JEAN K. FITZSIMON, Bankruptcy Judge.
Following a confirmation hearing (the "Confirmation Hearing") held on April 13 and 21, 2010, this Court confirmed the Amended Plan of Reorganization/Liquidation which the Debtor, Unbreakable Nation Co., filed on March 9, 2010. At the conclusion of the Confirmation Hearing, the Court issued a bench ruling confirming the Plan and explaining the rationale for its ruling. After the hearing, the Court issued an Order, dated April 21, 2010 (the "Confirmation Order"), confirming the Plan. See Docket entry no. 388. Zen Investments, LLC (f/k/a Stafford Investments, LLC), John Stafford, Jr., John Stafford, III and Charlestown, LLC (collectively, the "Objectors" or the "Staffords"), who filed an objection to confirmation of the Debtor's Plan, see Docket entry no. 371, appealed the Confirmation Order on May 4, 2010. The Court submits this Memorandum Opinion, pursuant to Local Rule 8001-1(b),
On January 7, 2009, the Debtor filed for bankruptcy protection under Chapter 11 of
Following contentious litigation between the Objectors and the Debtor regarding the Claims and certain other matters (including a Motion to Appoint a Trustee), the Debtor initially filed its Plan and Disclosure Statement on December 7, 2009. Docket entries nos. 291 and 292. These documents were twice revised into their current forms, filed on March 9, 2010. Docket entries nos. 336 and 337.
Unbreakable Nation is a Pennsylvania corporation that sells patented anti-theft devices generally known as Unbreakable AutoLock for cars, boats, and bikes. Disclosure Statement, Docket entry no. 337, at 8. The Debtor's products are distributed to Pep Boys, Autozone, O'Reillys and Strauss Discount Auto, among other stores pursuant to certain "shelf space" contracts. Id. Lawman Armor Corporation was the Debtor's predecessor and changed its name to Unbreakable Lock Company in 2004. Id. Unbreakable Lock Company merged with the Debtor in 2006. Id. at 9. The Debtor licenses the patents for the Unbreakable technology from VI Capital Company and has agreed to maintain the patents in exchange for a royalty-free license. The sale of the assets of the Debtor will trigger royalty provisions in the Licensing Agreements if Robert Vito will no longer be in charge of the Debtor. Id. at 9, 11. From 2002 until now (i.e., including post-petition financing), the Debtor has been financed by VI Capital, an entity owned by Mr. Vito. Id. at 10.
Robert Vito is the founder, President and Chairman of the Board of Directors of the Debtor. Disclosure Statement at 11. Kyle Cunningham is the Chief Financial Officer. Id.
The Plan of Reorganization provides a schedule for the distribution of the Debtor's assets (which will be sold pursuant to the terms of the Plan). In accordance with Plan, administrative claims of between $500,000 and $600,000 are not classified and will be paid in cash. Disclosure Statement at 20; Plan at ¶ 3.1. The priority and secured tax claims, in the total approximate amount of $10,838, are not classified and will be paid in full on the
--------------------------------------------------------------Class Name Status Voting Right -------------------------------------------------------------- 1 Other Priority Impaired Entitled to vote Claims -------------------------------------------------------------- 2A VI Capital Claim Impaired Entitled to vote -------------------------------------------------------------- 3 Stafford Claim Impaired Entitled to vote -------------------------------------------------------------- 4 Other Unsecured Impaired Entitled to vote Claims -------------------------------------------------------------- 5 Shareholders Impaired Not entitled to vote --------------------------------------------------------------
Plan at ¶ 4.1. Class One Claims consist of holders of priority claims which are not professional or tax claims and will be paid in full to the extent of the Allowed Priority Claim
Class Three, which is the one most relevant in this dispute, consists of the Objectors' Claims. See Exhibit B to Disclosure Statement. Treatment of Class Three is as follows:
Plan at ¶ 6.3.
