Free Bankruptcy Appeal - District Court of Delaware - Delaware

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IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE IN RE: EBC I, INC., f/k/a ETOYS, INC., Reorganized Debtor. ____________________________ EBC I, INC., f/k/a ETOYS, INC., Plaintiff, v. AMERICA ONLINE, INC., Defendant. ____________________________ ) Chapter 11 ) ) Case No. 01-00706(MFW) ) ) ) ) ) ) ) ) ) ) Adversary No. 03-50003 ) ) ) ) )

FINDINGS OF FACT AND CONCLUSIONS OF LAW1 I. FINDINGS OF FACT A. Parties and Background

1. From October 1997 through December 2000 eToys, Inc. ("eToys") was the leading online retailer focused on toys and children's products. (Ex. D-1 at 1)2 2. At all relevant times America Online, Inc. ("AOL") operated as an internet service provider. AOL provided its subscribers
1

These, together with the accompanying Opinion, constitute the findings of fact and conclusions of law of the Court pursuant to Rule 7052 of the Federal Rules of Bankruptcy Procedure. Citations to the Plaintiff's and Defendant's Exhibits are to "Ex. P- at [page]" and "Ex. D- at [page]," respectively. Citations to the transcript of the hearing held on June 26, 2007, are to "Tr. [page:line]" and to depositions are to "Dep. [name] [page:line]." Citations to the Pretrial Stipulation and Order are to "PT Stip. [page]." Citations to pleadings are to the docket as "D.I. [#]."
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("AOL Members") with access to the internet at large and to news, entertainment, sports, and online shopping services provided through third party retailers. (Tr. 22:17-23:24) 3. In the late 1990s AOL had approximately 20 million AOL Members each of whom paid a subscription fee of approximately $20 per month. (Tr. 23:17-25:2) 4. In the shopping area of the AOL site, people could locate products, compare them to others, and buy them directly from AOL's shopping partners. (Tr. 23:10-23:16) 5. Third party retailers paid AOL for the opportunity to provide shopping services to AOL Members. (Tr. 23:25-24:5) 6. Shopping partners purchased advertisements ("impressions") showing the retailers' logo or promotion ad in AOL's online shopping mall and other areas that AOL Members were expected to browse. (Tr. 26:24-27:22) 7. AOL did not have direct control over how many impressions would result from its contracts with marketing partners, because it depended on how many AOL Members visited a particular site over a particular period. (Tr. 30:4-30:12) 8. For shopping partners, the goal of an impression was to generate a "click through," whereby the AOL Member would visit the retailer's own website to shop and hopefully purchase products. (Tr. 28:3-28:11) 9. As of the late 1990s, approximately 80% of AOL's revenues resulted from subscriber fees paid by AOL Members and approximately 20% resulted from payments by third parties, including shopping partners. (Tr. 24:8-24:13) B. 1997 Interactive Marketing Services Agreement

10. On October 1, 1997, the day that eToys launched its website, eToys and AOL entered into their first Interactive Marketing Services Agreement which was to last through December 31, 1999. (PT Stip. at 2; Ex. D-1 at 1; Ex. D-2 at AOL 00491) 11. At the time of the 1997 Agreement, eToys was the only online toy retailer to provide a comprehensive selection of nationally advertised and specialty toy brands, and eToys' prices were as low as, or lower than, those of land-based toy retailers. (Ex. D-1 at 1; Tr. 35:1-35:18)

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12. AOL provided a demographic profile that was particularly compatible with eToys' target customer profile. (Dep. [Schoch] 65:9-65:18; Dep. [Lenk] 43:11-43:22) 13. Under the 1997 Agreement, AOL was to provide eToys with approximately 17 million impressions plus a presence on the AOL Shopping Channel and Service Shopping Channel Toys Department. (Ex. D-2 at AOL 00488, 00492) 14. If AOL failed to provide the required number of impressions in a year, AOL was required to "make good" by providing the impressions missed within four months. (Ex. D-2 at AOL 00488-89) 15. In the event that AOL failed to deliver more than 20% of the promised impressions, AOL would provide 1.5 times the missed impressions; if AOL failed to deliver more than 30% of the promised impressions, eToys had the right to terminate the 1997 Agreement. (Ex. D-2 at AOL 00488-89) C. 1999 Interactive Marketing Services Agreement

16. Before the end of the 1997 Agreement, eToys and AOL met to review the results achieved to date. (Ex. D-4 at AOL 00374) 17. eToys was eager to pursue additional promotional opportunities both online and offline and to increase its offers to AOL Members. (Ex. D-4 at AOL 00374) 18. eToys was interested in doing a large deal with AOL because it wanted to promote its brand and online store to become the dominant children's brand and compete effectively with established land-based toy retailers. (Tr. 37:8-39:24; Ex. D-12 at AOL 00454) 19. On August 10, 1999, eToys and AOL executed a new three-year Interactive Marketing Services Agreement (the "1999 Agreement"), whereby AOL made eToys' shopping services available to AOL Members and provided various forms of promotions for eToys in exchange for $18 million, payable in $1.5 million quarterly installments. (PT Stip. at 2; Ex. P-1) 20. eToys expressly agreed that its payments under the 1999 Agreement were "non-refundable." (Ex. P-1 at AOL 00204; Dep. [Brine] 84:12-84:18) 21. AOL had the right to terminate the 1999 Agreement if eToys became insolvent or ceased operations, which AOL felt was important to protect its Members and AOL's brand. (Ex. P-1 at AOL 00207; Dep. [Burger] 21:3-25:6) 3

