Free Appellant's Brief - District Court of Connecticut - Connecticut

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 1 of 81

UNITED STATES DISTRICT COURT DISTRICT OF CONNECTICUT ) ) ) SCOTT CABLE COMMUNICATIONS, INC., ) ) Debtor. ) ) UNITED STATES OF AMERICA, ) ) Appellant, ) v. ) ) SCOTT CABLE COMMUNICATIONS, INC., ) STATE STREET BANK AND TRUST CO. as ) Indenture Trustee for certain note holders, and ) AKIN, GUMP, STRAUSS, HAUER & FELD, LLP, ) ) Appellees ) ) In re:

No. 3:02-CV-1725 (AWT) (consolidated bankruptcy appeals) (Bankr. Ct. Case No. 98-51923)

UNITED STATES' OPENING APPEAL BRIEF

PETER SKLAREW Federal Bar No. CT 17864 Tax Division U.S. Department of Justice P.O. Box 55 Washington, D.C. 20044-0055 (202) 307-6571 Local Counsel: JOHN A. DANAHER, III United States Attorney ANN M. NEVINS Assistant United States Attorney Federal Bar No. CT06484 915 Lafayette Blvd., Room 309 Bridgeport, CT 06604 (203) 696-3000

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 2 of 81

TABLE OF CONTENTS Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Statement of Jurisdiction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Statement of the Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 A. Issues for Conversion Appeal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 B. Issues for Cash-Collateral/Interim-Fees Appeal . . . . . . . . . . . . . . . . . . . . . . . . . 5 Standard of Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Statement of the Case ­ Facts and Procedural History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1996 Reorganization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 1998 Petition; Rejected Plan; § 363 Liquidation; Tax Claim . . . . . . . . . . . . . . . . . . . . . . 7 The Adversary Proceeding, Appeal, Remand, and Transfer . . . . . . . . . . . . . . . . . . . . . . 8 The Attempted Appeal of the Transfer, and the Motion to Re-Transfer . . . . . . . . . . . . . 9 Debtor's Intervention in Delaware as Predicate to Cash Collateral Stipulation in Connecticut . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Evolving Motion to Convert or Appoint a Chapter 11 Trustee . . . . . . . . . . . . . . . . . . . . 10 Cash Collateral Stipulation and Objections and Responses . . . . . . . . . . . . . . . . . . . . . . 13 Additional Related Delaware Motions (and Notice to Connecticut Bankruptcy Court) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 The 7/18/02 Order and Appeal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Intervention by Noteholders; Comments of Delaware Bankruptcy Court Regarding its Jurisdiction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 The Fee Applications, U.S. Opposition, and Orders Granting Them . . . . . . . . . . . . . . . 19 12/3/02 Hearing and Bench Ruling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 The 12/23/03 Order . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Disposition of the Application in Delaware . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Delaware Appeal and Stay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Procedural Rulings in these Appeals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Judicial Notice of Status of the Delaware Adversary Proceeding . . . . . . . . . . . . . . . . . 26 Arguments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 A. THE CONVERSION APPEAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 1. Conversion to Chapter 7 Was (and Is) Required by the Impossibility of Confirming a Plan, Continuing Diminution of the Estate, and the Conflict of Interest on the Part of Debtor's Management . . . . . . . . . . . . . . . . a. Inability to Effectuate a Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . b. Continuing Diminution of the Estate . . . . . . . . . . . . . . . . . . . . . . . . . . . c. Conflict of Interest of Debtor's Management . . . . . . . . . . . . . . . . . . . . .

27 27 28 29

2.

Alternatively, A Chapter 11 Trustee Should Be Appointed . . . . . . . . . . . . . . 37 (ii)

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 3 of 81

B.

THE CASH COLLATERAL/INTERIM FEES APPEAL . . . . . . . . . . . . . . . . . . . . . 37 1. The Bankruptcy Court Lacked Power to Transfer Part of the Administration of the Estate to Another District and that Aspect of the Transfer Order is Void; But if the Transfer of Cash Collateral Applications is Not Void, then the 7/19/02 Order's Grant of the Cash Collateral Application Must Be Vacated for Want of Jurisdiction . . . . . . . . 37 a. Introduction ­ Ramifications; Parties' Positions . . . . . . . . . . . . . . . . . . 37 b. Construction of Current Statutory Provisions . . . . . . . . . . . . . . . . . . . . 39 c. Pre-1984 Legislative History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 d. The 1984 Amendments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 The Connecticut Bankruptcy Court Erred in Viewing the Delaware Bankruptcy Court's Grant of the Debtor's Motion to Intervene in the Adversary Proceeding as Disposing of Any Objection to the Use of Estate Funds to Compensate Debtor's Counsel for Legal Services in Defense of the Secured Claim of the Indenture Trustee . . . . . . . . . . . . . . . . . 56 It Was Error to Assume That the Estate's Funds Constitute "Collateral" for the Security Interest of the Indenture Trustee Where the Validity of That Security Interest Was under Litigation . . . . . . . . . . . . . . . . . . . . . . . . . . 60 It Was Error to Authorize the Use of Estate Funds to Finance Legal Services to Be Provided by Counsel for the Estate's Fiduciary Directed at Defending a Disputable Lien Against the Estate Which, If Upheld, Will Render the Estate Penniless; For Similar Reasons, It was Error to Award Interim Fees for Resisting Conversion and Performing Other Services Against the Interests of the Unsecured Creditors . . . . . . . . . . . . . . . 62 The Bankruptcy Court Erred in Authorizing 100% Payment of Allowed Interim Fees to Debtor's Counsel Where the Estate Is Administratively Insolvent And, Unless the Security Interest for the Junior Notes Is Upheld Fully, Debtor's Counsel Would at Most Be Entitled to a Pro Rata Dividend Based on Counsel's Allowed Fees in Comparison to Total Administrative Expenses . . . . . . . . . . . . . . . . . . 68

2.

3.

4; 5.

6.