Class Four consists of general unsecured claims. They shall receive an initial pro rata distribution of $50,000 and a final distribution 20 days after the date of the Final Order
The Plan will be funded through cash on hand, proceeds from a sale of the Debtor's assets, and proceeds from the sale, if any, of intellectual property contributed to the estate by VI Capital. Plan at ¶ 7.1.
The Plan calls for an auction of the all Debtor's assets with or without rights to the Licensing Agreements and patents as follows:
Pursuant to Article X of the Plan, one of the effects of confirmation of the Plan is that "any and all avoidance actions for the Debtor ... shall be extinguished." Plan at ¶ 10.3.
The Debtor filed three reports of plan voting: an initial report on April 5, 2010 (Docket entry no. 370), an amended report on April 13, 2010 (Docket entry no. 375) and a second amended report on April 14, 2010 (Docket entry no. 380). As discussed below, the last of these reports shows that the Debtor has sufficient accepting votes pursuant to 11 U.S.C. §§ 1126 and 1129(a)(10) to confirm the Plan.
As stated above, the Confirmation hearing was held on April 13, 2010 and continued telephonically on April 21, 2010. Following the Confirmation Hearing, the Court entered the Confirmation Order. The Court's ruling and reasons for confirming the Debtor's Plan over the objections were given on the record at the conclusion of the April 13th hearing.
At the Confirmation Hearing, Mr. Vito, President, Chairman, and CEO of the Debtor, testified that the Debtor filed for bankruptcy protection in 2009 due to the costs of the pending litigation. Transcript of the Confirmation Hearing, Docket entry nos. 412, 413, and 415, hereinafter "Tr.,"
With regard to the patents on the products, Mr. Vito is the licensor, but the underlying patents were transferred to VI Capital in 2005. Tr. at 39. Pursuant to these agreements (the "Licensing Agreements"), Mr. Vito licenses the patents for the 118 products to the company for "a dollar and other value," but if Mr. Vito is no longer president and CEO of the company then the licence would convert into a royalty agreement for which Mr. Vito would receive $250,000 per quarter, per patent license or $2.50 per unit, whichever is greater. Tr. at 39. The Staffords acknowledge receiving a private placement memorandum in 1999 which contained disclosure of the Licensing Agreements. Tr. at 47.
In December 2002, the Debtor's board of directors, independent of Mr. Vito, confirmed the Licensing Agreements. Tr. at 51-3; 93; Exhibit D-6.
Mr. Vito testified that the assets of the Debtor placed for auction on March 26, 2010 included existing inventory, shelf space contracts, accounts receivable, seven licence agreements, and the patents. Tr. at 58. Unbreakable Unlimited Company ("UUCO"), of whom Mr. Vito is the president, offered an opening bid for the assets of $850,000. Tr. at 59. Mr. Vito testified that he arrived at a figure of $850,000 through calculating that the receivables would be worth approximately $230,000, the inventory $200,000, and adding an amount for administrative cost. Id. There was an opportunity for other bidders to bid on the assets in addition to an assignment of the Licensing Agreements or outright purchase of the patents. Tr. at 60. Mr. Vito testified that he agreed to a reduced royalty under the Licencing Agreements; his fee was reduced from $250,000 for each of seven licenses to $250,000 for all seven licenses per quarter. Id. In addition, the Plan reduced the amount required by a bidder to escrow for
The minimum price for a bidder to pay for the assets plus the patents was three million dollars. Tr. at 61. Mr. Vito testified that VI Capital allowed the patents to be sold with the Debtor's assets "as a way to preserve the value of the estate and to get the most dollars into the estate." Tr. at 62. The Debtor marketed the patents and other assets by taking two consecutive ads out in the Philadelphia Inquirer, and by sending bid packages to its competition, other parties who previously had expressed interest, and investment bankers who would likely be interested in this type of product. Id. At least two parties indicated some interest and ultimately two other entities signed confidentiality agreements in exchange for the right to receive detailed information regarding the Debtor's operations. Tr. at 81.
