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IN RE WESTPOINT STEVENS

November 16, 2005.

In re WESTPOINT STEVENS, INC., et al., Debtors. CONTRARIAN FUNDS, LLC, et al., Appellants,
v.
WESTPOINT STEVENS, INC., et al., Appellees.



The opinion of the court was delivered by: LAURA SWAIN, District Judge

OPINION

Contrarian Funds, LLC, Satellite Senior Secured Income Fund, LLC, CP Capital Investments, LLC, Wayland Distressed Opportunities Fund I-B, LLC and Wayland Distressed Opportunities Fund 1-C, LLC (collectively, the "Steering Committee") and Beal Bank, S.S.B., in its capacity as First Lien Administrative Agent and Collateral Trustee ("Beal Bank" and, together with the Steering Committee, "Appellants") appeal from certain provisions of the Order Authorizing Sale of Substantially All of the Sellers' Assets Free and Clear of Liens, Claims, Encumbrances and Interests, the Assumption of Certain Liabilities, Approval of Successful Bidder and Certain Related Matters, entered by the United States Bankruptcy Court for the Southern District of New York (Drain, B.J.) on July 8, 2005, as amended by Errata Orders dated July 11, 2005, in the jointly administered Chapter 11 bankruptcy proceedings of WestPoint Stevens Inc. and certain of its affiliates*fn1 (the "Sale Order").*fn2 The Sale Order, as its title suggests, authorized the sale under section 363(b) of the Bankruptcy Code, free and clear of liens and other interests, of substantially all of the assets of Debtors-Appellees WestPoint Stevens Inc., WestPoint Stevens Inc. I and WestPoint Stevens Stores, Inc., and of certain trademarks of J.P. Stevens Enterprises, Inc. (these entities are collectively referred to herein as "Debtors" or "Sellers")*fn3 to Appellees WestPoint International, Inc., and WestPoint Home, Inc. (together, "Purchaser" or "Purchasers") in return for unregistered equity securities ("Parent Shares") and related unregistered subscription rights to acquire such securities of a corporate parent of the Purchaser ("Subscription Rights" and, together with the Parent Shares, the "Securities"), certain cash payments in respect of outstanding financing and expenses of the Debtors, and the assumption of certain of the Debtors' assets and liabilities. The Sale Order also provided that certain of the Debtors' secured creditors (including Appellants here) would receive replacement liens in the Securities and other proceeds of the purchase and sale transaction, determined the value of the Securities and the secured creditors' claims as of the closing date of the sale transaction, directed the distribution to constituents of the senior secured creditor group of which the Steering Committee member entities are part (the "First Lien Lenders") of a portion of the Securities upon the closing of the sale transaction in full satisfaction of the First Lien Lenders' secured claims, and further directed the distribution of the remainder of the Securities to members of the Debtors' junior secured creditor group (the "Second Lien Lenders") in partial satisfaction of those lenders' claims.

  In connection with these distributions, the Sale Order provides for the termination of the secured lenders' liens on the distributed sale proceeds. No Chapter 11 plan of reorganization or liquidation was confirmed before, or after, the entry of the Sale Order, which authorized and directed the consummation of all of the foregoing transactions without the necessity of prior confirmation of a Chapter 11 plan. The Steering Committee and its members, the other First Lien Lenders excluding Appellee Aretex, LLC ("Aretex") and Beal Bank in its representative capacities are referred to collectively in this Opinion as the "Objecting First Lien Lenders."

  The Appellant Steering Committee members hold a majority of the First Lien obligations. The Purchaser entities and their parent are affiliates of Aretex and of the investor Carl Icahn. (The Purchasers, their parent, Aretex and Icahn are sometimes referred to herein as the "Aretex/Icahn Group.") Appellee Aretex holds a minority of the First Lien obligations and a majority of the Second Lien obligations. As of the time the Sale Order was entered, the First Lien Lenders had a perfected lien on substantially all of the Debtors' assets, and the Second Lien Lenders had a perfected junior lien on those assets. Pursuant to the Bankruptcy Court's valuation of the transaction consideration and its analysis of the outstanding liabilities to these two creditor groups, the Sale Order calls for the proportionate distribution of a total of approximately $489 million of Parent Shares and/or Subscription Rights among the First Lien Lenders and such a distribution of approximately $95 million of Subscription Rights among the Second Lien Lenders, whose aggregate secured claim is approximately $167 million.