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22. The price paid by eToys under the 1999 Agreement was calculated by the sum of some (but not all) of the impressions to be delivered by AOL multiplied by a particular cost per thousand (CPM) reflected on AOL's rate card. (Dep. [Burger] 40:1-41:6; Tr. 80:4-80:11) 23. AOL's rate card represented an initial offer or starting point that AOL would use in negotiating an agreement with a retail partner like eToys. (Dep. [Brine] 114:2-114:18; Tr. 33:633:9; Dep. [Burger] 57:2-57:7) 24. Because eToys was negotiating a major agreement with AOL, the price reached was substantially below the rate card prices (averaging approximately 69% less). (Dep. [Baig] 92:4-92:15) 25. Based on the agreed prices, the 1999 Agreement provided that roughly $3.5 million in certain impressions would be provided by AOL in the first year, $5.8 million in the second year, and $8.7 million in the third year. (Ex. P-21 at AOL 00704; Dep. [Baig] 88:1-90:4) 26. Under the 1999 Agreement AOL agreed to provide in excess of 1 billion impressions with eToys' logo or ad. In the event impressions were not provided, AOL agreed to provide make good impressions at a rate of 1.5 times the missed impressions. (Ex. P-1 at AOL 00197-98, 00211-12, 00216-17; Dep. [Burger] 58:1758:20; Dep. [Valle] 38:5-38:13) 27. Although their value was not explicitly included in the price, eToys sought and received AOL's commitment to provide Welcome Screen impressions (impressions appearing on the AOL homepage) which eToys felt were valuable. (Tr. 86:5-86:18; Dep. [Lenk] 118:6-119:23; Dep. [Valle] 83:20-84:14; Dep. [Brine] 22:422:18, 23:8-23:25, 24:1-24:23, 27:23-29:9; Dep. [Burger] 98:20100:12; Dep. [Iannuccilli] 35:1-35:7, 65:1-65:7, 68:24-69:14; Ex. D-5 at AOL 01748; Ex. D-18 at AOL 01568) 28. In later years AOL charged other parties for the type of Welcome Screen impressions that it gave eToys under the 1999 Agreement and Amendment. (Tr. 86:16-86:18; Dep. [Burger] 99:6-100:4; Dep. [Baig] 77:6-77:11, 77:15-78:10) 29. Under the Agreement, AOL also allowed eToys to use AOL's brand and made eToys a premier retailer with exclusivity on some AOL sites. (Dep. [Baig] 86:16-87:2, 92:16-94:4, 137:1-137:11, 148:9-148:20, 149:6-149:12, 152:6-152:10)

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30. Specifically, under Exhibit G of the 1999 Agreement, eToys received a license to market, distribute, display, transmit, promote, and use certain trade names, trademarks, and service marks of AOL, which it did use in its television advertising. (Ex. P-1 at AOL 00226; Tr. 53:11-54:4) 31. Under the 1999 Agreement, eToys was an "Anchor Tenant" in various AOL online shopping areas, including toys, educational toys, kid and infant gear, and electronic games. (Ex. P-1 at AOL 00200; Ex. D-82 at TR 001976; Dep. [Brine] 34:12-34:17) 32. The 1999 Agreement also gave eToys exclusivity in some areas which meant that AOL would not put a competitor's placements in those areas. (Ex. P-1 at AOL 00199-200; Tr. 33:23-34:4; Dep. [Lenk] 88:9-89:9; Dep. [Burger] 116:18-117:6) 33. eToys valued the preclusive effect that the 1999 Agreement had on potential agreements between its competitors and AOL. (Dep. [Lenk] 69:4-69:21) 34. Section 1.5 of the 1999 Agreement provided that impressions delivered under the Agreement would link only to the eToys website and were limited to the categories of products listed on Exhibit D. (Ex. P-1 at AOL 00199, 00219) 35. Section 2.1 of the 1999 Agreement required that at least 50% of the net sales of the products on eToys' website be derived from the sale of children's toys, hobbies, arts and crafts, video games, and software. (Ex. P-1 at AOL 00200; Tr. 49:22-50:6) 36. The 1999 Agreement permitted eToys to collect and use information from AOL Members (which it did), but required that eToys comply with applicable privacy and disclosure requirements to protect the privacy of AOL Members, including their names, addresses, and purchases. (Ex. P-1 at AOL 00221, 00228; Tr. 52:10-54:18) 37. The Operating Standards in Exhibit E required that eToys' website rank among the top three interactive websites in the toy industry in the categories of competitive pricing, scope and selection of products, customer service and fulfillment, and ease of use. (Ex. P-1 at AOL 00221; Tr. 50:22-51:10) 38. If eToys failed to comply with the Operating Standards, section 2.7 of the 1999 Agreement allowed AOL to decrease or suspend the impressions it provided to eToys until such noncompliance was corrected. (Ex. P-1 at AOL 00203, Tr. 51:1151:16) 5

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39. Exhibit F of the 1999 Agreement required that eToys conform to AOL's Kids and Teens Policy, which was designed to protect children and teenagers from being misled by what they saw on AOL or the internet. (Tr. 53:1-53:10; Ex. P-1 at AOL 00225) 40. The parties agreed that, in the press release announcing the 1999 Agreement, eToys would be referred to as the premier retailer of children's products such as toys, children's videos, and children's books. This was intended by eToys to generate increased brand recognition, which it valued. (Tr. 88:1-88:10; Ex. D-17 at AOL 00844) 41. The potential effect of the 1999 Agreement on the investor community was important to eToys. (Tr. 87:9-87:12; Dep. [Iannuccilli] 99:19-99:24; Dep. [Schoch] 72:14-72:21; Dep. [Lenk] 51:4-51:15, 56:11-56:24, 69:4-69:21) 42. Investors viewed eToys' association with AOL favorably. (Dep. [Schoch] 40:9-40:11, 71:16-72:23; Dep. [Lenk] 113:6-113:13) 43. In the ten days following the execution of the 1999 Agreement, the price of eToys' common stock rose from $31.25 to $45.625, representing an increase in its market capitalization of $1.564 billion. (Ex. D-80 at TR 001965) D. Performance of the 1999 Agreement

44. Almost immediately after signing the 1999 Agreement, eToys expressed dissatisfaction with the results eToys was realizing from the Agreement. (Ex. D-26 at AOL 00397) 45. During the 1999 holiday season, shortly after the Agreement was signed, AOL began to deliver far fewer impressions than it was obligated to deliver. This was acknowledged by AOL in an internal e-mail dated December 16, 1999, which reported that: "We are VERY low on our impression delivery." (Ex. P-22) 46. The total shortfall in delivery of impressions during the 1999 holiday season was about 34 million. (Ex. P-6 at AOL 00155; Ex. P-18 at AOL 00722) 47. AOL tried to work with eToys to compensate for the underdelivery of impressions, including delivering more welcome screen impressions. (Dep. [Baig] 55:2-56:2, 70:20-71:12; Dep. [Burger] 78:24-79:9, 79:21-81:9, 104:16-105:2, 105:13-106:11; Dep. [Valle] 85:8-85:17; Dep. [Iannuccilli] 34:12-34:19)