Conclusions (Relief Sought) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

(iii)

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 4 of 81

TABLE OF AUTHORITIES Cases: C.F.T.C. v. Weintraub, 471 U.S. 343 (1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Dewsnup v. Timm, 502 U.S. 410 (1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
Green v. Warden, U.S. Penitentiary, 699 F.2d 364 (7th Cir. 1983) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Hartford Underwriters, Ins. Co. v. Union Planters Bank, 530 U.S. 1 (2000) . . . . . . . . . . 11, 31, 32 Hoffman v. Blasky, 363 U.S. 335 (1960) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49, 57 In re Barron, 73 B.R. 812 (Bankr.S.D.Cal.1987) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 In re Bowman, 181 B.R. 836 (Bankr. Md. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35, 36
In re Cohn, 54 F.3d 1108 (3d Cir.1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

In re Cybergenics Corp., 226 F.3d 237 (3d Cir. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58, 66 In re Energy Co-op., Inc., 55 B.R. 957 (Bankr.N.D.Ill. 1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 In re Flagstaff Foodservice Corp., 739 F.2d 73 (2d Cir. 1984) . . . . . . . . . . . . . . . . . . . . . . . . . . 70 In re Global Int'l Airways Corp., 82 B.R. 520 (Bankr. W.D.Mo. 1988) . . . . . . . . . . . . . . . . 62, 63 In re Golden Recipe Chicken, Inc., 109 B.R. 692 (Bankr. W.D.Pa. 1990) . . . . . . . . . . . . . . . . . . 63 In re Graf Bros. Inc., 19 B.R. 269 (Bankr. Me. 1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 In re IML Freight, Inc., 52 B.R. 124 (Bankr. Utah 1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 In re Indian Motocycle Co. 261 B.R. 800 (1st Cir. BAP 2001) . . . . . . . . . . . . . . . . . . . . . . . 39, 40 In re JLM Inc., 210 B.R. 19 (BAP 2d Cir. 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 In re Kean Corp. 205 B.R. 690 (Bankr. S.D.N.Y. 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 In re Kendavis Industries Intern., Inc., 91 B.R. 742 (Bankr. N.D.Tex. 1988) . . . . . . . . . . . . . . . 64 In re L.S. Good & Co., 8 B.R. 312 (Bankr. N.D. W.Va. 1980) . . . . . . . . . . . . . . . . . . . . . . . . . . 34 In re Lundborg, 110 B.R. 106 (Bankr. Conn. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 In re Marvel Entertainment Group, Inc., 140 F.3d 463 (3d Cir. 1998) . . . . . . . . . . . . . . . . . . . . . 34 (iv)

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 5 of 81

In re Nadler, 8 B.R. 330 (Bankr. E.D. Pa. 1980) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 In re Reed, 890 F.2d 104 (8th Cir. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 In re Robbins, 151 B.R. 364 (Bankr. W.D. Va. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 In re Schipper, 933 F.2d 513 (7th Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 In re Scott Cable, 227 B.R. 596 (Bankr. Conn. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 29 In re Sharon Steel Corp., 872 F.2d 1217 (3d Cir. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 In re Smith Technology Corp., 1999 WL 1427681 (D.Del. 1999) . . . . . . . . . . . . . . . . . . . . . 64, 65 In re Taxman Clothing Co., 49 F.3d 310 (7th Cir. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 In re Tel-Net Hawaii, Inc., 105 B.R. 594 (Bankr. D.Ha. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . . 36
In re The Caldor Corp., 303 F.3d 161 (2d Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

In re Top Grade Sausage, Inc., 227 F.3d 123 (3d Cir. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 In re Ward, 894 F.2d 771 (5th Cir. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 In re Waxman, 148 B.R. 178 (Bankr. E.D.N.Y. 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 In re Weinstein, 272 F.3d 39 (1st Cir. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Isaacs v. Hobbs Tie & T. Co., 282 U.S. 734 (1931) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Kawaauhau v. Geiger, 523 U.S. 57 (1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Lamie v. U.S. Trustee, 540 U.S. 526 (2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64 Liberty Mutual Ins. Co. v. Rotches Pork Packers, Inc., 969 F.2d 1384 (2d Cir.1992) . . . . . . . . . . . . . . . 16 Lopez-Soto v. Hawayek, 175 F.3d 170 (1st Cir. 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Lopez-Soto v. Hawayek, 175 F.3d 170 (1st Cir. 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Matter of Fiesta Homes of Georgia, Inc., 125 B.R. 321 (Bankr. S.D.Ga. 1990) . . . . . . . . . . . . . 35
Matter of Marin Motor Oil, Inc., 689 F.2d 445 (3d Cir. 1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Matter of Pro-Snax Distributors, Inc., 157 F.3d 414 (5th Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . 64 Matter of Ribs-R-Us, Inc., 828 F.2d 199 (3d Cir. 1987) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 (v)

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 6 of 81

Rumore v. Wamstad, 2001 WL 1426680 (E.D.La. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
Scherer v. Equitable Life Assurance Soc., 347 F.3d 394 (2d Cir. 2003) . . . . . . . . . . . . . . . . . . . . . . . . 16

United States Fidelity & Guaranty Co. v. Bray, 225 U.S. 205 (1912) . . . . . . . . . . . . . . . . . . . . . 57
United States v. Boatman's First Nat. Bank, 5 F.3d 1157 (8th Cir. 1993) . . . . . . . . . . . . . . . . . . . . 11, 32

United States v. Noland, 116 S.Ct. 1524 (1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70 United States v. State Street Bank and Trust, 2002 WL 417013 (Bankr. Del. 2002) . . . . 10, 44, 66 United States v. State Street Bank and Trust, 259 B.R. 536 (D.Conn. 2001) . . . . . . . . . . . . . . . . . 8 United States v. State Street Bank and Trust, 263 B.R. 6 (Bankr. Conn. 2001) . . . . . . . . . . . . . . . 9
Veg-Mix, Inc. v. United States Dep't of Agric., 832 F.2d 601 (D.C.Cir.1987) . . . . . . . . . . . . . . . . . . . . 16

Statutes: 11 U.S.C. § 101(16) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 11 U.S.C. § 101(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 11 U.S.C. § 1104 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 35 11 U.S.C. § 1106 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59, 65 11 U.S.C. § 1107 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38, 59, 62, 65 11 U.S.C. § 1109 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 11 U.S.C. § 1112 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 10, 27, 35 11 U.S.C. § 1129 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5, 27, 69 11 U.S.C. § 1141(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 11 U.S.C. § 307 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 11 U.S.C. § 323 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 11 U.S.C. § 327 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30, 34, 50, 51, 53, 62 11 U.S.C. § 330 . . . . . . . . . . . . . . . . . . . . 2, 5, 6, 22, 39, 40, 42, 43, 47, 51, 53, 59, 61, 62, 64, 71

(vi)

