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In re KII Liquidating, Inc.

United States District Court, D. Delaware

September 30, 2019

IN RE KII LIQUIDATING, INC., f/k/a KATY INDUSTRIES, INC., et al, Debtors.
v.
VICTORY PARK CAPITAL ADVISORS, LLC; VICTORY PARK MANAGEMENT, LLC; VPC SBIC I, L.P.; and JANSAN ACQUISITION, LLC, Appellees. EMERALD CAPITAL ADVISORS, as Plan Administrator, Appellant, Adv. Proc. No. 17-50937-LSS

         Chapter 11

          MEMORANDUM

          HONORABLE LEONARD P. STARK JUDGE

         I. INTRODUCTION

         Pending before the Court is an appeal (D.I. 1) from the Bankruptcy Court's July 6, 2018 decision, In re Katy Industries, Inc. 590 B.R. 628 (Bankr. D. Del. 2018), and related Order (Adv. D.I. 35) ("Dismissal Order")[1] (together, the "Decision"), issued by the Honorable Kevin J. Carey, [2] dismissing with prejudice a complaint (Adv. D.I. 18, Ex. A) ("Complaint") filed by the Official Committee of Unsecured Creditors ("Committee") in the above-captioned adversary proceeding ("Adversary Proceeding"). Emerald Capital Advisors, as Plan Administrator and successor to the Committee ("Appellant"), [3] appeals the Decision. For the reasons that follow, the Court will reverse the Decision in part and remand to the Bankruptcy Court for entry of an order granting leave to amend the Complaint.

         II. BACKGROUND

         A. The Debtors and Jansan

         Katy Industries, Inc. and its debtor affiliates (the "Debtors") filed for Chapter 11 relief on May 14, 2017 (the "Petition Date") to consummate a sale of substantially all of their assets to Jansan Acquisition, LLC ("Jansan"), their debtor-in-possession ("DIP") lender and proposed stalking-horse purchaser. (Complaint, ¶ 42) Jansan was a joint venture between the Debtors' prepetition second-lien lenders (the "Second-Lien Lenders" - i.e., Victory Park and Centrex[4]), which contributed their secured debt (the "Second-Lien Debt"), and Highview Capital, LLC, which contributed the cash needed to provide DIP financing to the Debtors. (Id. ¶¶ 8, 39-42)

         On the Petition Date, the Debtors filed motions (i) to approve the DIP financing from Jansan and provide certain protections to the prepetition Second-Lien Lenders (B.D.I. 13) (the "DIP Financing Motion"), and (ii) to approve bidding procedures and stalking-horse protections for Jansan in connection with the sale of the Debtors' assets and to approve the sale (B.D.I. 18) (the "Sale Motion"). On May 16, 2017, following the "first day" hearing in the Chapter 11 cases, the Bankruptcy Court entered an order granting the DIP Financing Motion on an interim basis (B.D.I. 48) (the "Interim DIP Order"). As is customary, the Interim DIP Order contained stipulations from the Debtors as to the amount and validity of the Second-Lien Debt and the absence of claims against the Second-Lien Lenders, and also included affirmative releases of any claims against the Second-Lien Lenders. (Id. at ¶ J(ii), (v)-(viii)) As is also required by the Bankruptcy Court's local rules, see Del. Bankr. L.R. 4001-2(a)(i)(B), the Interim DIP Order provided that the Debtors' stipulations and releases were subject to "Challenge" by an official committee of unsecured creditors within 60 days after its formation. (Id. at ¶ 26)

         The proposed stalking-horse asset purchase agreement with Jansan contemplated a credit bid of the entire amount of the Second-Lien Debt toward the purchase of the Debtors' assets. (See B.D.I. 18, Ex. B at 3.1; see also id, Ex. A at ¶ 14 (noting Jansan bid "is a credit bid"))

         B. Committee, Challenge Deadline, and the Sale Order

         On May 26, 2017, the United States Trustee appointed the Committee, pursuant to § 1102(a)(1) of the Bankruptcy Code. See Katy, 590 B.R. at 634. On June 12, 2017, the Committee filed an objection to final approval of the DIP financing and the proposed bidding procedures, wherein the Committee noted it was specifically investigating whether the most recent $7.5 million of advances by Victory Park prior to the Petition Date (the "Challenged Advances") "were more properly characterized as an equity infusion or [were] susceptible to equitable subordination pursuant to 11 U.S.C. § 510(c)." (B.D.I. 119 at ¶ 11 n.6; see also Id. at 26 n. 14)