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48. The under-delivery of impressions was, in part, the result of fewer AOL Members browsing the internet and seeing the areas where eToys' ads were placed. (Dep. [Valle] 43:10-43:17) 49. eToys also complained that AOL's redesign of its website caused eToys to lose business because it increased the options for AOL Members, thereby reducing the number of viewers of the eToys' impressions. (Dep. [Baig] 116:14-116:22; Dep. [Lenk] 135:1-136:3; Dep.[Valle] 91:24-92:10) 50. Because of AOL's inability to deliver impressions at the rate specified in the 1999 Agreement, eToys asked to restructure the Agreement beginning in February 2000. (Ex. D-28 at AOL 00762; Dep. [Baig] 51:5-51:8) 51. By late spring of 2000, AOL was aware that it would be unable to provide eToys with the impressions (including "make good" impressions) it was obligated to deliver in the first year of the 1999 Agreement and projected that there would be massive delivery shortfalls in the second and third years as well. (Dep. [Burger] 104:16-105:12, 107:3-108:7) 52. Internally, AOL recognized that the actual and projected shortfall in delivery of impressions "was material" and that eToys could assert it had the right to terminate the 1999 Agreement as a result. (Ex. P-23; Dep. [Baig] 66:21-67:17, 107:22-109:19; Dep. [Burger] 140:5-140:19) 53. AOL delayed renegotiation of the 1999 Agreement, however, because it felt it would have greater leverage over eToys closer to the holiday season. (Ex. P-18 at AOL 00725; Dep. [Baig] 62:16-63:8; Dep.[Burger] 82:19-83:8) 54. Renegotiation of the 1999 Agreement began in earnest in August and September 2000. (Ex. D-45 at AOL 00629; Tr. 47:547:7) 55. In the course of negotiations about the Amendment, AOL acknowledged that it had under-delivered impressions during the first year of the 1999 Agreement by approximately 54 million. (Dep. [Iannuccilli] 73:14-73:23) E. November 15, 2000, Amendment

56. On November 15, 2000, eToys and AOL executed the Amendment to the 1999 Agreement. (PT Stip. at 2; Ex. P-3 at AOL 00535) 57. Under the Amendment, eToys paid an additional $750,000 to AOL and AOL agreed to provide impressions for the following two 7

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years without any further payments by eToys. 00534, 00537)

(Ex. P-3 at AOL

58. After the Amendment, therefore, the total price paid by eToys to AOL for the three-year period was reduced from $18 million to $8.25 million and was fully pre-paid. (Ex. P-3 at AOL 00534, 00537; Dep. [Lenk] 154:11-155:1; Dep. [Baig] 166:18166:21) 59. An internal AOL summary stated that the total dollar figure paid under the Amendment was derived "for years 2 and 3 using current rate cards," which were significantly less than the rate card prices at the time the 1999 Agreement had been negotiated. (Ex. P-3 at AOL 00534; Ex. P-10; Dep. [Brine] 114:2-115:11; Dep. [Valle] 90:23-91:14; Dep. [Baig] 130:8-131:4, 135:1-135:14) 60. The Amendment deemed AOL to have satisfied all its obligations with respect to the delivery of impressions in the first year of the Agreement. (Ex. P-3 at AOL 00534-35; Dep. [Burger] 171:3-171:14) 61. The Amendment also reduced AOL's obligations to deliver priced impressions in the second and third years and eliminated eToys' exclusivity rights under the 1999 Agreement. (Ex. P-3 at AOL 00534) 62. However, under the Amendment, AOL agreed to provide eToys with one billion impressions in all categories, including 889 million Welcome Screen impressions, during the second and third years of the Agreement. (Ex. P-3 at AOL 00541; Dep. [Iannuccilli] 120:14-120:21) 63. In the event of a shortfall in AOL's delivery of impressions, AOL again agreed to deliver additional impressions but only at the rate of one times the missed impressions unless there was a shortfall of 50% or more of the combined number of promised impressions, in which case the make good impressions would equal 1.5 times the shortfall. (Ex. P-3 at AOL 00536-37) 64. Under the Amendment, AOL waived its right to collect $397,000 due from eToys' wholly owned subsidiary, BabyCenter, Inc. (Ex. P-3 at 00537; Dep. [Lenk] 155:2-155:9) 65. All terms of the 1999 Agreement not expressly modified by or in direct conflict with the Amendment remained in effect. (Ex. P-3 at AOL 00538)

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66. In the negotiations that resulted in the Amendment, the parties did not allocate any value to exclusivity or the Welcome Screen impressions to be delivered. (Tr. 86:16-86:18; Dep. [Burger] 116:18-117:13) F. Performance of the 2000 Amendment

67. AOL produced schedules showing the impressions it delivered (1) from the commencement of the 1999 Agreement through termination, (2) from the Amendment through January 31, 2001, and (3) from February 1 to 26, 2001. (Ex. P-4; Ex. P-5; Ex. P-6) 68. However, AOL has said that: "a perfect comparison between the carriage plan contained in schedule A of the [A]mendment and the impressions actually provided is not possible. Both changes in the nomenclature used by AOL and any changes agreed to by the parties regarding what impressions would actually be delivered make such a side-by-side comparison impossible. There is thus no `key' that ties the information in [the] exhibits . . . to schedule A of the [A]mendment." (Ex. P-8) 69. Nonetheless, the Exhibits evidence that AOL did not deliver any of the various impressions it committed to provide, including (a) "Pop-up" impressions to be delivered by the end of 2000, (b) Section 2 impressions, such as the "People.com" impressions, (c) the 10.7 million "Winter Holiday-Shopping Package" impressions, (d) the 1.6 million "Santa's Home Page" banners, and (e) the 600,000 "Baby Registries" banners. (Ex. P-3 at AOL 00539-40; Ex. P-4; Ex. P-5; Ex. P-6) 70. The Exhibits also demonstrate that AOL delivered only a small percentage of other impressions it was obligated to deliver: (a) 20,524 of the 3 million "Birthday Club" banners, (b) 29,486 of the 3 million "Run Of Parenting Channel" impressions, (c) 1,832,130 of the 7,533,334 "Movies: Gold" impressions, (d) 2,206,962 of the 10,777,778 "Books and Magazines: Gold" impressions, (e) 132,096 of the 490,000 "Kids Wish List" banners, (e) 432,643 of the 1,766,660 "Maternity: Gold" impressions, (f) 2,086,772 of the 9,252,000 "Home Page" impressions, (g) 1,507,342 of the 4,500,000 "Educational Toys: Anchor" impressions, and (h) 6,262,425 of the 15,750,000 "Toys & Games: Anchor" impressions. (Ex. P-3 at AOL 00540; Ex. P-4; Ex. P-5; Ex. P-6) 71. However, eToys received a substantial number of the Welcome Screen impressions that it had sought in the Agreement and the Amendment: approximately 231 million from August 1999 to August 2000 and 475 million from August 2000 to February 2001. (Tr. 86:5-86:15; Dep. [Burger] 75:7-75:10, 162:4-162:14; Dep. 9

