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In re Source Enterprises

August 12, 2008

IN RE: SOURCE ENTERPRISES, INC.
WINDELS MARX LANE & MITTENDORF, LLP APPELLANT,
v.
SOURCE ENTERPRISES, INC., ET AL., APPELLEES.



The opinion of the court was delivered by: Sidney H. Stein, U.S. District Judge

(USBC-SDNY, 06-B-11707 (AJG))

OPINION & ORDER

Windels Marx Lane & Mittendorf, LLP ("Windels") appeals pro se from an order of the United States Bankruptcy Court for the Southern District of New York confirming the Source Enterprises, Inc. debtors' Fourth Amended Plan of Reorganization dated August 22, 2007 (the "Plan"). In an Order dated October 1, 2007, Bankruptcy Judge Arthur J. Gonzalez confirmed the Plan, and overruled objections, including those filed by Windels. In re Source Enters., Inc., No. 06-11707 (AJG), 2007 WL 2903954, at *9 (Bankr. S.D.N.Y. Oct. 1, 2007). Windels here argues that the Plan should not have been confirmed because (1) the debtors should not have been substantively consolidated with each other; (2) the Plan ignores the fact that corporate governance requirements-such as board approval of filing a bankruptcy petition-were not met; (3) the Plan violated section 1122(a) of the Bankruptcy Code by placing creditors with substantially dissimilar claims in the same class; (4) the Plan violated section 1123(a)(4) of the Bankruptcy Code by treating creditors in the same class differently; and (5) the Plan was modified in a way that led to disparate treatment of one creditor in violation of sections 1127(a), (c), (d), (f)(1) and (f)(2) of the Bankruptcy Code. Windels' objections lack merit, and, furthermore, its claims are barred as equitably moot. This Court therefore affirms the Bankruptcy Court's confirmation of the Plan.

I. BACKGROUND

The debtors published The Source, a monthly magazine, and The Source Latino. The debtors also engaged in related businesses, such as the licensing of Enterprises' trademarks and trade names for use in connection with programming, Source-branded CDs and DVDs, and the sale of products including ring tones and "wallpaper" for mobile telephones and computers.

The debtors include the following entities: (1) Source Enterprises, Inc., a Delaware corporation ("Enterprises"); (2) Source Entertainment, Inc., a Delaware corporation ("Entertainment"); (3) Source Magazine, LLC, a New York company ("Magazine") (collectively, "primary debtors"); and each of the following entities and pseudonyms by which any or all of Enterprises, Entertainment and/or Magazine have been known, including (4) Source Entertainment, LLC, a California company; (5) Source Holdings LLC, a Delaware company; (6) Source Merchandising LLC, a New York company; (7) The Source.com, LLC, a New York company; (8) Source Sound Lab, LLC, a Delaware company; (9) Source Music, LLC, a New York company; (10) Source Broadcast Media, LLC, a New York company; (11) The Source; (12) Source Publications, Inc.; (13) Source Magazine; (14) The Source Magazine; (15) The Source Awards; (16) Hip-Hop Hits; (17) Source Sports; (18) Unsigned Hype LLC; and (19) Source Media and Merchandising, Inc. (collectively, "subsidiary debtors"). See Source, 2007 WL 2903954, at *1.

Enterprises' bankruptcy case commenced in July 2006, when three of its creditors filed an involuntary petition for relief under Chapter 7 of Title 11 of the United States Code. Id. The Bankruptcy Court converted the Chapter 7 case to a Chapter 11 case in September 2006, and the debtors other than Enterprises filed voluntary petitions for relief under Chapter 11 in April 2007. Id. The Court ordered that debtors' cases be administered jointly and that all of the substantive orders in Enterprises' case would apply to Entertainment and Magazine as well. Id.

A hearing was held in the debtors' bankruptcy cases on August 21, 2007, and the next day, the debtors filed the Plan and a Disclosure Statement with Respect to the Fourth Amended Plan of Reorganization of the Source Debtors ("Disclosure Statement"). Id. As part of the Plan, Black Enterprise/Greenwich Street Corporate Growth Partners, L.P. ("BE/GS"), which had been running debtors since at least 2006, would receive 85 percent of the reorganized debtor*fn1 and releases from liability. Id. at *17, *19. On August 23, 2007, the Bankruptcy Court entered an order approving the Disclosure Statement. Id. at *2.