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 7 of 81

11 U.S.C. § 331 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 25, 39, 40, 42, 51 11 U.S.C. § 361 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 11 U.S.C. § 363 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 13, 27, 38, 41, 42, 50, 51, 57, 61 11 U.S.C. § 502 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51, 53, 61 11 U.S.C. § 503(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 11 U.S.C. § 506(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 31-34 11 U.S.C. § 507(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 11 U.S.C. § 510(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36, 60, 66 11 U.S.C. § 522 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 11 U.S.C. § 525 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 11 U.S.C. § 541(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 11 U.S.C. § 544(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58, 65 11 U.S.C. § 55 (repealed) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 11 U.S.C. § 551 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 11 U.S.C. § 554 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 11 U.S.C. § 704 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59, 65 11 U.S.C. § 725 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 11 U.S.C. § 726(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20, 69, 71 28 U.S.C. § 1334 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 20, 38-42, 45, 47-49, 51-56 28 U.S.C. § 1404 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48, 49, 54 28 U.S.C. § 1409 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45, 52, 53 28 U.S.C. § 1412 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20, 39, 40, 45, 46, 48, 54, 55 28 U.S.C. § 1471 (repealed) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48-50, 52-54 28 U.S.C. § 1473 (repealed) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 (vii)

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 8 of 81

28 U.S.C. § 1475 (repealed) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48-51, 54 28 U.S.C. § 151 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 28 U.S.C. § 157 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41, 55 28 U.S.C. § 158 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 28 U.S.C. § 586(a)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Rules: Fed.R.Bankr.P. 1014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45, 46 Fed.R.Bankr.P. 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39, 41, 42 Fed.R.Bankr.P. 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25, 42, 53 Fed.R.Bankr.P. 3007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 Fed.R.Bankr.P. 4001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Fed.R.Bankr.P. 7001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39, 61 Fed.R.Bankr.P. 7087 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Fed.R.Bankr.P. 8013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6, 71 Fed.R.Bankr.P. 9014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40, 41 Fed.R.Civ.P. 24(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 Other Authorities: H.R.Conf.Rep. 98-882, 98th Cong., 2d Sess. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 H.Rep. 98-9, 98th Cong., 1st Sess. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 H.Rep. No. 95-595, 95th Cong., 1st Sess. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49-51 S.Rep. 95-989, 95th Cong., 2d Sess. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25, 46, 50, 52 S.Rep. 98-55, 98th Cong., 1st Sess. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

(viii)

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 9 of 81

UNITED STATES' OPENING APPEAL BRIEF Introduction The United States is appealing two orders of the Bankruptcy Court (Judge Shiff).1/ The first, entered July 18, 2002 (7/18/02 Order), contained two rulings, both of which the government is appealing. First, the 7/18/02 Order denied the government's motion to convert the case to Chapter 7, pursuant to § 1112, or to appoint a Chapter 11 trustee pursuant to § 1104.2/ Second, it granted a joint application (stipulation) of the debtor and the indenture trustee ["Indenture Trustee"] for the secured, junior subordinated payment-in-kind (PIK) notes ["junior notes"] to authorize the debtor, pursuant to § 363, to use part of the cash proceeds of the sale of all of the debtor's assets, which proceeds are claimed as "cash collateral" securing the lien of the Indenture Trustee.3/ The order approved a budget committing $800,000 for payment of past and future legal services to the debtor in helping the Indenture Trustee defend against the government's adversary complaint seeking to recharacterize the junior notes as equity instruments or to equitably subordinate the security interest to administrative taxes. The adversary proceeding had previously been transferred to the District of Delaware where the debtor was allowed to intervene on the side of the Indenture Trustee. Tacked on to the transfer order as an afterthought (not addressed or even noticed by the parties at the time) was the transfer of any cash collateral or fee applications for services or expenses associated with the adversary proceeding. Notwithstanding that transfer, the Connecticut Bankruptcy Court adjudicated the cash collateral application. The appellees in the first appeal are the debtor and the Indenture Trustee. The second order, entered on December 23, 2002 ("12/23/02 Order), awarded interim fees

1/ By order of March 14, 2005, this Court allowed a combined brief for both appeals, up to 75 pages. 2/ Statutory references are to the Bankruptcy Code (11 U.S.C.) unless indicated otherwise. 3/ U.S. Bank National Association is the successor to Street Bank & Trust as the Indenture Trustee.

1

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 10 of 81

to the Akin Gump law firm (the only appellee in the second appeal4/) as counsel for the debtor in possession, pursuant to § 330 and § 331, for services in connection with the Connecticut case. It presents issues that are closely intertwined with the appeal from the court's grant of the cash collateral application. Accordingly, we sometimes refer in combination to the "cash-collateral/interimfees appeal." We also generally refer to the "conversion appeal" since conversion to Chapter 7 is the primary relief sought and appointment of a Chapter 11 trustee is only a fall-back. As noted below, there are multiple issues. Most fundamentally, the government maintains that the case should have been converted to Chapter 7 long ago, and still should be, because of the impossibility of confirming a Chapter11 plan, diminution of the estate, and the conflict of interest of debtor's management which holds a 21.5% stake in any recovery on the junior notes.5/ As for the cash collateral/interim fees appeal, most fundamentally, the government maintains that (1) it is not proper for the estate's fiduciary to litigate in favor of upholding a lien on property of the estate (and this effort was simply another part of the tax avoidance scheme that caused the Connecticut Bankruptcy Court to deny confirmation of the debtor's prepackaged plan of liquidation); (2) it is not proper, in considering interim disbursements, to assume that the government will lose the Delaware adversary proceeding and thus it was not proper to treat the proceeds of the assets sale as "collateral" for a lien securing the junior notes; (3) the case should have been converted and, if it had been converted, there would be no occasion for fee applications by any attorneys for any debtor in possession, and (4) disbursements of interim fees are improper when a bankruptcy estate is administratively insolvent (meaning administration expenses exceed assets) and has no prospect for altering that circumstance. Also, Judge Shiff ruled that the government's contention that it is
4/ Fees were also awarded to debtor's local counsel, Zeisler & Zeisler, which entered a stipulation with the government partially resolving the government's objections and partially deferring them until a final application for fees in the future. That stipulation is docketed as item 2 in the pre-consolidation docket for the second appeal, Case No. 3:03-cv-357 (AWT). 5/ The appellees may insist that the Delaware bankruptcy court's overruling of the debtor's attorneyclient privilege with respect to certain discovery, on the basis of the crime-fraud exception, eliminates the government's need for conversion, but that is not so.

