests, the seventh of which consist of its equity interest holders. As previously mentioned, the shareholders of Submarina are: debtor Kerensa 1 (2,198,958 shares), Robert Pina (532,500 shares), Zeller (169,926 shares) and Rosenthal (19,064 shares). The equity interest in Kerensa 1 is held 99 percent by Rosenthal and 1 percent by Kerensa & Company. For purposes of Section 1129(a)(10), acceptance by at least one impaired class is determined without reference to acceptance by an insider class. Under Section 101(31), the equity interest holders are insiders of Submarina as well as Kerensa 1.
The only other impaired class under the proposed Plan is Class Six, which consists of the general unsecured creditors of Submarina. Holders of claims in the general usecured creditors class either get paid in full if Submarina is able to collect on judgments obtained against various franchisees, or, get paid on a pro rata basis from the judgment collections over a period of 120 months. If no funds are recovered on the judgments, Class Six does not provide any other source of funds for any payments to unsecured creditors. Zeller apparently is the holder of the largest unsecured claim in Class 6.
That four creditors submitted ballots on the proposed Plan raises the inference that sufficient information was provided for a hypothetical reasonable investor to vote to accept or reject Submarina's proposed Plan. Adequacy of the disclosure aside, however, the ballots submitted in Class Six more clearly evidence that Submarina currently has zero possibility of confirming a plan. The Plan consists of only two impaired classes, Classes Six and Seven, and Class Seven cannot satisfy the acceptance requirement for plan confirmation under Section 1129(a)(10). Because the only other impaired class, i.e., unsecured Class Six, rejects the proposed plan treatment, there are no impaired accepting classes at all. Without any impaired accepting classes, Submarina has no ability whatsoever to seek to cramdown its proposed treatment of claims in Class Six pursuant to Section 1129(b)(2)(B).
Even if Submarina could obtain acceptance by some other impaired accepting class, any attempt to cramdown on a dissenting unsecured class likely runs afoul of the absolute priority rule
Under Class Seven, which curiously is described as both impaired and unimpaired by the Plan,
Generally, the sole source of any payments made under the proposed Plan will be from operating income and collection of judgments obtained against defaulting franchisees.
According to Rosenthal's written testimony, any judgments obtained against defaulting franchisees, including Warfield, may be uncollectible.
In this instance, Kerensa 2 is an affiliated insider of Submarina that is owned by Rosenthal. Rosenthal directly owns substantially all of the equity interest in Kerensa 1, which in turn owns more than 75% of the equity interest in Submarina. Under the proposed Plan, Kerensa 2 receives not just the exclusive opportunity to acquire the equity interest in the reorganized Submarina entity, but is simply given the entire equity interest in the reorganized Submarina entity. Even if there is an impaired class that accepted the proposed Plan, and even if the new value corollary to the absolute priority rule is valid, Submarina's proposed treatment of its unsecured creditors fails to meet the fair and equitable requirements of Section 1129(b)(2)(b)(ii).
More important, the Plan proposed by Submarina transfers all of the interest in the reorganized entity to Kerensa 2 and then the reorganized debtor proceeds as an operating entity, rather than liquidating. The legal result of confirming the proposed Plan would be that the reorganized debtor receives a discharge of all of its unsecured debts pursuant to Section 1141(d)(1)(A) because the disability imposed by Section 1141(d)(3) would not apply. The discharge would be effective immediately upon confirmation because there is no provision in the Plan delaying its effective date. See Plan, Article IX, page 21. The revested debtor, controlled by Rosenthal through his interest in Kerensa 2, would be relieved of personal liability for all prepetition claims, without any requirement that the claims in Class Six ever get paid if there are no funds collected from defaulting franchisees beyond the amounts needed to pay administrative claims of the professionals and Kerensa & Company.
Confirmation under Chapter 11 requires that the subject plan of reorganization be proposed in good faith. 11 U.S.C. § 1129(a)(3). It is well established that a plan of reorganization is proposed in good faith only if, under all of the circumstances, it will "fairly achieve a result consistent with the objectives and purposes of the Bankruptcy Code."
The Plan proposed by Submarina evidences that after more than five years in Chapter 11, Kerensa 1 and Submarina are unable or perhaps unwilling to propose a confirmable plan of reorganization. Submarina seeks additional time to propose an amended plan some point after it obtains an additional judgment against various defaulting franchisees in the Second Adversary, even though it already obtained a prior judgment in the First Adversary against various defaulting franchisees. As previously discussed at note 25, Rosenthal has acknowledged that any judgments obtained by Submarina against defaulting franchisees may well be uncollectible. No evidence is offered of a different reality that will exist if Submarina prevails in the Second Adversary.
On the uncollectibility score, Rosenthal may well be correct, but that possibility does not prevent Submarina from proposing a confirmable plan. Nothing prevents the holders of equity interests in Submarina, Kerensa 1, or any business for that matter, from contributing new capital to protect their original investments in an ongoing business. Outside of bankruptcy, there are few impediments to equity interest holders taking such steps at the risk of "throwing good money after bad." Inside any bankruptcy proceeding, however, court approval is required for the disposition of estate property because the risk of loss falls upon unsecured creditors.
In a Chapter 11 proceeding, fair and equitable treatment of dissenting unsecured creditors requires that they be paid in full under Section 1129(b)(2)(B)(i). Alternatively, dissenting unsecured creditors must have an opportunity under Section 1129(b)(2)(B)(ii) to acquire equity in the reorganizing debtor. Finally, even if unsecured creditors are provided an opportunity to acquire equity in the reorganizing debtor, new value in the form of money or money's worth must be contributed by existing equity holders that want to retain an equity position in compliance with Section 1129(b)(2)(B)(ii). There is no mystery to these requirements and the limitations imposed by the Court in its
The court already granted so Submarina and Kerensa 1 on an ex parte basis, one extension of the confirmation deadline set forth in the Conversion Order. In light of the previous discussion, Submarina and Kerensa 1 have failed to meet their burden of establishing that an additional extension of the plan confirmation deadline is warranted.
The court is mindful that other franchisees have an interest in the ongoing operations of Submarina.
In late 2008, Submarina began to struggle. Warfield contacted Rosenthal for assistance in procuring a potential investor, or alternatively, a purchaser of the company. Rosenthal apparently was unable to secure an outside investor, but he made several personal loans to the ailing Submarina operation. In September 2009, Rosenthal purchased Submarina through his company, Kerensa Investment Fund 1, LLC. After the sale of the company to Rosenthal, Warfield resigned as CEO, and, in lieu of stock, he received certain "area developer rights" for Riverside County as part of his separation agreement. At the time the separation agreement was entered, along with an area developer agreement for Riverside County, there were eight Submarina stores operating in the area, which he thereafter expanded to eighteen stores.
On October 14, 2011, Zeller had filed Proof of Claim 2-1 in the Kerensa 1 proceeding, in the approximate amount of $338,000, based on a promissory note executed by Kerensa 1, dated December 31, 2009.