The Debtor has a commitment from the Coleman Group, an investment banking firm, to raise capital of between three and five million dollars in funding once the bankruptcy is complete and the Debtor is free and clear of litigation and liens. Tr. 97-8.
Mr. Gregory Urbanchuk, an expert in forensic economics,
The Objectors' pleading quarrels with the Plan on the following six bases:
The remaining four bases of the Objectors' pleading are either moot or settled. First, the Objectors' contention that Classes One and Two are artificially impaired is irrelevant because even if this were so (and the Court were to discount these classes as impaired), Class Four is impaired and voted to accept the Plan in compliance with 11 U.S.C § 1129(a)(10). The Objectors do not dispute this.
Second, once the Court determines that the Plan's classification of the Objectors' Claims is permissible (as it did at the Confirmation Hearing and expounds on below), the Objectors' point four (that estimation of the Claims is improper for confirmation purposes) becomes moot. In other words, the Claims are in a separate class, so the amount of the Claims for voting purposes is not a substantive point; these Claims are the only members of the class.
Third, the argument that the Plan does not meet the Best Interests of Creditors Test as laid out in the Objection merely incorporates and repeats the Objectors' assertions regarding both the Plan's alleged lack of good faith and impropriety of the non-debtor releases. Therefore, the argument need not be separately addressed.
Last, with regard to the objection that release of avoidance actions provided for in Section 10.3 is impermissible, the Plan was modified to reflect that if the motion of the Objectors to prosecute avoidance actions (Docket entry no. 363) is granted, then the avoidance actions would not be extinguished as of the Effective Date of the Plan. This compromise satisfied the Objectors' request.
Therefore, the Court's discussion focuses on two of the six bases raised in the Objectors' pleadings, namely whether the Plan was filed in good faith and whether the classifications are permissible. Neither of these arguments presents a basis for denying confirmation of the Plan.
In Order for a bankruptcy plan to be confirmed, the plan proponent must show that each of the elements enumerated in 11 U.S.C. § 1129(a) have been met. In re H.H. Distributions, L.P., 400 B.R. 44, 50 (Bankr.E.D.Pa.2009). In discussing the Debtor's demonstration of having met the requirements of § 1129, the Court will address the remaining two objections to the Debtor's Plan. In addition, because the
The first and primary complaint of the Objectors is that the Plan was not filed in good faith. This is inextricably intertwined with the good faith of the auction as it is the basis of the Plan. After consideration of the case law, the pleadings, the facts, and evidence presented at the Confirmation Hearing, the Court rejects this argument and finds that the Plan was, in fact, filed in good faith.
Pursuant to § 1129(a)(3), a plan must be filed "in good faith and not by any means forbidden by law." In determining good faith, the "important point of inquiry is the plan itself and whether such a plan will fairly achieve a result consistent with the objectives and purposes of the Bankruptcy Code." In re PWS Hldg. Corp., 228 F.3d 224, 242 (3d Cir.2000) (citation and internal quotation omitted). The requirement that a purchaser act in good faith "speaks to the integrity of his conduct in the course of the sale proceedings. Typically, the misconduct that would destroy a purchaser's good faith status at a judicial sale involves fraud, collusion between the purchaser and other bidders or the trustee, or an attempt to take grossly unfair advantage of other bidders." In re Abbotts Dairies of Pennsylvania, Inc., 788 F.2d 143, 147 (3d Cir.1986). The "totality of the circumstances" must be considered by a court when determining whether a case has been filed in "good faith." In re TCI 2 Holdings, LLC., 428 B.R. 117, 142 (Bankr.D.N.J.2010) (citing In re PPI Enterprises, Inc., 324 F.3d 197, 211 (3d Cir. 2003)). The burden to establish good faith is on whomever is proposing the plan. In re PPI Enterprises, Inc., 324 F.3d 197, 211 (3d Cir.2003). Mr. Vito testified that the Debtor was completely out of funds to continue operations or purchase inventory and that no investor or lender was willing to come forward until the Debtor resolved all litigation against it; thus a sale plan was the Debtor's only option.