2

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 11 of 81

not proper to pay the attorney for a debtor-in-possession to litigate in favor of upholding a lien against the estate was precluded because the Delaware Bankruptcy Court already decided the issue against the government when it allowed the debtor to intervene in the adversary proceeding. The United States maintains that this misreads the ruling of the Delaware bankruptcy court, and also that the Delaware Bankruptcy Court lacked jurisdiction to issue any such preclusive ruling. Statement of Jurisdiction The Connecticut Bankruptcy Court at all times had and continues to have "exclusive" jurisdiction over the bankruptcy "case" and over property of the estate. 28 U.S.C. § 1334(a), (e). There is some question as to whether it had jurisdiction to issue the cash collateral order since it had transferred venue over future cash collateral or fee applications to the District of Delaware to the extent related to the expense of defending the adversary proceeding transferred there. Nonetheless, the United States maintains the Connecticut Bankruptcy Court had full jurisdiction over the cash collateral issue because, regardless of whether or not it abused its discretion in transferring the merits of the adversary proceeding to the Delaware Bankruptcy Court, the supplemental transfer of future cash collateral or fee applications to that court is without effect as it exceeded the power of the Connecticut Bankruptcy Court. There is no dispute that the Connecticut Bankruptcy Court had jurisdiction to issue the cash collateral order to the extent it enabled payment of debtor's counsel's fees incurred in connection with the case in Connecticut. There is also no dispute that the Connecticut Bankruptcy Court had jurisdiction to entertain the motion to convert to Chapter 7. As this Court ruled on March 14, 2005, it has jurisdiction under 28 U.S.C. § 158(a)(1) over the appeal from denial of conversion and the grant of the cash collateral application as final rulings, either traditionally or under the collateral order doctrine. Alternatively, this Court has jurisdiction under § 158(a)(3), having granted the government's alternative motion for interlocutory appeal from those rulings. Prior to that, on February 7, 2003, this Court granted interlocutory appeal from the 12/23/02 order allowing the interim fees award and disbursements. 3

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 12 of 81

In exercising its jurisdiction to review the cash collateral order and order awarding interim fees, this Court has jurisdiction to consider the effectiveness of the venue transfer order's tack-on of the transfer of future cash collateral and/or fee applications, incident to determining whether the Connecticut Bankruptcy Court erred in concluding that the Delaware Bankruptcy Court's order granting the debtor's motion to intervene in the adversary proceeding constitutes "law of the case" on the propriety of compensating debtor's counsel. This Court must also determine the validity of that supplemental transfer incident to determining whether the Connecticut Bankruptcy Court retained jurisdiction to enter the 7/18/02 Order to the extent it authorized the use of cash collateral for purposes of paying fees associated with the Delaware adversary proceeding.6/ Statement of the Issues The argument portion of this brief is broadly divided in two by treating first the conversion appeal and then the cash-collateral/interim-fees appeal due to the relationships between the cash collateral issues and interim fees issues. The issues are therefore similarly categorized, but there is also overlap in that the government maintains that compensation for counsel for the debtor should be denied partly because the case should have been converted as soon as the government moved for conversion and certainly long before the debtor moved to intervene in the Delaware adversary proceeding to promote the security interest claimed by the Indenture Trustee for the junior notes over the interests of the bankruptcy estate. A. Issues for Conversion Appeal

The issues for the appeal from the denial of the government's motion to convert or appoint a Chapter 11 trustee are:

6/ The entire transfer order (i.e., including the merits of the adversary complaint) remains interlocutory and subject to eventual appeal in Delaware where the court denied a motion to re-transfer the matter back to Connecticut. Additionally, in the currently pending appeal from the Delaware Bankruptcy Court's interim fees order to the Delaware District Court (which stayed that appeal pending the resolution of this one), the government is also arguing, inter alia, that the provision of that order tacking on the transfer of venue for cash collateral and fee applications is void.

4

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 13 of 81

1.

Did the Connecticut bankruptcy court err in denying the motion to convert or appoint a Chapter 11 trustee, where confirmation of a plan that complies with § 1129 is impossible, the estate had been reduced to a cash fund subject only to litigation over a secured claim, and the debtor's management holds a 21.5% stake in the recovery on that secured claim (and is there any reason to remand, or should the District Court reverse and grant the motion to convert)? In the alternative, did the Connecticut Bankruptcy Court err in denying the appointment of a Chapter 11 trustee in view of the undeniable conflict of interest on the part of debtor's management to the extent the debtor is required to act as a fiduciary primarily for unsecured creditors? B. Issues for Cash-Collateral/Interim-Fees Appeal

2.

The questions presented by the appeal from the order granting the stipulated application to use cash collateral and the subsequent appeal from the allowance of interim fees are: 1. Did the Connecticut Bankruptcy Court have jurisdiction over the cash collateral issue to the extent it pertained to legal services to be rendered in the Delaware Adversary Proceeding, notwithstanding the provision at the end of the venue transfer order which purported to transfer future "administrative expense and cash collateral applications associated with it," or was that aspect of the transfer order void and of no effect because the determination of an administration expense, such as compensation for a debtor's attorney, cannot properly be divided between two districts. Did the Connecticut Bankruptcy Court err in concluding that the government was precluded, by the order of the Delaware Bankruptcy Court granting the debtor's motion to intervene in the adversary proceeding, from objecting to the use of estate funds to compensate debtor's counsel for legal services in defense of the secured claim of the Indenture Trustee. Did the Connecticut Bankruptcy Court err in assuming that the estate's funds constitute "collateral" for the security interest of the Indenture Trustee where the validity of that security interest was under litigation or should the court instead have viewed the motion to use estate funds as evidence of further diminution of the estate, calling for conversion to Chapter 7? May a bankruptcy court authorize the use of estate funds to finance legal services to be provided by counsel for the estate's fiduciary (trustee or debtor in possession) directed at defending a disputable lien against the estate which, if upheld, will render the estate penniless, and where the secured creditors are represented by able counsel? Did the Connecticut Bankruptcy Court err in granting interim fees to debtor's counsel for legal services in defense of a lien against the estate, given that § 330(a)(4) prohibits compensation for "services that were not-- (I) reasonably likely to benefit the debtor's estate; or (II) necessary to the administration of the case." Assuming debtor's counsel may be compensated for the legal services at issue, did the Bankruptcy Court err, where the estate is administratively insolvent (because the 5

2.

3.

4.

5.

6.