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[Iannuccilli] 65:11-65:14; Ex. P-6 at AOL 00155; Ex. P-4 at AOL 01802) 72. The Amendment obligated AOL to deliver only 862,400,000 Welcome Screen impressions (not the impressions listed in Exhibit A as referenced in section 1a and the impressions listed in section 1b). (Ex. P-3 at AOL 00535) G. 2000 Holiday Season

73. Quite surprisingly, the 2000 holiday season was terrible; internet businesses particularly suffered. 74. It was clear by mid-December 2000, that the 2000 holiday season was a failure and that eToys would miss its projected sales. (Ex. D-77 at TR 001868; Dep. [Brine] 57:14-57:19; Dep. [Schoch] 54:2-54:16) 75. On December 15, 2000, eToys revised its projected sales for the quarter downward from $210-$240 million to $120-$130 million. (Ex. D-77 at TR 001868) 76. eToys' downward adjustment of its projected sales resulted in a downward revision in the estimate of cash the company would have on hand at the end of December from $100-$120 million to $50-$60 million. (Ex. D-77 at TR 001868) 77. To advise it on its options, eToys hired Goldman Sachs which quickly determined that financing was not available and began seeking strategic and financial buyers. (Dep. [Lenk] 63:15-64:4) 78. eToys and its management talked with numerous prospective buyers, none of whom presented an offer. (Dep. [Lenk] 64:564:25; Dep. [Schoch] 55:24-57:11, 141:21-142:15) 79. By January 3, 2001, eToys' management recognized that the company would not be able to proceed in its current configuration. (Dep. [Schoch] 54:17-55:10, 132:10-133:2, 141:21143:15; Dep. [Bousquette] 22:20-23:2) 80. On January 4, 2001, eToys issued job elimination notices to approximately 700 of its 1,000 full-time employees. (Ex. D-78 at TR 001963; Dep. [Brine] 18:5-18:8; Dep. [Schoch] 55:11-55:23) 81. On January 10, 2001, eToys' unsecured creditors formed an informal committee which entered into a standstill agreement with eToys on January 16, 2001. (Tr. 132:9-132:14)

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82. By the end of January 2001, eToys' search for a buyer was reaching the desperation stage. (Dep. [Schoch] 145:5-145:11) 83. On February 5, 2001, eToys issued job elimination notices to all its remaining employees. (Tr. 132:15-132:19; Ex. D-78 at 001893) 84. During the month of February, eToys tried to raise cash by selling large quantities of inventory on its website at discount prices in an informal liquidation. (Dep. [Schoch] 99:21-100:7, 104:25-105:8; Dep. [Lenk] 169:6-169:15) 85. During this period, eToys' management knew that paying all its bills would prevent it from continuing as a viable company and started to conserve cash. (Dep. [Schoch] 50:7-52:16, 99:21-100:9; Dep. [Lenk] 165:14-165:19) 86. While eToys was able to sell BabyCenter for $10 million, it was clear by February 26, 2001, that eToys would not be able to find a buyer for the company as a whole. (Tr. 119:20-120:3; Dep. [Schoch] 148:15-148:22, 149:5-149:11, 184:11-184:23) 87. By February 26, 2001, eToys had no alternative than to file for bankruptcy, and its Board of Directors authorized it to file a chapter 11 bankruptcy petition. (Ex. P-16 at 6; Ex. D-59 at AOL 00349) 88. On February 26, 2001, eToys began valuing its remaining assets on a piecemeal basis in preparation for selling them in a liquidation. (Dep. [Schoch] 183:7-184:10) 89. On that same day, eToys issued a press release announcing that it would cease operations, close its website, wind down its business and liquidate its assets because it had concluded that "under any scenario, its outstanding liabilities, which totaled approximately $274 million as of January 31, 2001, will substantially exceed the value of any proceeds or assets that may be received in a strategic transaction." (PT Stip. at 2; Ex. D59 at AOL 00349; Dep. [Schoch] 183:7-184:23) 90. AOL learned of eToys' intentions shortly after the press release was issued. (Tr. 55:1-55:11) H. Notice of Termination

91. On February 28, 2001, AOL sent eToys a notice of termination of the 1999 Agreement as authorized by section 5.6 of the 1999 Agreement. (Tr. 57:3-57:5; PT Stip. at 2; Ex. P-1 at AOL 00207) 11

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92. If eToys' banner and promotions continued to appear on AOL's website after eToys' website had shut down, AOL Members clicking on that banner would have seen a static splash page saying that eToys was no longer open and would not have received any of the services that eToys was obligated to provide under the 1999 Agreement. (Dep. [Lenk] 68:8-68:20; Tr. 55:18-56:14) 93. AOL was concerned that if there were continuing transactions between AOL Members and eToys after its announcement that it was going out of business, eToys would not have had the product or the necessary personnel to complete the sales and to ensure compliance with AOL's applicable merchant certification requirements. (Tr. 56:15-57:12; Dep. [Baig] 154:2-155:8, 163:15164:15; Dep. [Lenk] 170:5-170:7) 94. AOL feared that AOL Members could have asserted that AOL was liable for any failure of eToys to meet its obligations. (Tr. 51:11-52:3; Dep. [Baig] 154:2-155:8, 163:15-166:17) 95. AOL had a finite amount of advertising space which it could sell on its system and the effect of the termination of the Amended Agreement with eToys was to free up advertising space which could be sold to other customers at potentially higher rates. (Dep. [Baig] 162:12-162:16; Dep. [Burger] 172:20-175:7; Dep. [Brine] 126:2-126:16) I. eToys' Bankruptcy and Sale of Assets