In support of their argument that the Plan was not filed in good faith, the Objectors cite In re Coram Healthcare Corp., 271 B.R. 228 (Bankr.D.Del.2001). In Coram, the court held that the debtor's plan was not filed in good faith because the debtor's CEO and President had a conflict of interest due to the fact that he held a separate employment contract with one of the debtor's largest creditors. 271 B.R. at 235-6. Such is not the case here; there is no suggestion that Mr. Vito, the Debtor's President and CEO, has a conflict of interest or divided loyalties. Similarly, In re Barr, 38 B.R. 323 (Bankr.E.D.Mich.1984), also relied on by the Objectors, is inapposite. In Barr, the debtor's plan was held to lack good faith where a wealthy relative stepped in to fund the plan and keep his family members employed in the same business while discharging approximately one million dollars in unsecured debt. The court there held that the cramdown clause "presupposes a rational economic calculus as a premise to competitive bidding." 38 B.R. at 325. As discussed below, here the Debtor has shown that it took rational and planned steps to insure that the bidding process was competitive. There is no evidence that the auction was rigged to insure that UUCO would prevail; Barr is therefore not instructive. Moreover, the Plan was proposed to ensure a return to unsecured creditors; in the absence of the sale no money would be available for anything but administrative claims.
The Objectors allege that the Court cannot confirm the Debtor's Plan because the auction was not proposed or conducted in good faith. The Court rejects this argument
In addition to objecting to the first auction option (the one which prevailed), the Objectors also take issue with auction options two and three proposed in the Plan— that the assets could be purchased with an assignment of the Licensing Agreements or (option three) that the assets could be purchased with the addition of the intellectual property. Plan at ¶ 7.2(a). The Objectors contend that each of these options chill bidding because they would require over-payment to UUCO and Mr. Vito. Objection at 6-8. However, Mr. Vito testified both that the board of directors independently confirmed the Licensing Agreements and that he has voluntarily taken a reduction in the amount he is entitled to receive by virtue of these agreements. Tr. at 51-3; 60. The Objectors' assertion that the Debtor has somehow conspired with Mr. Vito with regard to the Licensing Agreements has no merit. Again, as the Objectors had unfettered access to all potential bidders, had these been impediments to bidding, the Objectors could have raised the issue before or at the time of the auction or could have produced potential bidders who so alleged.
The Objectors also rely on the report and testimony of Mr. Urbanchuk, their expert witness, who testified that he does not consider auction options two and three viable because 1) the cost of the Licencing Agreements exceeds net sales; and 2) the value of the Debtor is closer to $1.2 million than $3 million. However, Mr. Urbanchuk did not take into account all relevant factors that impacted the Debtor's sales, such as the Debtor's inability to acquire funding in order to operate and grow. Nor does Mr. Urbanchuk's report analyze projections past next year. Docket entry 371-1, Exhibit A.
Contrary to the assertion of the Objectors, the Plan's separation of classes is not in violation of the Code or contrary to law. Pursuant to 11 U.S.C § 1122(a), "a plan may place a claim ... in a particular class only if such claim ... is substantially similar to the other claims or interests of such class." According to the Third Circuit, "Section 1122(a) does not expressly provide that `substantially similar' claims may not be placed in separate classes ... the Code does not necessarily prohibit the placement of similar claims in different classes." John Hancock Mutual Life Ins. Co. v. Route 37 Business Park Associates., 987 F.2d 154, 158, 162 (3d Cir.1993) (further noting that "[i]f the debtor had offered reasons that created a reasonable possibility of confirmation, we would hold that the lift stay motion was properly denied."). Classification of claims by the debtor must be reasonable. See, e.g., Olympia & York Florida Equity Corp. v. The Bank of New York (In re Holywell Corp.), 913 F.2d 873 (11th Cir.1990); In re Bryson Properties, XVIII, 961 F.2d 496 (4th Cir.1992).