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 14 of 81

administrative federal and state tax expenses exceed the proceeds of a complete liquidation of assets) in authorizing 100% payment of allowed interim fees to debtor's counsel, where, unless the security interest for the junior notes is upheld fully, debtor's counsel would at most be entitled to a pro rata dividend based on counsel's allowed fees in comparison to total administrative expenses? Standard of Review The District Court reviews the Bankruptcy Court's fact findings for clear error. Fed.R.Bankr.P. 8013. It reviews conclusions of law de novo. It reviews awards of compensation of professionals for abuse of discretion provided such awards are within the parameters permitted under § 330. The orders on appeal here were not premised on any evidentiary hearings involving witnesses and therefore, the issues are purely issues of law and discretion. Statement of the Case ­ Facts and Procedural History In this case, the facts relevant to the issues presented for review are to a significant extent coextensive with the procedural history. Accordingly, the course of the proceedings below is subsumed in the following statement of facts. 1996 Reorganization In 1996, Scott Cable Communications, Inc. filed a prior Chapter 11 case in the District of Delaware and underwent reorganization via a confirmed plan. As part of that reorganization, certain unsecured junior subordinated notes held by the debtor's shareholders were exchanged for new notes ­ the secured, junior subordinated PIK notes. The holders did not invest any new cash; rather they just exchanged their unsecured notes for secured ones paying a higher PIK interest rate and with a new maturity date, except that they agreed that 15% of the new secured junior notes would be distributed to the next higher class of creditors ­ public bond holders. The public bond holders also upgraded their own securities from unsecured to senior secured subordinated PIK notes with a new maturity date, also without contributing new cash Existing secured indebtedness

6

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 15 of 81

of Scott Cable was refinanced at the time by a new senior secured lender.7/ At the time of the 1996 reorganization, Scott Cable owed no federal taxes. It did, however, have assets that had been greatly depreciated for tax purposes, lowering their adjusted basis. The value of those assets substantially exceeded their tax-depreciated basis. The excessive depreciation for tax purposes had helped the debtor defer prior taxes that would then presumably be recaptured and paid on a sale of the assets. This is sometimes referred to as "built-in gain."8/ Because of that built-in gain, if the assets had been sold in the 1996 bankruptcy, the need to pay the administrative tax, after payment of secured debt, would have left the debtor with little or no funds left to distribute in payment of the unsecured junior notes that were instead exchanged in the reorganization for the secured junior notes.9/ 1998 Petition; Rejected Plan; § 363 Liquidation; Tax Claim In late 1998, debtor filed a new Chapter 11 petition in Connecticut while proposing a prepackaged plan of liquidation. On December 12, 1998, the Bankruptcy Court denied debtor's
7/ The facts in the foregoing paragraph can be derived from the 1996 plan and disclosure statement which were exhibits in a prior appeal to this Court leading to its reversal of the Bankruptcy Court's order dismissing the government's adversary complaint. No. 3:99-CV-918(AWT). This Court may take judicial notice of its own files in that appeal. The government does not believe these facts are disputed. 8/ The built-in gain is indirectly reflected in the magnitude of the tax claim that was filed in this case after the sale of assets in 1998, although that claim also reflects some appreciation in value between 1996 and 1998. If necessary, the United States can produce filings from the pending summary judgment motion record in the Delaware adversary proceeding, of which this Court may take judicial notice, to demonstrate the built-in gain. 9/ The United States believes that it is appropriate for this Court, when deciding these appeals, to keep in view at least a skeletal understanding of the basis for the government's contentions in the Delaware adversary proceeding. The United States maintains, based on a massive discovery record, that the junior note holders, the management of Scott Cable, and their outside counsel developed a scheme to use a Chapter 11 reorganization to exchange the deeply devalued unsecured junior notes for new secured junior notes without providing any new money to Scott Cable, essentially leapfrogging the repayment of their investment ahead of the built-in gains tax. Using a new capital structure that employed notes with heavily back-loaded terms requiring most repayment in balloon payments at maturity, they hoped that, by stalling for time, cable system values would appreciate. Under their scheme, the assets would be sold in a couple of years and the new secured junior notes would be paid before the taxes resulting from the sale. The United States also maintains that the public bond holders, who received 15% of the new secured junior notes while also upgrading their investment in their bonds to a secured one, through their representatives, knowingly participated in the scheme and negotiated for a "piece of the action."

7

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 16 of 81

prepackaged plan upon finding it was proposed primarily as a tax avoidance scheme. See In re Scott Cable, 227 B.R. 596 (Bankr. Conn. 1998). On February 12, 1999, all of the estate's assets were sold pursuant to § 363 for about $160 million, of which all but about $38 million was distributed for expenses and to purported senior secured creditors. The sale generated an administrative federal income tax (for the year 1999) of $44,590,177 plus penalties and interest, plus various state tax liabilities. The estate now holds about $40, million, all of which is claimed to be subject to a lien securing the junior notes, which would leave nothing to pay the administrative tax claims. The Adversary Proceeding, Appeal, Remand, and Transfer On November 19, 1998, the United States filed a complaint commencing Adversary Proceeding No. 98-5104 in the Connecticut Bankruptcy Court against the Indenture Trustee, seeking to recharacterize the junior notes as equity and, alternatively, seeking equitable subordination (under § 510) of the security interest created for those notes in the 1996 bankruptcy reorganization. If the government prevails, the $40 million remaining will go to it and eleven state taxing authorities, pro rata. The Bankruptcy Court granted summary judgment against the United States in the adversary proceeding on April 26, 1999. The government appealed to this Court. (See Case No. 3:99-CV-918(AWT).) On March 9, 2001, this Court reversed and remanded the matter for trial. United States v. State Street Bank and Trust, 259 B.R. 536 (D.Conn. 2001) (reversing 232 B.R. 558 (Bankr. Conn. 1999)). The Bankruptcy Court then issued an order to show cause in the Chapter 11 case (not in the adversary proceeding) why the Chapter 11 case or the adversary proceeding should not be transferred to Delaware. (DI# 301.10/) The United States opposed. (DI# 303.) The debtor and Indenture Trustee filed a joint response under the caption of the adversary proceeding (although it was docketed by the clerk in the main case, as item 305). They agreed with the government that the Connecticut Bankruptcy Court should retain jurisdiction over the Chapter 11 case, but urged
10/ All DI# references are to the items on the docket of the main Chapter 11 bankruptcy case, No. 98-51923, unless otherwise indicated.