  Appellants challenge principally the in-kind distribution, claim satisfaction and lien release provisions of the Sale Order, which effectively convert the Objecting First Lien Lenders' more than $240 million of secured monetary claims against the Debtors into an illiquid minority equity interest in the parent of successor entities controlled by Mr. Icahn and his affiliates. In the auction that preceded entry of the Sale Order, the Steering Committee, in collaboration with the investor Wilbur Ross, had been the only other bidder for acquisition of the Debtors' assets and control of the successor business.

  The Court has jurisdiction of this appeal pursuant to 28 U.S.C. § 158(a)(1), and has considered carefully all of the parties' papers and arguments in connection with these proceedings. For the following reasons, the Bankruptcy Court's determination that the Objecting First Lien Lenders' claims can be satisfied through the in-kind distribution of Securities in the context of the sale of the Debtors' assets pursuant to section 363(b) of the Bankruptcy Code and certain related determinations are reversed, certain aspects of the Sale Order are vacated, and this matter is remanded to the Bankruptcy Court for further proceedings consistent with this Opinion.

  FURTHER BACKGROUND AND PROCEDURAL HISTORY

  The Sale Order, which was entered following an auction of substantially all of the Debtors' assets pursuant to a bidding procedure put in place by the Bankruptcy Court several months earlier, was the culmination of a contest for control of what could, for lack of a better term, be characterized as an informally reorganized debtor. The Debtors had entered Chapter 11 approximately two years beforehand and, in that time, had been unable to negotiate arrangements with their creditors that would permit them to confirm a Chapter 11 reorganization or liquidation plan consensually.*fn4 As of the time of the approval of the Sale Order, the Debtors were in a very precarious financial condition. Indeed, the Bankruptcy Court noted in its June 29, 2005, oral ruling approving the Aretex/Icahn Group's bid and the transaction terms here at issue that the Debtors lacked sufficient cash, or the ability to generate such cash, to retire their debtor-in-possession financing and the secured claims of the First Lien Lenders. (Tr. of June 29, 2005 Bankruptcy Ct. Hr'g, JA item A72 ("6/29 Tr."), at 200.)

  Earlier in the year, the Steering Committee, in collaboration with Mr. Ross (this grouping will sometimes be referred to in this opinion as the "Steering Committee/Ross Group"), negotiated a proposed transaction with the Debtors, similar in structure to the transaction approved by the Sale Order, under which substantially all of the Debtors' assets would have been transferred pursuant to Bankruptcy Code section 363(b) free and clear of liens and interests to a Steering Committee/Ross Group affiliate and the Debtors would have received equity in the affiliate in return. Those equity securities would have been distributed in satisfaction of, inter alia, the First Lien Lenders' secured debt. By virtue of the Steering Committee's majority holding of the First Lien Debt and/or provisions of a certain collateral trust agreement*fn5 that the Steering Committee contends give it the right to act on behalf of the First Lien Lenders as a group, the Steering Committee would have controlled the new company, which would have carried on the Debtors' business. This Steering Committee/Ross Group transaction was proposed by the Debtors in a motion to the Bankruptcy Court.*fn6

  The Bankruptcy Court denied the motion for approval of the Steering Committee/Ross Group transaction,*fn7 but ultimately approved and set in motion an auction procedure in which a similarly-structured Steering Committee/Ross Group bid was the stalking horse.*fn8

  The Sale Order was entered, over strenuous objections by the Steering Committee and objections by Beal Bank, following a two-month effort to solicit bids for acquisition of the Debtors' assets, an auction in which there were only two bidders — the Steering Committee/Ross Group and the Aretex/Icahn Group —, and a four-day hearing. The Bankruptcy Court found, based on bids tendered at the auction and the evidence presented at the hearing, that the overall value of the Aretex/Icahn Group transaction was $703.5 million, that the value of the Parent Shares and Subscription Rights available for distribution to First and Second Lien Lenders was $575.8 million, that the amount of the First Lien Holders' collective allowed secured claim as of June 30, 2005 was $488,371,841.20, and that the value of the sale consideration flowing to the Debtors in the transaction exceeded the First Lien Lenders' aggregate claim by $95 million, warranting distribution of the Subscription Rights remaining after satisfaction of the First Lien Lenders' claims through the in-kind distribution, to the Second Lien Lenders. (See, e.g., Sale Order ¶¶ Q, S-T.) The Bankruptcy Court further found that such direct, in-kind distributions were permissible under an Intercreditor Agreement among the Debtors and the First and Second Lien Lenders,*fn9 and that a distribution to the Second Lien Lenders was necessary by way of adequate protection of their interests. (Sale Order ¶ R; 6/29 Tr. at 221-22.)