Here, the Debtor's placement of the Stafford claimants in a separate class is certainly reasonable. These claimants are distinct from the other unsecured creditors for at least two reasons. First, the other unsecured creditors (in Class Four) are trade creditors or debts acquired in the ordinary course of business and are distinct from the Stafford claimants, whose alleged debts exclusively arise from their shareholder status in the Debtor's predecessor. See Exhibit B to Disclosure Statement.
Second, the Claims belong in a separate class because they may well be subordinated pursuant to section 510(b) of the Code. According to 11 U.S.C. § 510(b), "a claim arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or sale of such a security, or for reimbursement or contribution allowed under section 502 on account of such a claim, shall be subordinated to all claims...." (emphasis added). Section 510(b) "represents a Congressional judgment that, as between shareholders and general unsecured creditors, it is shareholders who should bear the risk of illegality in the issuance of stock in the event the issuer enters bankruptcy." Baroda Hill Investments, Ltd. v. Telegroup, Inc. (In re Telegroup, Inc.), 281 F.3d 133, 141 (3d
In order to confirm the Plan and satisfy the requirements of 11 U.S.C § 1129(a), all impaired classes must accept the Plan. If all impaired classes fail to accept the Plan, the Code permits confirmation through the cramdown provision in 11 U.S.C § 1129(b)(1), which allows the confirmation of a plan over the objection of an impaired class if the "plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan." 11 U.S.C § 1129(b)(1).
In order for a Debtor to proceed with a cramdown, all requirements of § 1129(a) (except for the plan's acceptance by each impaired class of claims or interests pursuant to § 1129(a)(8)), must be met. See Bank of America Nat'l Trust and Savings Ass'n v. 203 North LaSalle Street P'Ship, 526 U.S. 434, 441, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999). Of particular importance is that a debtor satisfy provision § 1129(a)(10) (that the plan be accepted by at least one class of impaired creditors) and § 1129(a)(7) (the Best Interests of the Creditors Test). Id. As discussed above, the Plan satisfies § 1129(a)(10) because Class Four is impaired and has voted to accept the Plan. The Court also finds that the Plan satisfies § 1129(a)(7) and is in the best interests of the creditors. Upon consideration of whether the impaired classes would receive "on account of such claim ... a value... that it not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7...." the Court finds that there is ample evidence that the claimants will receive a better payout through the Plan than if this case were converted to Chapter 7. If this case were converted, the Debtor's sales will decline to nothing upon exhaustion of the existing inventory, resulting in the loss of the shelf space contracts, and the unsecured creditors would then receive no payment on their debts.
Given that all other requirements of § 1129(a) are satisfied, the question remains of whether the Plan satisfies the requirements for a cramdown. The Plan must not discriminate unfairly and must be fair and equitable. The Court finds that both of these conditions are met.
First, the Debtor's Plan does not "discriminate unfairly" pursuant to § 1129(b)(1). See In re Armstrong World, Inc., 348 B.R. 111, 121 (D.Del.2006) ("[t]he pertinent inquiry is not whether the plan discriminates, but whether the proposed discrimination is `unfair'"). A court only needs to reach the question of whether discrimination is unfair "if it first finds that the Plan discriminates at all." Id. at 122. (citing In re Dow Corning Corp., 244 B.R. 696 (Bankr.E.D.Mich.1999)) and noting that "a presumption of unfairness only arises if the proposed plan provided for `either a materially lower recovery or a greater allocation of risk' for the dissenters. A finding that all classes of the same priority will receive the identical amount under the proposed Plan is not necessary to find that the Plan does not discriminate"). Here, the Court determines that the Plan does not discriminate. Classes Three and Four (the unsecured classes) are treated the same in the Plan and will each receive $50,000 from the $100,000 Unsecured Fund. There is no evidence— indeed the Objectors have offered none— that the Plan should be rejected because it fails to satisfy the "unfair discrimination" clause of § 1129(b)(1).