8

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 17 of 81

that the adversary proceeding be transferred to Delaware. On June 7, 2001, the Connecticut Bankruptcy Court issued an order in the adversary proceeding (docketed therein as item number 52), entitled ORDER TRANSFERRING ADVERSARY PROCEEDING TO THE DISTRICT OF DELAWARE ("transfer order"). United States v. State Street Bank and Trust, 263 B.R. 6 (Bankr. Conn. 2001). The order's introductory paragraph stated that "For reasons that follow, it is determined that in the interest of justice the adversary proceeding will be transferred" to Delaware (emphasis added). The discussion in the order explained only why the adversary proceeding should (in the Bankruptcy Court's view) be transferred. Notwithstanding this, and apparently unnoticed by the parties at the time (as demonstrated below), the final paragraph of the order states that "adversary proceeding 98-5104, and any administrative expense or cash collateral applications associated with it, are hereby transferred" to Delaware. At that time, there were no administrative expense or cash collateral applications associated with the adversary proceeding. The Attempted Appeal of the Transfer, and the Motion to Re-Transfer The United States moved for leave to appeal the transfer of the adversary proceeding, pursuant to 28 U.S.C. § 158(a)(3) and Bankruptcy Rule 8003. That motion was docketed under the same cause number as the prior appeal (No. 3:99-CV-918(AWT)). On August 30, 2001, Judge Thompson denied leave to appeal. All of the papers related to the Rule 8003 motion addressed only the transfer of the adversary proceeding; the premature transfer of future administrative expense and cash collateral applications was overlooked. The United States then filed a protective motion in the Delaware Bankruptcy Court to retransfer the adversary proceeding (now number A-01-04605 in that court) back to Connecticut, in view of precedent requiring a re-transfer motion for a party to preserve the right to appeal a venue transfer at such time as a final appealable judgment is entered by the court to which a case is transferred. The Delaware Bankruptcy Court denied the re-transfer motion. All of the papers 9

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 18 of 81

related to the re-transfer motion addressed only the transfer of the adversary proceeding; the transfer of administrative expense and cash collateral applications was overlooked. Debtor's Intervention in Delaware as Predicate to Cash Collateral Stipulation in Connecticut After the transfer, the debtor moved to intervene in the adversary proceeding in Delaware. The government opposed that motion. On March 4, 2002, the Delaware Bankruptcy Court granted intervention. United States v. State Street Bank and Trust, 2002 WL 417013 (Bankr. Del. 2002). It observed that, under binding Third Circuit precedent a debtor is a party in interest for all purposes "with an unconditional statutory right to intervene" in any adversary proceeding. Id. at *2. The Delaware Bankruptcy Court also opined that the debtor in possession had a duty to protect the capital structure and the bargain that the junior note holders negotiated in the prior bankruptcy involving the predecessor of the debtor. Id. at *3. The Delaware Bankruptcy Court's March 4, 2002 order does not discuss the source from which any legal counsel representing the debtor in the adversary proceeding would be paid. Evolving Motion to Convert or Appoint a Chapter 11 Trustee Meanwhile, on June 29, 2000, the United States had filed a motion in the Chapter 11 case to convert to Chapter 7, pursuant to § 1112(b). (DI# 256.) The original motion was premised on the debtor's inability to reorganize. At a hearing on August 8, 2000, Assistant U.S. Attorney Ann Nevins ["AUSA Nevins"] agreed with a court suggestion that the motion be "marked off at this time," because the bankruptcy judge, Judge Shiff, had recently granted summary judgment against the United States in the adversary proceeding, and it made more sense to await the outcome of the pending appeal in this Court. On May 29, 2001, after this Court reversed the summary judgment in the adversary proceeding, the United States requested a hearing on its motion to convert. (Dkt. at DI# 304.) Shortly thereafter, on July 3, 2001, the government supplemented the motion to convert, arguing that the debtor's management had a conflict of interest in determining whether to have the debtor in possession prosecute a § 506(c) claim to recover the capital gains tax from the 10

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 19 of 81

proceeds of the § 363 sale of assets as an expense of disposing of the assets. (DI# 312.) That supplement was prompted by the then-recent decision of the Supreme Court in Hartford Underwriters, Ins. Co. v. Union Planters Bank, 530 U.S. 1 (2000), holding that only a trustee (or debtor in possession with the powers of a trustee) may invoke § 506(c).11/ On July 23, 2001, Judge Shiff informed the parties that he was deferring the motion to convert indefinitely.12/ The motion to convert lay dormant until the government reminded the court of it during a hearing on the cash collateral stipulation discussed infra, and requested that the two contested matters (U.S. motion to convert and debtor's and State Street's request for a cash collateral order) be consolidated. (DI# 364.) The Bankruptcy Court then determined that the motion to convert had to be re-noticed for hearing and the government re-noticed it. (Ibid.) On May 22, 2002, the debtor and the indenture trustee filed oppositions to the conversion motion. (DI## 365, 366.) On May 31, 2002, the United States filed a reply and "supplemented" its motion to convert (DI# 373), based on intervening events during the year since the motion was last supplemented, and made an alternative request for the appointment of a Chapter 11 trustee. The supplement's additional bases for conversion or the appointment of a Chapter 11 trustee included (1) the Delaware Bankruptcy Court's having granted the debtor's motion to intervene, and (2) the filing with the Connecticut Bankruptcy Court of the cash collateral stipulation by which State Street and the debtor were seeking to establish the propriety of using estate funds to pay debtor's counsel for helping fight the United States in the Delaware adversary proceeding even if the government
11/ Hartford Underwriters thus abrogated the conclusion in United States v. Boatman's First Nat. Bank, 5 F.3d 1157 (8th Cir. 1993), that a creditor may prosecute a § 506(c) recovery, but did not disturb Boatman's treatment of tax incurred in a transaction that benefitted a secured creditor as coming within § 506(c). 12/ As reflected in the transcript of the record made the next day on July 24, 2001 (DI# 325), AUSA Nevins stated: "Your Honor, I'd also just like to state for the record that the decision to defer the motion to convert . . . was made by the court, not at the request of the Internal Revenue Service. . . ." The Court responded: "Yes, yes. Right. I understand that. I said I wasn't going to do it, and you didn't -- what were you going to do[?]. You were stuck."

