MIKE K. NAKAGAWA, Bankruptcy Judge.
On January 5, 2017, the court heard the Motion to Reconsider Order on Emergency Motion to Extend Time in Which to File an Amended Plan of Reorganization and Disclosure Statement ("Reconsideration Motion") brought by Kerensa Investment Fund 2, LLC.
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). Submarina's primary liquid assets consist of accounts receivable owed by various franchisees ("Franchisee AR's") and a limited amount of equipment.
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").
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 reorganization 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, an order was entered scheduling the requested 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 but without success.
On May 23, 2016, an order was entered denying the Conversion Motion ("Conversion Order"), but setting specific deadlines for Submarina and Kerensa 1 to complete their 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 the debtors in possession to confirm a joint Chapter 11 plan.
On June 23, 2016, Submarina filed a proposed Chapter 11 plan as debtor in possession ("DIP 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 complaint ("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 noticed 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 DIP 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 its Emergency Motion to Extend Time in Which to File An Amended Plan of Reorganization and Disclosure Statement ("Emergency Motion") by which it sought 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 sought 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 DIP 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. (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.
On November 9, 2016, an order was entered denying the Emergency Motion and scheduling a further status hearing on November 30, 2016, with respect to the Subros Parties' Conversion Motion ("Emergency Motion Order"). (Submarina ECF No. 535). In the Emergency Motion Order, the court concluded that in response to the Conversion Order, Submarina had filed a proposed plan of reorganization that could not be confirmed under Section 1129. Among the reasons that the DIP Plan could not be confirmed, there was no accepting impaired class of creditors to satisfy Section 1129(a)(10). More important, even assuming there was an accepting impaired class to permit cramdown to be attempted under Section 1129(b), the treatment of dissenting unsecured creditors still did not satisfy the fair and equitable requirements of Section 1129(b)(2)(B) as interpreted by the Supreme Court in
On November 21, 2016, Kerensa 2, rather than the debtors in possession, filed the instant Reconsideration Motion. (Submarina ECF No. 539). On the same date, Kerensa 2 filed a joint plan of reorganization ("Kerensa 2 Plan") along with a proposed disclosure statement ("Kerensa 2 Disclosure Statement"). (Submarina ECF Nos. 540, 541). Kerensa 2 noticed its Reconsideration Motion to be heard on January 18, 2017. (Submarina ECF No. 543).
On November 30, 2016, the status hearing was held on the Conversion Motion. As a result of the status hearing, the hearing on the Reconsideration Motion was rescheduled for January 5, 2017, and deadlines were set for oppositions and replies to be filed. (Submarina ECF No. 550). The hearings on all other pending motions were continued.
On December 22, 2016, opposition to the Reconsideration Motion was filed by the Subros Parties ("Subros Opposition"), along with numerous declarations from various franchisees. (Submarina ECF Nos. 556, 557, 558, 559, 560,561, 562, 563, 564). On the same date, a joinder in that opposition was filed by creditor Zeller ("Zeller Joinder"). (Submarina ECF No. 565).
On December 29, 2016, Kerensa 2 filed its reply ("Kerensa 2 Reply"). (Submarina ECF No. 568). The reply was accompanied by numerous declarations from various creditors stating that "If given the opportunity I would vote to approve the Plan of Reorganization proposed by Kerensa Investment Fund 2, LLC.". (Submarina ECF Nos. 569, 570, 571, 572, 573, 574, 575, 576).
On January 5, 2017, the rescheduled hearing was conducted on the Reconsideration Motion. The appearances of counsel were noted on the record. After arguments were presented, the matter was taken under submission.
The court having reviewed the Reconsideration Motion, the response filed by the Subros Parties, the joinder by Zeller, the Plan and First Amended Disclosure Statement previously filed Submarina, the Kerensa 2 Plan, the Kerensa 2 Disclosure Statement, and the entire record in this proceeding, concludes that the Reconsideration Motion must be denied. Moreover, the court also concludes that the appointment of a Chapter 11 trustee is appropriate pursuant to Section 1104(a)(2).
At the outset, the court notes that the Reconsideration Motion is brought by Kerensa 2, an insider, postpetition creditor, rather than by either of the Chapter 11 debtors, i.e., Kerensa 1 and Submarina. Moreover, neither of the Chapter 11 debtors filed a written joinder in the Reconsideration Motion although a belated oral motion for joinder was made at the hearing.
As presented, there is no relief requested from the operative provisions of the Emergency Motion Order and therefore no grounds for reconsideration under FRCP 59(e) or FRCP 60(b).
The court also notes that Kerensa 2 currently is represented by counsel who previously represented the Chapter 11 debtors in these proceedings.
Whether or not such waivers were ever executed is immaterial, however, because all of the clients are controlled by the same individual, i.e., Rosenthal. It is hardly a surprise that Rosenthal would execute a written waiver that directly benefits himself. The actual surprise is that both Kerensa 1 and Submarina, as Chapter 11 debtors in possession, have largely ignored their fiduciary obligations to creditors of their bankruptcy estates.