Considering the possible argument (which the Objectors have not offered), that the Plan unfairly discriminates against the Stafford claimants because it may potentially provide Class Three with a smaller percentage of recovery, the Court further finds that such discrimination would not be unfair pursuant to § 1129(b)(1). A rebuttable presumption of unfair discrimination arises when there is:
In re Armstrong World Indus., Inc., 348 B.R. 111, 121 (D.Del.2006). Because the Objectors assert their Claims—if not subordinated—are worth approximately four million dollars
Further, the Debtor did not discriminate unfairly against the Objectors because there is a rational basis for treating the claims of the Staffords differently. A plan will not be found to have unfairly discriminated if:
In re TCI 2 Holdings, LLC., 428 B.R. 117, 157 (Bankr.D.N.J.2010) (citation omitted). These four factors are present here. First, as addressed in the discussion of classification of claims above, the different treatment of the Stafford Claims is reasonable. These Claims will likely be subordinated and are based on litigation—not trade or ordinary course debt. Therefore, individualized allocation to these Claims makes sense. Second, the Claims may need to be treated differently for reorganization; Class Four represents, in part, trade creditors whom it is reasonable for the Debtor to prefer because it may want to continue to do business with these vendors. Third, there is no evidence that the supposed discrimination was not proposed in good faith and, as discussed above, the Debtor has acted in good faith in implementing its Plan. Fourth, the degree of the discrimination is minor (1.5% for Class Four verses 1.25% for Class Three). In short, any discrimination of the Objectors' Class in not unfair because their Claims are fundamentally different from the claims in Class Four. See In re Sacred Heart Hosp. of Norristown, 182 B.R. 413, 421 n. 8 (Bankr.E.D.Pa.1995) ("[d]issimilar treatment for dissimilar claims does not run afoul of the unfair discrimination provision").
Likewise, the Plan is "fair and equitable" pursuant to § 1129(b)(1). The Code gives guidance with regard to what qualifies a plan as "fair and equitable." With respect to a class of unsecured creditors, a plan must provide either of the following:
11 U.S.C. § 1129(b)(2)(B)(I)-(ii). Provision (ii) is the "absolute priority rule," specifying that "a plan cannot give priority to junior claimants over the objection of a more senior class that is impaired." In re Armstrong World Industries, Inc., 432 F.3d 507, 513 (3d Cir.2005). The Debtor's Plan is fair and equitable and complies with § 1129(b)(2)(B)(ii). As it stands, all unsecured creditors will receive the same payout pursuant to the Plan and no junior interest holder will receive a payment or retain its rights. If the Stafford Claims are deemed subordinated, then these Claims will receive no payment in assurance that the absolute priority rule is not violated. The Objectors do not contend and there has been no showing that the Debtor's Plan is not fair and equitable. The cramdown provision of the Code has, therefore, been satisfied. The Court is mindful that it is in the best interests of this estate not to allow a minority of creditors to set the course and determine the fate of the entire body of creditors, especially where, as here, that minority may well be subordinated to unsecured creditors. Indeed, this is one of the purposes
For the reasons set forth above, the Court concluded that the Debtor's Plan of Reorganization/Liquidation is in the best interests of the creditors. The Debtor demonstrated that the Plan was proposed and executed in good faith. The Court remains satisfied that the Plan will provide the creditors of this cash strapped Debtor with a fair return in a timely fashion. The Objectors, on the other hand, failed to demonstrate that that this Plan and the accompanying auction were tainted by fraud, bad faith, or conspiracy. For these reasons, the Court confirmed the Debtor's Plan of Reorganization.