  Although the Sale Order contemplated the possibility that the transactions it authorized could be accomplished in connection with a plan of reorganization, it provided that no plan or further order of the Court was required to effect the transactions. (Sale Order ¶ F.) The Sale Order thus by its terms permitted consummation of the transactions, including the transfer of substantially all of the Debtors' assets to the Aretex/Icahn affiliates free and clear of liens, the grant of replacement liens to the First and Second Lien Lenders in the Securities to be issued by the Aretex/Icahn affiliated holding company and other sale consideration, and the issuance of illiquid Securities*fn10 to the Objecting First Lien Lenders, in a quantity valued by the Bankruptcy Court as of the closing date to equal the accrued amount of those lenders' secured claims as of the transaction closing date, in complete satisfaction of their claims, and termination of the Objecting First Lien Lenders' liens in the replacement collateral, all without the confirmation of any Chapter 11 plan or any other action of the Court. The Objecting First Lien Lenders' secured monetary claims against the Debtors would thus be converted into equity in a new company operating with the Debtors' former assets and controlled by the Steering Committee's auction rival.

  The Steering Committee moved before the Bankruptcy Court for a stay of the Sale Order pending appeal. Judge Drain denied that application in an oral decision rendered on July 22, 2005, but agreed to stay the order for a brief period pending a stay application to this Court. (Tr. of July 22, 2005 Bankruptcy Ct. Hr'g re: Second Lien Agent's Mot. for an Order Dissolving Adequate Protection Escrow, Objection of Bank of America, N.A., . . . Mot. for Stay Pending Appeal, JA item A91 ("7/22 Tr."), at 130-31.) The Objecting First Lien Lenders then filed motions in this Court for expedited consideration of their appeal of the Sale Order and for a stay of the Sale Order pending appeal. Those matters came on before the undersigned on August 5, 2005. After hearing arguments of counsel concerning a stipulation resolving the stay application, proposed by the Steering Committee, Beal Bank, the Purchaser, Aretex and the Debtors, the Court overruled objections by Second Lien Lenders other than Aretex and the Second Lien Agent (collectively, the "Second Lien Appellees") to entry of the stipulation, granted a stay consistent with the terms of the stipulation, and granted the expedited appeal application to the extent of setting a briefing schedule therefor.

  This Stipulation Between Steering Committee of First Lien Lenders, Debtors, Aretex and Purchasers Regarding Steering Committee's and Beal Bank's Motion for Stay, entered by this Court on August 5, 2005 in miscellaneous matter No. M47 (the "Stay Order") provided, inter alia, that the Objecting First Lien Lenders withdrew their application to stay the closing of the sale to Purchaser of the Debtors' assets and that the distribution of the Subscription Rights allocable to the Second Lien Lenders under the Sale Order was stayed on the following terms:*fn11

 
3 . . . a. The Second Lien Distribution [of Subscription Rights] to the Second Lien Lenders shall be made at the closing, but shall be held in escrow . . . pursuant to an escrow agreement. . . . (Until placed in escrow, the Second Lien Distribution shall be held in escrow by WestPoint International, Inc.).
b. The escrow agreement will provide that the Second Lien Distribution shall be disbursed to the Second Lien Lenders as provided in the Sale Order on the earlier of (i) October 31, 2005 or (ii) two business days after the District Court issues an order regarding its decision on the appeal of the Sale Order (the `Escrow Release Date') . . .; provided, however, that if the District Court in its order on the appeal provides that some or all of the subscription rights should be distributed to the First Lien Lenders under the Intercreditor Agreement or otherwise, or remands to the Bankruptcy Court to determine the allocation of Subscription Rights held in escrow, then the Subscription Rights being held in escrow shall be disbursed or further held in escrow in accordance with such order unless such order is stayed by further order of the appropriate Court on application by a party other than the Steering Committee, its members or Beal Bank, in which case the Distribution shall remain in escrow pending further order. If the registration statement [for the Securities] goes effective prior to the Escrow Release Date, the exercise period shall be extended as necessary to provide a full thirty-day exercise period after the Escrow Release Date, but in no event beyond November 30, 2005.
* * *
e. In all other respects, the distributions noted above shall be in accordance with the Sale Order and the terms of the Asset Purchase Agreement, including Section 3.3(b) thereof.
4. Except as specifically set forth herein, the rights of all parties to this appeal, including Aretex, Purchasers, the Second Lien Lenders, the Second Lien Agent, the Debtors, the First Lien Agent, the Collateral Trustee and the Steering Committee, as to the appeal and all other disputes and matters between them, including without limitation rights under paragraph R of the Sale Order, are expressly preserved and are not affected by this stipulation. (Stay Order ¶¶ 3-4.)*fn12 The Aretex/Icahn/WestPoint asset purchase transaction closed on August 8, 2005, following entry of the Stay Order. The Subscription Rights designated by the Sale Order for distribution to the Second Lien Lenders have been held in escrow since that time pursuant to the Stay Order. In accordance with the Sale Order and as permitted by the Stay Order, Securities have been distributed to the First Lien Lenders in proportion to their holdings of First Lien debt.
  The undersigned accepted the instant appeal as related to the stay application; the appeal was argued on September 20, 2005, and ancillary briefing was completed shortly thereafter. The Court heard further arguments on November 9, 2005.