The failure of Kerensa 1, Submarina, and now Kerensa 2, to appreciate the fiduciary obligations of a debtor in possession is amply illustrated by the Kerensa 2 Plan and the arguments presented at the hearing.
Instead of the seven classes proposed in the DIP Plan, the Kerensa 2 Plan consists of only three classes, with no class at all for the equity interest holders of Kerensa 1 and Submarina.
All three classes in the Kerensa 2 Plan are impaired and all three classes are unsecured. Zeller's unsecured claim is paid in a substantially reduced amount in separate Class One, unsecured claims that are less than or which are voluntarily reduced to $1,000 or less will be paid 50 cents on the dollar in separate Class Two, and all other unsecured claims will be paid pro rata in separate Class Three. Even though Section 1123(a)(1) requires Chapter 11 plans designate,
According to Kerensa 2's counsel, Zeller's unsecured claim under the Kerensa 2 Plan can be separately classified from other general unsecured creditors, because Zeller's claim is against both Chapter 11 estates
Under Class One, Zeller's unsecured claim in the amount of $431,151.57 is treated by giving her a three-year $300,000 promissory note ("Zeller Note") apparently payable by an entity identified as Sub Solutions Company, LLC ("SSC").
Under Class Two, general unsecured creditors holding claims of $1,000 or less, or who agree to reduce their claims to $1,000, will be paid 50 percent of that claim either within 30 days of the effective date of the Kerensa 2 Plan,
Under Class Three, all other general unsecured creditors that Kerensa 2 estimates to have claims totaling approximately $700,000, will be paid pro rata solely from amounts recovered from the Adversary Actions.
"Insider Administrative Claim" is not defined in the Kerensa 2 Plan, but the term presumably was meant to refer to Insider Priority Claims defined under Section 2.01(C) of the proposed plan. But exactly what "administrative fees are due to insiders of the Debtors?" Kerensa 2 itself is an insider of the Debtors. Under the Kerensa 2 Plan, SSC will pay Kerensa 1 the amount of $312,000 to "purchase 100% of the equity of Kerensa 1." Kerensa 2 Plan at 10:16-17. This makes little sense because the equity in Kerensa 1 is held by 99 percent by Rosenthal and 1 percent by Kerensa & Company. Is SSC purchasing Rosenthal's and Kerensa & Company's interests in Kerensa 1? Kerensa 1 owns 2,198,958 shares of voting common stock in Submarina, while 532,500 shares are owned by Robert Pina, 169,926 shares are owned by Zeller, and 19,064 shares are owned by Rosenthal. Is SSC purchasing Kerensa 1's equity interest in Submarina? The latter seems more plausible as it would give Kerensa 1 a source of funds to make a new value contribution. Kerensa 1 will then contribute the $312,000 received from SSC to Submarina in exchange for 312,200,000 shares of stock in Submarina.
Kerensa & Company also is an insider of the Debtors. But Kerensa & Company already is being paid $675,000 from the Adversary Action proceeds. So if it is not Kerensa 2 nor Kerensa & Company, who or what are the other insiders of the Debtors who may have administrative claims? Apparently, the disclosed insiders, according to Kerensa 2, are: Rosenthal, Victoria A. Wofford, Kerensa 1, Kerensa 2, SSC, Kerensa & Company, and Submarina.
The other "general administrative claims" that also are paid from the Adversary Action recoveries, before Class Three general unsecured creditors are paid, are non-insiders. Under the Kerensa 2 Plan, these claims are limited to professional fees allowed under Section 330, as well as any other non-insider priority claims under Section 507(a)(1).
As the foregoing discussion illustrates, for Class One and Class Two, there is certainty that even under the best of circumstances, none of the holders of the unsecured claims will be paid in full. For Class Three, there is virtual certainty that none of the holders of unsecured claims will be paid in full.
As proposed under the terms of the Kerensa 2 Plan, the net recoveries from the Adversary Actions therefore are paid as follows: (a) $675,000 to Kerensa & Company, (b) an undetermined amount to insider administrative claimants other than Kerensa & Company and Kerensa 2, (c) $191,325 to allowed professional fees and UST fees (estimated as of the Kerensa 2 Disclosure Statement), and (d) up to $300,000 to Zeller on the promissory note. Anything remaining after that could go to Class Three general unsecured creditors, but even Kerensa 2 concedes that the value of any favorable judgments in the Adversary Actions is uncertain at best. See Kerensa 2 Disclosure Statement at 18:3-25.
Moreover, the proposed plan on its face requires Submarina to assign to Kerensa & Company all of the net proceeds of the Adversary Actions until Kerensa & Company receives $675,000.
Based on the foregoing, there is no business justification for placing Zeller's unsecured claim into a separate class because there is no on-going business relationship to be preserved,
Under these circumstances, the plan proponent's dubious attempt to place Zeller into a class separate from general unsecured creditors reflects the type of prohibited classification often known as gerrymandering.