11

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 20 of 81

prevails. Thus, the government's May 31, 2002 filing argued that the intervention combined with the effort to lock in a right to use estate funds to pay to have the debtor's lawyer help the junior note holders take away the estate's remaining property (leaving nothing for administrative creditors), demanded the appointment of a disinterested trustee. The government argued that a disinterested trustee, whose duties include objecting to claims if there is a reasonable basis to do so (see §§ 544 and 704(5)) would recognize the inappropriateness of litigating against the estate and, upon being substituted for the debtor in the Delaware adversary proceeding, would likely side with the government and waive the debtor's attorney-client privilege in discovery and at trial. The supplement to the motion to convert also cited the ongoing diminution of the estate. It thus observed that, in addition to $535,000 received by the law firm originally retained as debtor's counsel (Stroock & Stroock), on March 16, 1999, the Connecticut Bankruptcy Court granted that firm $376,663 in interim fees plus $28,770 in interim expenses ("subject to final review by this [Connecticut] Court"). When attorney Daniel Golden left Stroock & Stroock and joined the Akin, Gump firm in 1999, the Strook & Strook firm filed a "final" application for $596,540 in fees plus $45,521 in expenses. Since then, the Akin, Gump firm had been granted the following interim fee/expense awards (all subject to final review): on January 18, 2000, the sums of $128,070 in fees plus $22,864 in expenses; on December 12, 2000, another $26,285 in fees plus $3,071 in expenses; and on December 11, 2001, another $125, 512 in fees and $13,041 in expenses. All of this predates the March 4, 2002 order granting intervention (for which the cash collateral stipulation involved in this appeal sought to release another $800,000 as discussed in a moment). The government's motion to convert was supported by the State of Connecticut (which has a $1.2 million administrative tax claim) and by the United States Trustee (whose statutory function is to monitor improprieties by estate fiduciaries, including potential conflicts of interest). See July 18, 2002 Order at 2 n.2. A hearing on the motion to convert was held on June 5, 2002.

12

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 21 of 81

Cash Collateral Stipulation and Objections and Responses On April 2, 2002, the debtor and Indenture Trustee filed a STIPULATION AUTHORIZING CONTINUED USE OF CASH COLLATERAL ("4/2/02 Stipulation"). (DI# 351.) As represented therein, this was the sixth time the debtor and Indenture Trustee asked the Court to authorize the use of estate funds. As the 4/2/02 Stipulation explained (page 3, ¶ I), the Delaware Bankruptcy Court had recently granted the debtor's motion to intervene in the adversary proceeding to help defend the secured status of the junior notes. The 4/2/02 Stipulation's attached budget through year-end included $800,000 in fees for debtor's counsel. It unabashedly explains that it would be in "the best interests of the holders of the Junior Secured PIK Notes, for the Debtor to pay the [legal] fees and expenses set forth in the 2002 Budget."13/ It does not include any suggestion as to how the bankruptcy estate or any other creditors would benefit. Since the 4/2/02 Stipulation's budget was mostly for the adversary proceeding, obviously the debtor and Indenture Trustee had overlooked that the June 7, 2001 order transferring the adversary proceeding to Delaware also purported to transfer "any administrative expense or cash collateral applications associated with it."14/ The United States objected to the 4/2/02 Stipulation, arguing that it improperly assumed that the Indenture Trustee would prevail in the Delaware adversary proceeding, and that it was in any event improper to treat as an "administrative expense" a fee charged by counsel to make arguments in favor of removing funds from the estate, which the estate's fiduciary (debtor-inpossession) should not be arguing for in the first place. (DI# 355.) A hearing was held on May 1, 2002 (corrected transcript filed as DI# 367). Although all parties had initially overlooked the language at the end of the venue transfer order, counsel for the government stated at the hearing
13/ Assuming the estate funds are indeed collateral securing the Junior Subordinated PIK Notes, the Indenture Trustee's permission was necessary under § 363(c)(2)(A). But, regardless of whether the Note Holders have a valid lien, court authorization was also required because the funds are property of the estate and were sought to be used outside the ordinary course of business. See 11 U.S.C. § 363(b)(1). 14/ Not only does the Stipulation seek funding for the debtor's participation in the adversary proceeding but also its first proposed "finding of fact" recites that the junior note holders are "lenders" -- a claim that is at the heart of one of the issues in the adversary proceeding.

13

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 22 of 81

that he had recently reviewed the transfer order and noticed that it purported also to transfer cash collateral and fee applications related to the adversary proceeding. (DI# 367 at 7-8.) He noted that the United States maintains that the Connecticut Bankruptcy Court lacked jurisdiction to transfer a portion of the administration of the Chapter 11 "case" without transferring the entire case -- a problem that was not implicated by the transfer of the adversary proceeding. Nevertheless, government counsel argued that, unless the June 7, 2001 order's partial transfer of administrative matters was declared void, the 4/2/02 Stipulation for use of cash collateral had to be filed in Delaware, and the Connecticut Bankruptcy Court lacked jurisdiction to consider it. At the May 1, 2002 hearing, Judge Shiff acknowledged that his earlier venue transfer order purported to transfer to Delaware any cash collateral issues as well as applications for administrative expenses related to the adversary proceeding, but nevertheless indicated that the Connecticut Bankruptcy Court could entertain argument on the proposed cash collateral order. On the merits, debtor argued essentially that the Delaware court's March 4, 2002 order granting intervention implicitly endorses use of estate funds to pay debtor's counsel and that the United States' objection to the use of cash collateral was an attempt to collaterally attack the Delaware court's order granting intervention, which the United States had not appealed. Judge Shiff agreed, as the following two colloquies with government counsel reflect: MR. SHAPIRO: That's true. That's absolutely true, but it just emphasizes my point further. That they don't need the Akin, Gump law firm. And that's what they're trying to do, they're trying to use estate funds to pay for a law firm that has no purpose in this case. It's the job of the State Street Bank to defend the note holders. And all they're trying to do is an end run to use the estate funds for an improper purpose. THE COURT: And your argument is an attempt to make an end run around Judge Walsh. He said they could do it. (DI# 367 at 59-60.) The colloquy on the point resumed a few moments later: MR. SHAPIRO: Suppose the Court deems them to have a priority administrative expense and, therefore, to at least share pro rata in some distribution at a later time. It's a pretty likely event, even if the government were to win, then we 14