         On June 19, 2017, the Bankruptcy Court entered a final order approving the DIP financing (B.D.I. 167) (the "Final DIP Order") and an order approving bidding procedures and stalking-horse protections for Jansan (B.D.I. 163) (the "Bidding Procedures Order"), both of which reflected certain changes from the original proposed forms of order, to resolve the Committee's objections. See Katy, 590 B.R. at 634-35. Like the Interim DIP Order before it, the Final DIP Order contained stipulations from the Debtors as to the amount and validity of the Second-Lien Debt and the absence of claims against the Second-Lien Lenders, and also included affirmative releases of any claims against the Second-Lien Lenders - all subject to the Committee's right to bring a "Challenge" by the "Challenge Deadline" of July 25, 2017. (B.D.I. 167 at ¶¶ I(ii), (v)-(viii), and 26)

         The Debtors and Jansan went to market with a stalking-horse bid of $63 million. See Katy, 590 B.R. at 637 (discussing amount of Jansan purchase price). The stalking horse bid resulted in a required minimum overbid of $64.25 million in order for another bidder to "qualify" and force an auction for the Debtors' assets pursuant to the Bidding Procedures Order. (See B.D.I. 163, Ex. 1 at 17-18 (discussing requirements for "Qualified Bids"))

         On July 5, 2017, the Debtors filed a proposed form of sale order in the event that Jansan was deemed the "Successful Bidder" in accordance with the Bidding Procedures Order. (B.D.I. 218) Around this time, the Committee's investigation revealed colorable grounds for recharacterization or subordination of the Challenged Advances. Accordingly, on July 11, 2017, the Committee filed an objection and reservation of rights with respect to the Debtors' proposed form of sale order, to the extent it could be construed to limit or otherwise affect the Committee's "Challenge" rights under the Final DIP Order, if the sale were approved and consummated prior to the July 25, 2017 Challenge Deadline. (See B.D.I. 268) The Committee requested the inclusion of the following language in the order:

Notwithstanding anything to the contrary in this Order or in the Final APA, entry of this Order and approval and consummation of the transactions contemplated hereby shall not limit or otherwise affect the rights or remedies of the Debtors' estates, the Committee, or any other party in interest, with respect to any "Challenge" as defined in paragraph 26 of the Final DIP Order.

(B.D.I. 268 at ¶ 5 (emphasis added))

         On July 12, 2017, the Debtors filed a notice indicating that there were no qualified bids other than Jansan's for the Debtors' assets, and declaring Jansan the "Successful Bidder" pursuant to the Bidding Procedures Order (B.D.I. 276). Katy, 590 B.R. at 634. On July 17, 2017, the Bankruptcy Court held a hearing on the Sale Motion. Prior to that hearing, the Debtors, Jansan, and the Committee agreed upon a revised form of sale order (B.D.I. 295) (the "Sale Order") containing the Committee's requested language (with non-material modifications) as a new paragraph 48:

Notwithstanding anything to the contrary contained in this Order or in the Final APA, entry of this Order and approval and consummation of the transactions contemplated hereby shall not limit or otherwise affect the rights or remedies of the Debtors' estates or the Committee with respect to any "Challenge" as defined in paragraph 26 of the Final DIP Order.

(B.D.I. 295 at ¶ 48 (emphasis added))[5] At the hearing, Debtors' counsel walked the Bankruptcy Court through the changes to the Sale Order from the original proposed version:

And lastly, paragraph 48, this is the language with respect to the committee. It simply makes clear that the challenge rights of the committee baked into the final DIP order are in no way impacted by the relief requested or the order being entered today, and all of their rights and remedies are preserved.

(B.D.I. 303, 7/17/2017 Hr'g Tr. at 37 (emphasis added)) Later in the hearing, the Committee's counsel stated that there were "still some fairly pointed issues the Committee continues to look at" with respect to its Challenge Deadline, but "that's all been preserved by virtue of the language in the order." (Id. at 42-43) (emphasis added) Counsel for Jansan was present at the hearing (id. at 5), and no party disputed the characterization of the effect of paragraph 48 of the Sale Order.

         On July 18, 2017, the Court entered the Sale Order, which approved the final form of Amended and Restated Asset Purchase Agreement with Jansan, which was attached as Exhibit A thereto (B.D.I. 295, Ex. A) (as amended and supplemented, the "Final APA"), and authorized the Debtors and Jansan to immediately close upon the transactions contemplated in the Final APA. On July 21, 2017, the Debtors and Jansan closed on the sale of the Debtors' assets pursuant to the Final APA. It appears undisputed that, at the closing, Jansan offset approximately $36.7 million of the Victory Park Second-Lien Debt (including the $7.5 million arising from the Challenged Advances) against the $63 million purchase price for the Debtors' assets.

         C. The Adversary ...


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