Before a confirmation hearing was held, Northstar Marketing Group, Inc. ("Northstar") and BE/GS disclosed the existence of an agreement concerning a contemplated transaction pursuant to which Northstar would have the right, after a certain date, to purchase from BE/GS a portion of the equity of the reorganized debtor that BE/GS was to receive under the Plan. Id. At the same time, a principal of Northstar, L. Londell McMillan, withdrew an objection to an earlier version of the Plan filed by his law firm, L. Londell McMillan P.C. (the "McMillan Firm").

Two objections were filed to the final version of the Plan: one by Windels and one by David Mays, the founder and former President and CEO of the debtors. Id. at *3. Windels is a law firm that represented various Source entities pre- and post-petition. Id. at *17. In its objections, it stated that it had been retained by Enterprises, Entertainment and BE/GS on January 24, 2006, as counsel to the primary and subsidiary debtors, and was owed $104,636.09 for services rendered. (Objection of Windels Marx Lane & Mittendorf, LLP with Respect to the Proposed Fourth Amended Plan of Reorganization of the Source Debtors ("Windels Obj.") at ¶ 1-2.) Windels withdrew as Enterprises' Chapter 11 counsel in April 2007. (Id. ¶ 3.) Windels objected to the Plan on several grounds, but, at bottom, it was objecting to being classified as a pre-petition unsecured creditor rather than as an administrative creditor as a result of its prior role as debtors' bankruptcy counsel. Source, 2007 WL 2903954, at *17. It objected to the Plan in the first instance because it argued that BE/GS was effectively the same entity as the debtors and was using its complete control of the debtors to direct them to submit a Plan that wholly insulated BE/GS from the debtors' debts. (Windels Obj. ¶¶ 11, 14.) Windels also objected to the subsidiary debtors being granted relief under the Bankruptcy Code, because those entities were legitimate companies in their own right and had not filed voluntary petitions for relief or adhered to other corporate governance requirements. (Id. ¶¶ 17-21.) Windels asserted that the Plan violated section 1122(a) and 1123(a)(4) of the Bankruptcy Code by lumping together all holders of unsecured claims (id. ¶ 22), and by treating those claimants differently (id. ¶¶ 23-24). Finally, Windels objected because the plan was modified to satisfy the objections of another creditor, the McMillan Firm, which was treated differently from-and more favorably than-all the other general unsecured creditors. (Id. ¶¶ 26-27.)

After a two-day confirmation hearing, and the Bankruptcy Court issued its findings of fact and conclusions of law on October 1, 2007. Source, 2007 WL 2903954. Bankruptcy Judge Gonzalez confirmed the Plan and overruled the objections. Id. at *9. In disposing of the objections, the Bankruptcy Court first approved the substantive consolidation of the debtors "in recognition of the economic reality that the Debtors' books and records are incapable of being 'untangled' from one another, and creditors, as well as the debtors themselves, have dealt as though the debtors are a single entity." Id. at *5, *10. The Bankruptcy Court also found that the Plan complied with "all applicable provisions of the Bankruptcy Code," including sections 1122 and 1123 because the classes designated by the Plan contained claims or equity interests that were "substantially similar" to each other, and provided for the same treatment of the claims and interests within each class. Id. at *5.

In response to Windels' objections, Judge Gonzalez noted that a secured creditor, Textron Financial Corporation, had a claim "far in excess" of the entire value of the debtors' assets, and yet it had agreed to the terms of the Plan and was waiving an "overwhelming deficiency claim." Id. at *18. In light of the enormous concessions made by Textron, Windels' assertion that unsecured creditors could have obtained more value "is simply not credible," Judge Gonzalez concluded. Id. Furthermore, the Unsecured Creditors' Committee had agreed to the terms of the plan, and "[e]very conceivable alternative to the Plan was investigated by the Committee." Id. The Court found that BE/GS was not receiving any more than it had invested post-petition, and it was also not credible that BE/GS had manipulated the process in some way. Id. at *19. The Court noted that substantive consolidation was proper because despite the fact that the different debtor entities had signed separate retainer agreements with Windels, Windels was only paid for its work by Enterprises. Id. Based on the testimony of Jeremy Miller, President and CEO of debtors, and David Berliner, a partner of BDO Seidman, LLP ("BDO"), an accounting and financial advisory firm that provided services to debtors throughout the Chapter 11 process, the Court found "substantial identity between the entities to be consolidated": the debtors had the same officers, directors, and shareholders, conducted the same business operations under similar names, corporate formalities were not observed for inter-company dealings, and accounts receivable were billed from Enterprises alone. Id. at *20. The agreement between Northstar with BE/GS was prospective and not a modification of the Plan. Id. And finally, the Bankruptcy Court noted that the two board members who did not approve the filing of the bankruptcy petitions were given adequate notice of the board meetings, and the board's actions were therefore proper. Id.