But even assuming that impaired Class Two or impaired Class Three are properly classified, and that both accept plan treatment, the Kerensa 2 Plan cannot be confirmed over Zeller's objection without meeting the requirements for cramdown under Section 1129(b)(2)(B)(ii). As discussed in connection with the DIP Plan, a plan proponent that does not pay a dissenting unsecured class in full must satisfy the requirements of Section 1129(b)(2)(B)(ii). That provision prohibits junior interests from retaining or receiving any property under the plan unless the dissenting unsecured class is paid in full. That provision also is commonly referred to as the "absolute priority rule."
As previously emphasized, Zeller not only opposes the Reconsideration Motion, but also rejects her proposed treatment under the Kerensa 2 Plan.
The DIP Plan previously proposed by Kerensa 1 and Submarina provided for Rosenthal through Kerensa 2 to acquire all of the controlling interest in the debtors' operations without providing any opportunity for other parties in interest to acquire the same interests.
The Kerensa 2 Plan obviously is not proposed in the name of Kerensa 1 and Submarina, but it is equally obvious that it is proposed by the same principal, Rosenthal. Kerensa 2 suggests that its proposed plan somehow avoids the exclusive opportunity prohibition discussed in
Inasmuch as Kerensa 2 concedes that the member interests in Kerensa 1 and SSC are held by the same parties
In this instance, Kerensa 2 argues that a new value contribution is made by SSC's payment of $320,000 to Kerensa 1 which will in turn be contributed to Submarina to pay the $320,000 balance owed to Kerensa 2 on the DIP Loan. None of these funds, however, will ever be distributed to unsecured creditors. At the hearing on the Reconsideration Motion, Kerensa 2 argued that this contribution is equal to the value of the interest retained by current equity holders because unsecured creditors will receive at least what they would receive in a Chapter 7 liquidation. In other words, because liquidation of Kerensa 1 and Submarina would produce zero funds to distribute to unsecured creditors in Chapter 7, the value of the interests held and to be retained by existing equity holders is zero. Although the net result suggested by Kerensa 2's argument may comply with the best interests test under Section 1129(a)(7), the argument ignores that the cramdown requirements under Section 1129(b)(1) already assumes that best interests test has been met and imposes
The very language of Section 1129(b)(2)(B)(ii) prohibits any of the existing equity holders of Submarina, i.e., Kerensa 1, Robert Pina, Zeller, and Rosenthal, from retaining any property of Submarina, i.e., the Franchisee AR's, unless senior interests, i.e., the dissenting unsecured creditors, are paid in full. Similarly, the language of Section 1129(b)(2)(B)(ii) prohibits any of the existing equity holders of Kerensa 1, i.e., Rosenthal and Kerensa & Company, from retaining any property of Kerensa 1, i.e., the shares of stock in Submarina, unless the dissenting unsecured creditors of Kerensa 1 are paid in full. Kerensa 2 has proposed a plan that by its terms assures that unsecured creditors will not be paid in full, while assuring that all of the equity interest holders in Kerensa 1 and Submarina retain property of the respective debtors. In essence, current equity holders are contributing nothing to retain their interests in the operations of the debtors in possession because all of the funds return to them.
By refusing to expose the equity interests in Kerensa 1 and Submarina to the market,
526 U.S. at 455 (citations omitted). To suggest that those interests must have a value equal only to the amount the unsecured creditors would receive in Chapter 7 is unsupportable.
Moreover, the so-called new value contribution by Kerensa 1, the benefit of which never reaches dissenting unsecured creditors of either debtor in possession, would not permit the other equity holders, i.e., Robert Pina, Zeller, and Rosenthal, to retain any interest in Submarina. Additionally, there is no new value contribution at all that would permit Rosenthal and Kerensa & Company to retain any property of Kerensa 1. The cramdown requirements under Section 1129(b)(2)(B)(ii), separate and apart from the requirements discussed in
On its face, the Kerensa 2 Plan is not confirmable and provides no legal or equitable basis to grant relief from the Emergency Motion Order.
As discussed above, Kerensa 1 and Submarina have been remiss in carrying out their fiduciary obligations to all creditors of the estate in light of their relationship with the various entities controlled by Rosenthal. Two Chapter 11 plans of reorganization have now been proposed by entities owned or controlled by the same principal, and neither survive careful scrutiny.
Continued operation of the business may be financially possible but only prolonged and continuous litigation is assured. At this juncture, appointment of a Chapter 11 trustee to independently examine the viability of the franchise operation, in lieu of immediately converting the proceedings to a Chapter 7 liquidation, offers the best hope of producing an objectively reasonable basis for reorganization. The court having considered the record and history in this matter concludes that such appointment is in the best interests of the creditors, the bankruptcy estates, and all parties in interest, including the franchisees, within the meaning of Section 1104(a)(2).
In light of the foregoing, the Reconsideration Motion will be denied and a Chapter 11 trustee will be appointed. A separate order has been entered contemporaneously herewith.
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.
As the moving party, Kerensa 2 also offers as "newly discovered" evidence copies of Kerensa 2 Plan and Kerensa 2 Disclosure Statement.