96. On March 7, 2001, eToys filed a voluntary petition under chapter 11 of the Bankruptcy Code. (PT Stip. at 3) 97. On the Petition Date, eToys also filed a motion seeking, inter alia, authority to auction the reorganized stock of eToys under a plan of reorganization or to sell substantially all its assets. (D.I. 19) 98. After renewed efforts to identify potential purchasers for its assets or stock, eToys held an auction on March 22, 2001, at which a bidder was tentatively selected, who ultimately withdrew its bid. (Ex. D-67 at 10) 99. On April 27, 2001, eToys filed a renewed motion to sell substantially all its assets (including inventory, plant, fixtures, intellectual property, and the right to solicit eToys' 3.4 million customers) to KB Consolidated, Inc., for $12.2 million. (Ex. D-68 at TR 000229; Ex. D-67; Ex. D-69; Ex. D-78 at TR 001887)

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100. The sale to KB was approved by Order dated May 2, 2001. (D.I. 279) J. Standard Tests of Solvency

101. There are three standard tests applicable to an analysis of solvency: the balance sheet test, the capital adequacy test, and the cash flow test. (Tr. 99:3-99:19) 102. The balance sheet test compares the fair value of a company's assets to the company's debts to determine solvency. (Tr. 99:4-99:9) 103. Application of the balance sheet test includes the following steps: (1) determine the appropriate premise of value to apply; (2) determine the appropriate valuation methodology; (3) construct a pro forma balance sheet; (4) analyze individual asset categories and determine the fair value of assets; and (5) compare the total value of the assets to the total debt to determine whether or not the company is solvent as of the transfer date. (Tr. 103:5-103:16) 104. There are two alternative premises of value: a going concern premise and a liquidation premise. (Tr. 103:22-104:20) 105. There are standard factors for a valuation analyst to consider in determining the appropriate premise of value: (1) whether the company continued to make capital investments and open new operating facilities during the relevant period; (2) whether the company had access to capital and credit; (3) whether management and the investment community were optimistic about the company's prospects; (4) whether the company's employment base was expanding; (5) whether there was a discovery of material fraud; and (6) whether there was a loss of major customers or vendors. (Tr. 104:22-105:15, 109:25-111:2) 106. The capital adequacy test evaluates whether the company had sufficient capital to fund operations for the foreseeable future. (Tr. 99:10-99:15) 107. The cash flow test addresses whether the company had the intent and ability to pay its debts as they matured. (Tr. 99:1699:19)

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K.

eToys' Solvency as of November 15, 2000, Amendment 1. Balance Sheet Test

108. The going concern premise of value is the appropriate premise of value to apply in analyzing eToys' solvency as of the November 15 Amendment. (Tr. 113:22-114:1) 109. From March to December 2000, eToys continued to make capital investments of nearly $100 million in property and equipment, including leasing a new headquarters and opening two new operating facilities from which it could ship products and provide customer service. (Tr. 106:9-106:19; Dep. [Schoch] 112:23-114:7, 163:16-163:20) 110. eToys' full-time employees increased from 306 to more than 1,000 between March 1999 and December 2000. (Tr. 109:18-109:24) 111. eToys' customer base increased from 1.7 million to 3.4 million between December 1999 and December 2000. (Ex. D-78 at TR 001887) 112. eToys did not lose any major vendors before the November 15, 2000, Amendment. (Tr. 110:14-111:2) 113. eToys had access to capital and credit during the relevant period: it raised $175.2 million at its initial public offering in May 1999, raised an additional $145 million through unsecured convertible notes in December 1999, raised $100 million more in June 2000 primarily from a preferred stock offering, and entered into a $40 million two-year revolving credit facility on November 15, 2000. (Tr. 106:7-107:7; Ex. D-75 at TR 001534-36; Dep. [Schoch] 119:12-119:15, 124:24-126:02, 133:17-133:23; Dep. [Lenk] 187:18-189:7) 114. As of November 2000, eToys was able to pay its debts as they came due and expected to have sufficient cash to do so through the spring of 2001. (Dep. [Lenk] 155:14-155:17, 161:2-161:5; Dep. [Schoch] 49:22-52:16) 115. In early fall 2000, eToys' management and the investment community had a positive view about eToys' long-term prospects and believed that the company was competitive. (Tr. 108:2108:23) 116. eToys' management felt it was a going concern at least through Thanksgiving 2000. (Dep. [Schoch] 94:14-94:19, 96:4-96:11, 131:16-133:16) 14

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117. On November 10, 2000, investment analysts at ABN-AMRO issued a report saying that eToys was well-positioned for a record holiday season in 2000. (Tr. 108:24-109:10) 118. As of the Amendment date no material fraud had been uncovered at eToys. (Tr. 110:14-110:19; Dep. [Schoch] 153:23154:4) 119. The fact that eToys had recurring operating losses does not, by itself, mean that the company was no longer a going concern. (Tr. 111:8-112:20) 120. Since its formation in 1997, eToys had experienced recurring operating losses, yet eToys' March 2000 audited financial statements did not contain any reservations about the company's ability to remain a going concern. (Tr. 111:12-111:16; Dep. [Schoch] 123:21-124:3) 121. As of October 30, 2000, eToys predicted that it would end the quarter with $100 to $120 million in cash, a better cash position than it had in September. (Tr. 112:7-112:13) 122. As of November 15, 2000, eToys had at least $80 million in working capital, which was sufficient to fund its continuing operations. (Tr. 112:2-112:5) 123. Using the going concern premise of value, a pro forma balance sheet based on eToys' actual balance sheet as of September 30, 2000, adjusted to reflect eToys' operating results through November 15, 2000, appropriately takes into account eToys' cash equivalents, inventory, prepaid and other current assets, property and equipment, goodwill, intangible value, and other assets. (Tr. 115:2-115:13) 124. In converting the book value of eToys' individual asset categories into fair market value, a conservative 21% upward adjustment is appropriate for the book value of eToys' inventory. (Tr. 115:24-116:2; Dep. [Schoch] 167:15-168:18) 125. No adjustment to the book value of cash, cash equivalents, prepaid expenses, and other current assets is appropriate. (Tr. 118:5-118:12) 126. A 33% downward adjustment is appropriate for the book value of property and equipment, including software. (Tr. 118:13119:1, 174:19-175:10) 127. It is appropriate to adjust the value of eToys' goodwill from $124 million to zero. (Tr. 119:2-119:5) 15

