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In re Zohar III, Corp.

United States District Court, D. Delaware

December 19, 2019

IN RE ZOHAR III, Corp., et al., Debtors.
ZOHAR III, CORP., et al., Appellees. LYNN TILTON, et al., Appellants,


          Honorable Maryellen Noreika, United States District Judge.

         At Wilmington this 19th day of December 2019:

         Before the Court is Appellants' Motion for Stay Pending Appeal (D.I. 4)[1] (“Stay Motion”) filed by appellants, Lynn Tilton (“Tilton”) and the Patriarch Stakeholders[2] (together, “Appellants”) on October 15, 2019, seeking a stay pending appeal of the Bankruptcy Court's Order, entered on September 27, 2017 (B.D.I. 974) (“Order”) in the Chapter 11 cases of appellees, Zohar III, Corporation and certain affiliates (together, “Debtors”). The Order requires the parties to continue their joint effort to monetize certain assets in accordance with a heavily negotiated, Bankruptcy Court ordered Mediation Term Sheet (B.D.I. 266), referred to in these Chapter 11 proceedings as the “Settlement Agreement.” Also before the Court is Appellants' unopposed Motion to Expedite (D.I. 28) (“Motion to Expedite”) this Court's consideration of the Stay Motion as well as the Court's consideration of the merits of the appeal. The Debtors have filed an opposition to the Stay Motion (D.I. 19), which is joined by intervenor and appellee MBIA Insurance Corporation (D.I. 20). The Court did not hear oral argument because the facts and legal arguments are adequately presented in the briefs and record, and the decision process would not be significantly aided by oral argument. For the reasons set forth below, the Stay Motion is DENIED, and the unopposed Motion to Expedite is GRANTED. Upon completion of merits briefing, which is currently scheduled to conclude on December 20, 2019 (D.I. 37), this appeal will be considered on an expedited basis.

         1. Background.

         Debtors Zohar CDO 2003-1, Limited (“Zohar I”), Zohar II 2005-1, Limited (“Zohar II”), and Zohar III, Limited (“Zohar III”) (collectively, “the Zohar Funds”) are collateralized loan obligation funds created by Tilton. Funds raised by the Zohar Funds through note issuances were invested into operating companies (“the Portfolio Companies”) evidenced by debt and equity instruments. Every quarter, Zohar Fund investors receive an interest payment financed by the collective payments the Zohar Funds receive from their loans to, and equity interests in, the Portfolio Companies.

         2. The Portfolio Companies are primarily private, mid-sized companies and have been managed at the operational level by Tilton. Tilton's stated management strategy for the Zohar Funds included rehabilitating the Portfolio Companies, paying off their debt, and then selling them, with the proceeds of any increased equity value being applied to pay down the notes issued by the Zohar Funds.

         3. On March 3, 2016, Alvarez & Marsal Zohar Management LLC (“AMZM”) replaced Tilton-affiliated entities as the collateral manager for the Zohar Funds. The collateral manager was responsible for selecting and managing the investments made by the Zohar Funds in the Portfolio Companies. Shortly after AMZM took over, divesting Tilton of her control over the Debtors' interests in the Portfolio Companies, Tilton argued the Zohar Funds' equity interests in the Portfolio Companies - memorialized in stock certificates and LLC Agreements naming the Zohar Funds as the holders of equity - did not actually belong to the Zohar Funds, but to Tilton and Tilton-controlled entities, and she had simply “gifted” to the Zohar Funds the “upside interest” in that equity.[3]

         4. In November 2016, Zohar II and Zohar III commenced an expedited special proceeding in the Delaware Chancery Court (“225 Action”), seeking a determination that the Zohar Funds own the equity of three Portfolio Companies and have the power to name those companies' boards of directors - notwithstanding purportedly “irrevocable” proxies that Tilton granted herself shortly before exiting as Collateral Manager of the Zohar Funds. In November 2017, Vice Chancellor Slights issued a 96-page opinion, finding that the Zohar Funds were the legal and beneficial owners of the disputed shares and that Tilton's self-dealing proxies were invalid.[4]

         5. Tilton appealed and obtained a stay of judgment. Tilton thus remained a director of the Portfolio Companies at issue throughout the appeal. On March 11, 2018 (“Petition Date”), nine days before oral argument before the Delaware Supreme Court, Tilton commenced the Debtors' chapter 11 cases. Tilton testified to the Bankruptcy Court that she was seeking “a mechanism to maximize value for all of the Zohar Funds' stakeholders and to protect the Portfolio Company constituents and monetize their considerable value, ”[5] and the chapter 11 filing would still the “litigious environment [that] made it difficult to sell or refinance the Portfolio Companies, while maximizing their value.”[6]

         6. The Debtors' chapter 11 cases were contentious from the very outset, as various adversarial pleadings were filed. Among them, on March 26, 2018, MBIA and the Zohar III Controlling Class filed the Dismissal/Trustee Motion.[7] A trial was scheduled for April 17-18, 2018 to adjudicate the Litigated Contested Matters, and the parties devoted significant effort towards preparing for trial. On April 5, 2018, the Bankruptcy Court appointed Judge Gross (“Mediator”) to mediate the parties' disputes (B.D.I. 143). Beginning on April 16, 2018, the day before trial, the parties engaged in mediation, which lasted four days and went late into each night. As a result of the good-faith mediation efforts overseen by the Mediator, the parties agreed to a comprehensive resolution of the Litigated Contested Matters, the terms of which are embodied in the Settlement Agreement.