  In addition to the Objecting First Lien Lenders' appeal of the distribution, claim satisfaction and lien termination provisions of the Sale Order, Aretex has cross-appealed on issues relevant to the selection of the winning bid. As Aretex acknowledges in its cross-appeal papers, the Court need not reach those issues if it does not invalidate the sale of the Debtors' assets to Aretex. This Opinion and its accompanying Order do not invalidate the sale; Aretex's cross-appeal is therefore dismissed.

  The Second Lien Appellees have moved to strike Beal Bank's appeal as well as portions of the Steering Committee's papers that proffer information postdating the documents in the Joint Appendix and certain arguments the Second Lien Appellees contend have been waived. The motion to strike Beal Bank's appeal is denied because, as explained below, Beal Bank adequately preserved its issues for appeal. The remainder of the motion to strike is also denied. As explained below, the Court finds that the relevant challenged arguments have not been waived. Furthermore, the factual information sought to be stricken is not pertinent to the grounds upon which the Court has determined this appeal.

  DISCUSSION

  In its opening brief, which was filed prior to entry of the Stay Order and prior to the closing of the Aretex/Icahn/WestPoint transaction, the Steering Committee characterized the issues presented on appeal as:
1. Whether the Bankruptcy Court erred in concluding that the transfer to the First Lien Lenders of only a portion of the noncash replacement collateral securing the First Lien Indebtedness constitutes full satisfaction and/or adequate protection of the First Lien Indebtedness[;]
2. Whether the Bankruptcy Court erred in concluding that, contrary to the explicit and unambiguous terms of the Intercreditor Agreement, the Second Lien Lenders can nonetheless receive any payment or transfer of collateral even though the First Lien Lenders are not receiving full payment in cash[;]
3. Whether the Bankruptcy Court erred in concluding that the Debtors can, pursuant to sections 363(f)(3) or 363(f)(5) of the Bankruptcy Code, sell the Purchased Assets free and clear of the Interests of the First Lien Collateral Trustee and/or the First Lien Lenders[;]
4. Whether the Bankruptcy Court erred in concluding that the Successful Bid by Icahn was authorized, and higher and better, than the competing credit bids directed by the Steering Committee, even though the Successful Bid did not provide for payment in full and in cash of the First Lien Lenders[; and]
5. Whether the Bankruptcy Court erred in concluding that the Debtors are authorized to transfer the collateral directly to First Lien Lenders, rather than to the First Lien Collateral Trustee in its capacity as the lienholder under the First Lien Collateral Trust Agreement.
(Steering Committee Appellants' Opening Br. at 1-2.)

  In the following Discussion the Court will address the standards governing its review of the Bankruptcy Court's determinations, the extent to which certain of the issues designated for appeal have been mooted by the closing of the Aretex/Icahn/WestPoint transaction, whether any of the arguments that have not been mooted have been waived and, as to the merits of the remaining appellate issues, whether the distribution of Securities in-kind to Objecting First Lien Creditors in satisfaction of their claims and the follow-on distribution called for by the Sale Order are authorized by the relevant contracts among the parties, and whether Sections 363 and/or 105 of the Bankruptcy Code supplied the Bankruptcy Court with the requisite authority to approve the challenged aspects of the transaction. The Discussion will thereafter address the question of available remedies.

  Standard of Review

  On appeal, the legal determinations of the bankruptcy court are reviewed de novo and its findings of fact are reviewed under a clearly erroneous standard. See Consumer News and Bus. Channel P'ship v. Fin. News Network Inc. (In re Fin. News Network Inc.), 980 F.2d 165, 169 (2d Cir. 1992); Able v. Shugrue (In ...


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