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128. It is appropriate to reduce the book value of eToys' other assets by 15%. (Tr. 119:6-119:13) 129. As of November 15, 2000, BabyCenter was a wholly owned subsidiary of eToys. (Tr. 119:14-119:16) 130. In converting the book value of BabyCenter into fair market value, it is appropriate to increase the book value of BabyCenter to $5 million, which is a reasonable portion of the sale price ($10 million) to ascribe to the intangible value of BabyCenter which had only $1 million in net tangible assets at the time of its sale. (Tr. 119:14-120:18) 131. It is appropriate, when conducting the balance sheet test, to make no adjustments to eToys' liabilities, but preferred stock should not be treated as debt. (Tr. 121:11-121:17) 132. Including the value of eToys' intangible assets, the fair value of its assets exceeded its debts by approximately $258 million on November 15, 2000. (Ex. D-81 at TR 001966; Tr. 121:1121:3, 125:16-125:19; Dep. [Schoch] 49:14-49:21, 94:7-94:13, 100:14-100:25) 133. Even excluding the value of eToys' intangible assets, the total fair value of its other assets ($302.4 million) exceeded its debts ($287.2 million) by approximately $15.2 million as of November 15, 2000. (Tr. 121:18-122:8; Ex. D-83 at 15) 134. Thus, under the balance sheet test, eToys was solvent on the date of the Amendment because the fair value of its assets was greater than its total debts. (Tr. 125:10-126:6) 2. Capital Adequacy Test

135. eToys did not have unreasonably small capital at the time of the November 15, 2000, Amendment. (Tr. 122:9-122:22) 136. eToys' September 30, 2000, 10-Q report filed with the SEC stated that eToys had sufficient capital to fund its operations through June 2001. (Ex. D-76 at TR 001715) 137. eToys' capital position did not change materially between September 30 and November 15, 2000. (Tr. 122:24-123:4) 138. As of October 30, 2000, eToys expected to have more cash to fund operations on December 31, 2000, than it had on September 30, 2000. (Tr. 123:7-123:16)

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139. eToys entered into a $40 million two-year revolving credit facility on November 15, 2000. (Tr. 123:16-123:20) 140. The November 15 Amendment with AOL reduced eToys' debt obligations by nearly $10 million thereby increasing eToys' ability to fund future operations. (Ex. P-3; Tr. 123:20-123:24) 141. Applying the capital adequacy test, eToys was solvent as of November 15, 2000. (Tr. 122:15-122:22) 3. Cash Flow Test

142. As of November 15, 2000, eToys was able to, and intended to, pay its debts as they came due. (Dep. [Lenk] 56:25-57:3; Tr. 124:3-124:9) 143. Throughout November 2000, eToys was paying its debts as they came due. (Dep. [Lenk] 63:5-63:7) 144. It did not become apparent until after the Thanksgiving weekend in 2000 that eToys would significantly miss hitting its sales targets for the holiday season. (Dep. [Brine] 56:3-56:15) 145. As of November 15, 2000, eToys' current assets exceeded its current debts by $80 million. (Tr. 124:10-124:15) 146. Applying the cash flow test, eToys was solvent as of November 15, 2000. (Tr. 124:3-124:17) 147. The amount indicated in a company's accumulated deficit account is not relevant to an analysis of its solvency. (Tr. 126:7-126:24) 148. The unsuccessful efforts of eToys to sell the company after December 15, 2000, are not relevant to its solvency as of November 15, 2000. (Tr. 127:18-128:4) L. eToys' Solvency as of Termination

149. As of February 28, 2001, eToys was insolvent. EBC I, Inc. v. America Online, Inc. (In re EBC I, Inc.), 356 B.R. 631, 636 (Bankr. D. Del. 2006). 150. It is appropriate to use the liquidation premise of value in evaluating eToys' solvency as of February 28, 2001, because after December 2000: (1) eToys was not continuing to make any capital expenditures but was conserving its cash; (2) eToys was not able to access the capital or credit markets; (3) its management and the investment community were not optimistic and, in fact, were 17

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voicing serious concerns about its ability to survive; (4) eToys was firing substantial numbers of its employees; and (5) its sales were vastly diminished from its projections. (Tr. 104:16105:4, 110:6-111:25, 130:3-130:15; Dep. [Lenk] 169:6-169:15) 151. Using the liquidation premise of value, eToys' debts exceeded its liabilities. (Ex. D-83) 152. eToys did not have sufficient capital (or access to the capital markets) to fund its continuing operations as of February 28, 2001. (Ex. D-59) 153. Further, eToys did not have sufficient cash flow to continue to pay its debts as they came due as of February 28, 2001. (Ex. D-59) M. eToys' Remaining Rights on Termination

154. The value of the contract rights eToys lost as a result of the termination of the 1999 Agreement must be determined as of the date of the termination, February 28, 2001. (Tr. 100:5100:17, 130:8-130:12) 155. The liquidation premise of value is appropriate in analyzing the value of eToys' remaining rights under the 1999 Agreement as of February 28, 2001. (Tr. 130:8-130:12) 156. If the rights under the 1999 Agreement were not legally transferable to a third party, the contract rights would have had zero value, as eToys - which was not operating - could not use them. (Tr. 143:25-145:1) 157. Even if the 1999 Agreement were transferable, it had minimal value. 158. Qualitative factors that would affect the value of eToys' contract rights at the date of termination include the state of the internet advertising industry, the state of the internet industry, general economic conditions, the number of buyers who would be interested in the contract rights at the time of termination, and the remaining term of the contract rights. (Tr. 134:24-135:6) 159. In 2000-2001, clicked through to 2% to roughly 0.3% prices charged for the rates at which viewers of impressions access an advertiser's website declined from resulting in significant deflation in the internet advertising. (Tr. 135:11-135:18)