         7. On May 21, 2018, the Bankruptcy Court entered an Order approving the Settlement Agreement between (i) the Debtors, (ii) Tilton, (iii) Patriarch and its affiliates, (iv) MBIA, and (v) the Zohar III Controlling Class (B.D.I. 266) (“Settlement Order”). Also on May 21, 2018, the Bankruptcy Court entered an Order appointing retired Judge Joseph J. Farnan, Jr. as Independent Director (B.D.I. 266, 267) to replace Tilton as the Debtors' sole director. Further, pursuant to the Settlement Agreement, Michael Katzenstein was appointed as Chief Restructuring Officer (“CRO”), and Robert Kost was appointed as Chief Monetization Officer (“CMO”) (B.D.I. 297, 298).

         8. It appears undisputed that a foundational element of the Settlement Agreement was the establishment of a monetization process to unlock the value of the Debtors' interests in the Portfolio Companies. Paragraph 10 of the Settlement Agreement establishes the general parameters of the process to monetize the Zohar Funds' interest in the Portfolio Companies, whether though sale or refinancing.[8] In recognition of the value-destructive litigation that loomed over the Portfolio Companies, the Settlement Agreement also provided for a 15-month armistice (“15-Month Window”). The 15-Month Window would have been extended if proceeds in the monetization process were generated to pay 50% of the amounts owed to the Zohar Funds' noteholders, an amount in excess of $800 million. Only two sales closed by the time the 15-Month Window expired on September 30, 2019, and the sales generated less than $200 million. Accordingly, the 15-Month Window was not extended beyond September 30, 2019.

         9. Weeks before the scheduled expiration of the 15-Month Window, Tilton informed the Debtors that she believed the monetization process would terminate with the 15-Month Window's expiration. The Debtors disagreed, and the parties thereafter participated in a mediation session on July 31 with the Mediator to resolve the dispute. No resolution was reached, and in accordance with Paragraph 11 of the Settlement Agreement, the Debtors requested that the Bankruptcy Court resolve the dispute and confirm that the Settlement Agreement is unambiguous regarding the duration of the monetization process and the parties' obligations thereunder. The Debtors argued that the Agreement calls for the continuation of the monetization process following the 15-Month Window and directed the Bankruptcy Court's attention to Paragraphs 3, 10, and 12 of the Settlement Agreement. Debtors argued that Paragraph 10 establishes the parties' agreement for an independent director, CRO, and Tilton to conduct a joint process to monetize both the Group A portfolio companies and the Group B portfolio companies. Debtors argue that Paragraph 12 governs the duration of the monetization process. That section provides:

Tilton and the CRO shall work jointly as outlined herein to monetize the Group A Portfolio Companies until such time as the [sic] (i) the parties each agree in writing to terminate this settlement agreement, such agreement to be granted or withheld in their sole respective discretion or (ii) the Full Payment Date.

(Settlement Agreement, ¶ 12) (emphasis added).

         10. According to Debtors, the monetization process does not end when the 15-Month Window expires. Citing Paragraph 12, Debtors argued that the conclusion of the monetization process only occurs when the parties agree in writing to terminate the Settlement Agreement or on the Full Payment Date. Debtors further pointed to Paragraph 3, which provides that, if the full payment date does not occur within the 15-Month Window, Tilton and the CRO shall negotiate in good faith on how to monetize the Group B Portfolio Companies. This provision, Debtors argued, clearly indicates that the parties anticipated the monetization process to continue after the 15-Month Window expires.

         11. In opposition, Appellants argued, among other things, that the monetization process is precluded following the 15-Month Window because the Settlement Agreement would otherwise result in a litigious environment that may not yield the maximum value for the Portfolio Companies, that several provisions of the Settlement Agreement were inconsistent with one another, and that the Debtors' interpretation of the Settlement Agreement would lead to an absurd result.

         12. On September 27, 2019, the Bankruptcy Court issued an oral ruling and the Order which is the subject of this appeal. (B.D.I. 972, 974). As set forth in the transcript, the question before the Bankruptcy Court was one of contract interpretation: “whether the terms of the settlement agreement provide for termination or the continuation of the joint monetization process of the Group A portfolio companies at the conclusion of ...

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