This appeal followed.

II. STANDARD OF REVIEW

Because the order of the Bankruptcy Court below is a final one, this Court has jurisdiction on appeal pursuant to 28 U.S.C. § 158(a). The bankruptcy court's findings of fact must be accepted by this Court unless they are clearly erroneous, Fed. R. Bankr. P. 8013, whereas the bankruptcy court's findings of law are reviewed de novo. Kenton Cty. Bondholders Comm. v. Delta Air Lines, Inc. (In re Delta Air Lines), 374 B.R. 516, 522 (S.D.N.Y. 2007).

III. DISCUSSION

Windels objects to the Plan on essentially the same grounds here as it did before the Bankruptcy Court. Windels asserts that the Plan should not have been confirmed because (1) the debtors should not have been substantively consolidated; (2) the Plan ignored the fact that corporate governance requirements-such as board approval of filing for bankruptcy-were not met for some of the primary and all of the subsidiary debtors; (3) in violation of section 1122(a) of the Bankruptcy Code, creditors with substantially dissimilar claims were placed in the same class; (4) in violation of section 1123(a)(4) of the Bankruptcy Code, creditors in the same class were treated differently; and (5) the modification of the Plan that gave Northstar-and its principal, McMillan-opportunities with respect to the reorganized debtor that were not offered to any other creditors, violated sections 1127(a), (c), (d), (f)(1) and (f)(2) of the Bankruptcy Code by treating the McMillan Firm differently than all other general unsecured creditors. Debtors respond chiefly that Windels' appeal is equitably moot because there has been a "'comprehensive change in circumstances'" and the plan of reorganization has been "'substantially consummated'" (Appellees' Brief dated Jan. 29, 2008 ("Opp. Br.") at 13 (quoting Delta, 374 B.R. at 522), and, if the appeal is not equitably moot, it fails on the merits.

A. Equitable Mootness

Before considering the merits, the Court must address a threshold matter: whether this appeal is barred under the "equitable mootness" doctrine as set forth in Frito-Lay, Inc. v. LTV Steel Co. (In re Chateaugay Corp.) (Chateaugay II), 10 F.3d 944 (2d Cir. 1993). The mootness doctrine arises from the "fundamental jurisdictional tenet that Federal courts are empowered only to hear live cases and controversies." TWA, Inc. v. Texaco, Inc. (In re Texaco, Inc.), 92 B.R. 38, 45-46 (Bankr. S.D.N.Y. 1988). In bankruptcy cases, the doctrine is a prudential one, and the Second Circuit has applied it to hold that "'[a]n appeal should . . . be dismissed as moot when, even though effective relief could conceivably be fashioned, implementation of that relief would be inequitable.'" Deutsche Bank AG v. Metromedia Fiber Network (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 143 (2d Cir. 2005) (quoting Official Comm. of Unsecured Creditors of LTV Aerospace & Def. Co. v. Official Comm. of Unsecured Creditors of LTV Steel Co. (In re Chateaugay Corp.) (Chateaugay I), 988 F.2d 322, 325 (2d Cir. 1993)). The doctrine is therefore "invoked to avoid disturbing a reorganization plan once implemented," Metromedia, 416 F.3d at 144, and can be applied in two situations: "when an unstayed order has resulted in a comprehensive change in circumstances, and when a reorganization is substantially consummated," Delta, 374 B.R. at 522 (internal citations and quotation marks omitted).

As defined by the Bankruptcy Code, "substantial consummation" means the "transfer of all or substantially all of the property proposed by the plan to be transferred, . . . assumption by the debtor or by the successor to the debtor under the plan of the business or of the management of all or substantially all of the property dealt with by the plan; and . . . commencement of distribution under the plan." 11 U.S.C. § 1101(2). "[W]hen a reorganization has been substantially consummated . . . , there is a strong presumption that an appeal of an unstayed order is moot." Delta, 374 B.R. at 522 (internal quotations and citations omitted). This presumption can only be overcome if five circumstances are present:

(a) the court can still order some effective relief; (b) such relief will not affect the re-emergence of the debtor as a revitalized corporate entity; (c) such relief will not unravel intricate transactions so as to knock the props out from under the authorization for every transaction that has taken place and create an unmanageable, uncontrollable situation for the Bankruptcy Court; (d) the parties who would be adversely affected by the modification have notice of the appeal and an opportunity to participate in the proceedings; and (e) the appellant pursued with diligence all available remedies to ...


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