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160. The internet advertising market shrank by 7.8% during the first six months of 2001, relative to the same time period in 2000. (Tr. 135:21-136:4) 161. Between January 2000 and February 2002, 806 internet firms ceased operations. (Tr. 136:19-136:20) 162. eToys also cited the public's concerns over the general economic deterioration as one of the reasons that it had a disappointing 2000 holiday season. (Ex. D-77 at TR 001868) 163. There was not a significant pool of potential buyers for eToys after the disappointing 2000 holiday season. (Tr. 137:15137:24) 164. Under a liquidation premise of value, it is appropriate to use the purchase price paid by KB in its acquisition of eToys' other assets in bankruptcy as an indicator of the value of eToys' rights under the 1999 Agreement. (Tr. 139:3-139:5) 165. KB paid $3.35 million for eToys' intangible assets, i.e., its brand, its website, its intellectual property assets, and the right to solicit its 3.4 million customers. (Tr. 139:11-139:14; Ex. D-68 at TR 000229; Ex. D-69) 166. An indicator of the difference in value between liquidation and going concern is provided by the reduction in value of eToys' intangible assets from $243 million as of November 15, 2000, to the $3.35 million paid by KB for those intangibles or a discount of 98.6%. (Tr. 140:16-141:5) 167. In mid-2000, when it was a going concern, eToys valued its customer base at roughly $166 per customer times its 3.4 million customers for a value of $564 million. (Tr. 139:23-140:3; Ex. D78 at TR 001887) 168. If all of the KB purchase price of $3.35 million was for access to eToys' customer base, the value of that asset was 99.4% less in liquidation than as a going concern. (Tr. 140:4-140:15) 169. The holiday season was particularly important for eToys as it received roughly 70% of its business during that period. (Tr. 84:18-84:19; Dep. [Burger] 74:23-75:10, 82:19-83:5; Dep. [Iannuccilli] 34:12-34:19; Dep. [Lenk] 32:21-33:16) 170. Only one holiday season remained under the 1999 Agreement at the time of termination so, for purposes of applying the liquidation discount scenarios, the adjusted going concern value of the 1999 Agreement would have been one third of the contract 19

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price or $2.75 million. 142:16)

(Ex. P-1; Tr. 137:25-138:11, 142:12-

171. Applying the liquidation discount of 99.4% or 98.6% derived from the KB sale price for eToys' intangibles evidences that eToys' remaining rights under the 1999 Agreement at the time of termination had a value of $16,500 to $38,500. (Tr. 142:25143:13) 172. Because eToys announced its intent to file a bankruptcy petition on February 26, 2001, any sale of its rights under the 1999 Agreement would have been subject to applicable provisions of the Bankruptcy Code. (Ex. D-59 at AOL 00349; Tr. 144:17145:1) 173. The internet was in its early stages at the time the 1999 Agreement was executed and AOL wanted its retail partners to be successful to prove that online retail was a viable and easy way of doing business, and because AOL had a direct financial interest in the success of retail partners such as eToys. (Tr. 42:13-42:18; Dep. [Burger] 21:3-22:6) 174. In the late 1990s the unfamiliar nature of internet shopping made reliability an important issue for AOL in selecting merchant partners that would give its members a good shopping experience. (Tr. 25:6-25:25) 175. At that time, AOL Members were nervous about using their credit card numbers on the internet and also held other trust and safety concerns about the online shopping experience. (Tr. 26:126:4) 176. In order to provide good products and service to AOL Members in the shopping area, AOL sought to provide recognizable brands, good products, and good pricing. (Tr. 25:10-25:17) 177. AOL viewed eToys as a desirable retailer on its website because it felt eToys had the particular resources and commitment to deliver a high quality experience in all aspects of commerce from product selection to site design, transaction process, customer service, great merchandising, a broader selection of products than other online toy retailers, great promotion, and excellent marketing ideas and enthusiasm. (Ex. D-19 at AOL 00444; Ex. D-27 at AOL 01708-09; Ex. D-12 at AOL 00454) 178. During the 1999 holiday season Fortune Magazine had rated eToys first among the top 49 websites in an independent study of how internet retailers performed. (Ex. D-29 at AOL 00753) 20

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179. AOL would not have entered into the 1999 Agreement with any company other than eToys. (Tr. 54:19-54:25) 180. At no point in 2001, either before or after eToys filed bankruptcy, did it contact AOL seeking to reverse the termination or to transfer the remaining services due to eToys under the 1999 Agreement to a third party. (Tr. 57:11-57:22) II. CONCLUSIONS OF LAW A. November 15, 2000, Amendment 1. Fraudulent Conveyance under the Bankruptcy Code

1. The version of section 548(a) of the Bankruptcy Code which is applicable to this case3 establishes the requirements for avoiding a transfer as constructively fraudulent: (a)(1) The trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year before the date of the filing of the petition, if the debtor voluntarily or involuntarily . . . (B) (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and (ii) (I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; or (III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor's ability to pay as such debts matured. 11 U.S.C. § 548(a)(1) (2004). 2. The plaintiff bears the burden of proving each of the requirements of section 548(a), including that (1) the debtor was insolvent at the time of the transfer or became insolvent as a result thereof and (2) the debtor received less than reasonably
3

The amendments to section 548 contained in the Bankruptcy Abuse Prevention and Consumer Protection Act are not applicable. 21

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equivalent value in exchange for such transfer. BFP v. Resolution Trust Corp., 511 U.S. 531, 535 (1994); Mellon Bank, N.A. v. Official Comm. of Unsecured Creditors of R.M.L., Inc.(In re R.M.L., Inc.), 92 F.3d 139, 144 (3d Cir. 1996). 3. A company is solvent for purposes of section 548(a) if its assets, at fair valuation, exceed its liabilities. 11 U.S.C. § 101(32)(A). 4. Solvency is assessed as of the date of the transfer sought to be avoided. R.M.L., Inc., 92 F.3d at 154. 5. In evaluating the fair value of a company's assets for purposes of determining solvency, the appropriate premise of value must be applied: either the going concern premise of value or the liquidation premise of value. Travellers Int'l AG v. Trans World Airlines, Inc. (In re Trans World Airlines, Inc.), 134 F.3d 188, 193 (3d Cir. 1998) (finding that fair valuation of the debtor's assets required choice between going concern and liquidation premises of value); American Classic Voyages Co. v. JP Morgan Chase Bank (In re American Classic Voyages Co.), 367 B.R. 500, 508 (Bankr. D. Del. 2007) ("In determining a `fair valuation' of the entity's assets, an initial decision to be made is whether to value the assets on a going concern basis or a liquidation basis."). 6. The going concern premise of value will be applicable unless the company's bankruptcy is imminent. See, e.g., Moody v. Sec. Pac. Bus. Credit, Inc., 971 F.2d 1056, 1067 (3d Cir. 1992) ("Where bankruptcy is not `clearly imminent' on the date of the challenged conveyance, the weight of authority holds that assets should be valued on a going concern basis."). Accord American Classic Voyages, 367 B.R. at 508; Lids Corp. v. Marathon Inv. Partners, L.P. (In re Lids Corp.), 281 B.R. 535, 541 (Bankr. D. Del. 2002). 7. The balance sheet test is a valid and accepted methodology for valuing a company's assets for purposes of determining solvency. 11 U.S.C. § 101(32)(A) ("`[I]nsolvent' means . . . financial condition such that the sum of such entity's debts is greater than all of such entity's property . . . ."). See also, Peltz v. Hatten, 279 B.R. 710, 743 (D. Del. 2002) ("While the [solvency] inquiry is labeled a `balance sheet' test . . . . it is appropriate to adjust items on the balance sheet that are shown at higher or lower value than their going concern value and to examine whether assets of a company that are not found on its balance sheet should be included in its fair value."), aff'd sub nom. In re USN Commc'ns, Inc., 60 Fed. Appx. 401 (3d Cir. 2003). 22