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 23 of 81

would get less than - - for the taxpayers of this country then if they had not been able to participate with the cash collateral order at all. THE COURT: And that is a -- that probably is correct, but that is the law of this case. Judge Walsh, to say yet again, has authorized this. There is obviously going to be an expense, the question is, how much of an expense. He wouldn't let them in and not say that they couldn't get paid. He let them in as a representative of the estate. The debtor's attorneys are representing the estate. The estate has an interest, Judge Walsh said. MR. SHAPIRO: I don't think -THE COURT: Therefore, that interest is going to have to get paid by the estate which is served by their services by taking care of that interest. So it had to be part of the equation in Delaware that if they're allowed in, and he says they are, that they would be charging the estate or attempting to charge the estate for their services. The question is, what is reasonable and necessary and that's got nothing to do with why we're here today. Ibid. at 64-65. Judge Shiff noted, however, that if he were to grant the cash collateral order, any applications for fees pursuant to it would still have to be made to the Delaware Bankruptcy Court, and the United States could oppose specific fee requests on other grounds. The United States disputed Judge Shiff's interpretation of Judge Walsh's 3/4/02 order granting intervention, and also argued that the Delaware ruling could not have decided the fees issue because the Connecticut Bankruptcy Court could not transfer jurisdiction over the estate's purse to another court. Due to inadequate notice to other creditors, the cash collateral issue was continued to a further hearing on June 5, 2002, combined with the hearing on the government's motion to convert. (Transcript at DI# 372.) The State of Connecticut and the United States Trustee then both joined the United States' objection to the cash collateral stipulation and also jointed its motion to convert. The U.S. Trustee also filed a written statement in support. (DI# 371.) Additional Related Delaware Motions (and Notice to Connecticut Bankruptcy Court) In light of Judge Shiff's statements about being bound by the Delaware Bankruptcy Court's 3/4/02 order, and the discovery of the language at the end of the venue transfer order that purports also to transfer related cash collateral and/or fee applications, the United States filed two more motions with the Delaware Bankruptcy Court. One was a motion to clarify the 3/4/02 order and, if that order was meant to rule on the appropriateness of allowing fees to be paid from estate funds, 15

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 24 of 81

to reconsider it. Among the grounds argued for reconsideration was a procedural argument that the Delaware court lacked jurisdiction to pass on cash collateral issues or whether attorney fees are a proper expense of administration, because the transfer of such issues was void. The other motion was a MOTION OF THE UNITED STATES FOR ORDER RE-TRANSFERRING, BACK TO CONNECTICUT, PORTIONS OF MAIN CHAPTER 11 CASE THAT WERE NOT ADDRESSED IN PREVIOUS RE-TRANSFER MOTION. The ground for the additional re-transfer motion was that the transfer of the cash collateral and fee issues exceeded the authority of the Connecticut Bankruptcy Court. Both motions were filed on May 22, 2002.15/ On June 17, 2002, the debtor responded separately to each of the government's May 22, 2002 motions in Delaware. In response to the re-transfer motion, the debtor curiously argued (p.3) that Judge Shiff's June 7, 2001 transfer order "did not transfer cash collateral matters" to Delaware despite its explicit language to that effect. Debtor added that judicial and estate economy, certainty, uniformity, and the protection of the note holders all dictate that only one court -- the Connecticut Bankruptcy Court -- hear all matters relating to cash collateral. Debtor asked the Delaware court to defer any re-transfer until the Connecticut Bankruptcy Court issued a decision on the motion for use of cash collateral because, "[i]n reaching a decision on the 2002 Cash Collateral Stipulation and Order, it is likely that the Connecticut Bankruptcy Court will clarify or

15/ This Court may take judicial notice of filings in an adversary proceeding that is part of the same bankruptcy case. See Liberty Mutual Ins. Co. v. Rotches Pork Packers, Inc., 969 F.2d 1384, 1388 (2d Cir.1992) ("A court may take judicial notice of a document filed in another court not for the truth of the matters asserted in the other litigation, but rather to establish the fact of such litigation and related filings"; internal quotation omitted); Scherer v. Equitable Life Assurance Soc., 347 F.3d 394, 402 (2d Cir. 2003) (court of appeals may take judicial notice of events in related cases); Veg-Mix, Inc. v. United States Dep't of Agric., 832 F.2d 601, 607 (D.C.Cir.1987) (court of appeals may take judicial notice of official court records in other cases involving the same subject matter or questions of a related nature between the same parties, including bankruptcy pleadings); Green v. Warden, U.S. Penitentiary, 699 F.2d 364, 369 (7th Cir. 1983) (same). The filings are accessible via the PACER system as docket items 86 and 87 in the Delaware adversary proceeding, Adv. No. 01-4605 (Bankr. Del.). Also, after filing these two motions in Delaware, on May 23, 2003, the United States attached copies of the two motions to a submission filed with the Connecticut Bankruptcy Court (DI# 368), in which the United States also provided supplemental citations that Judge Shiff allowed to be submitted in support of the contention that it is improper to permit estate funds to be used to pay a fiduciary's counsel to litigate against the pecuniary interests of the estate.

16

Case 3:02-cv-01725-AWT

Document 35

Filed 04/07/2005

Page 25 of 81

interpret the Transfer Order."16/ The debtor's simultaneous opposition to the motion to have the Delaware Bankruptcy Court clarify whether its 3/4/02 order granting intervention was in fact intended to authorize payment of debtor's counsel from estate funds is also curious. It argued against any clarification because "the ramifications of This [Delaware] Court's intervention ruling is at issue before Judge Shiff in the Connecticut Bankruptcy Court."17/ The Delaware Bankruptcy Court never formally ruled on the two motions. But its 12/12/02 Order granting interim fees, discussed infra effectively mooted the clarification motion and implicitly denied the supplemental re-transfer motion. The 7/18/02 Order and Appeal On July 18, 2002, the Connecticut Bankruptcy Court issued the 7/18/02 Order (entitled ORDER GRANTING DEBTOR'S APPLICATION TO USE CASH COLLATERAL AND DENYING MOTIONS
TO CONVERT OR APPOINT TRUSTEE).

(DI# 377.) As the sole explanation for granting use of cash

collateral, it first stated that "the Delaware court had expressly found that Scott's intervention in the adversary proceeding was warranted"; it then quoted some of the Delaware Bankruptcy Court's reasons from the 3/4/02 order granting intervention (but did not mention that court's initial holding that a debtor has an unconditional statutory right to intervene in any adversary proceeding18/); and it held that "[t]he final order of the Delaware Bankruptcy Court is not subject to collateral

16/ Although debtor also argued that cash collateral issues should be in a "uniform forum at which all parties can be heard," it nevertheless ar