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8. The fair value of a company's intangible assets generally is included when applying the balance sheet test. Mellon Bank, N.A. v. Metro Commc'ns, Inc. (In re Metro Commc'ns, Inc.), 945 F.2d 635, 647 (3d Cir. 1991); Schubert v. Lucent Technologies, Inc. (In re Winstar Commc'ns, Inc.), 348 B.R. 234, 274 (Bankr. D. Del. 2005) (indicating that the balance sheet test may take into account value not "used to prepare a typical balance sheet" because it is "based upon a fair valuation and not based on [GAAP]") (citation omitted). 9. Applying the balance sheet test as of November 15, 2000, eToys was solvent. (FOF 108-34) 10. The cash-flow test (also called the inability-to-pay-debts test) is an alternative solvency test, which assesses whether, at the time of the transfer, the debtor intended to incur or believed that it would incur debts beyond its ability to pay as such debts matured. 11 U.S.C. § 548(a)(1)(B)(ii)(III). See also WRT Creditors Liquidation Trust v. WRT Bankr. Litig. Master File Defendants (In re WRT Energy Corp.), 282 B.R. 343, 414-15 (Bankr. W.D. La. 2001) ("The `inability to pay debts' prong of section 548 is met if it can be shown that the debtor made the transfer or incurred an obligation contemporaneous with an intent or belief that subsequent creditors likely would not be paid as their claims matured."). 11. eToys was not insolvent on November 15, 2000, under the cash-flow test as it had not as of that date incurred, nor did it believe that it would incur, debts that would be beyond its ability to pay when they matured. In fact, at that time eToys was paying its debts as they came due. (FOF 142-48) 12. A third test for solvency is the unreasonably small capital test, which analyzes whether at the time of the transfer the company has insufficient capital, including access to credit, for operations. 11 U.S.C. § 548(a)(1)(B)(ii)(II). See also Moody, 971 F.2d at 1073 ("[I]t was proper for the district court to consider availability of credit in determining whether [the debtor] was left with an unreasonably small capital."). 13. eToys was also solvent on November 15, 2000, under the unreasonably small capital test because it retained sufficient capital for operations, including access to credit. (FOF 135-41) 14. Therefore, the Amendment did not constitute or result in an avoidable transfer under section 548.

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2.

Fraudulent Conveyance under State Law

15. Under section 544 of the Bankruptcy Code, a debtor may avoid any transfer of property of the estate that is voidable under applicable state law by certain creditors. 11 U.S.C. § 544. 16. This case is governed by Virginia law (Ex. P-1 at AOL 00229) which provides that "[e]very gift, conveyance, assignment, transfer or charge which is not upon consideration deemed valuable in law . . . by an insolvent transferor, or by a transferor who is thereby rendered insolvent, shall be void as to creditors whose debts shall have been contracted at the time it was made . . . ." Va. Code Ann. § 55-81 (West 2003). See also In re Meyer, 244 F.3d 352, 355 (4th Cir. 2001) (discussing valuation of consideration for purposes of avoidance action). 17. "[S]light consideration, rather than `fair' or `reasonably equivalent' consideration, will suffice to save such a transfer from avoidance [under Virginia law] in the commercial context." In re Best Products Co., 168 B.R. 35, 52 (Bankr. S.D.N.Y. 1994), aff'd, 68 F.3d 26 (2d Cir. 1995). See also C-T of Virginia, Inc. v. Euroshoe Assocs. Ltd. P'ship, No. 91-1578, 1992 WL 12307, at *2 (4th Cir. Jan. 29, 1992) (Virginia law "does not require [the transfer of] reasonably equivalent value."). 18. The November 15, 2000, Amendment is not avoidable under Virginia law because eToys was solvent at that time and was not rendered insolvent by the Amendment. B. Termination on February 28, 2001 1. Fraudulent Conveyance under the Bankruptcy Code

19. eToys was insolvent as of February 28, 2001, the date AOL terminated the 1999 Agreement. EBC I, Inc. v. America Online, Inc. (In re EBC I, Inc.), 356 B.R. 631, 636 (Bankr. D. Del. 2006). 20. There was a transfer of a property interest of eToys on termination of the 1999 Agreement. EBC I, Inc., 356 B.R. at 637. 21. eToys received nothing in exchange for the termination of the 1999 Agreement. 22. Therefore, the termination is avoidable under section 548 of the Bankruptcy Code.

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a.

Value of Property Transferred

23. Section 550 provides that where a transfer is avoided under section 548, the estate may recover the property transferred or the value of such property. 11 U.S.C. § 550(a)(1). 24. Because the purpose of sections 548 and 550 is preservation of the estate for the benefit of creditors, the value of property transferred is determined from the perspective of the estate and the creditor body. See, e.g., Metro Commc'ns, Inc., 945 F.2d at 648 ("The purpose of [section 548] is estate preservation . . . ."); Rochez Bros., Inc. v. Sears Ecological Applications Co., (In re Rochez Bros., Inc.), 326 B.R. 579, 588 (Bankr. W.D. Pa. 2005) ("Section 550(a) is intended to restore the estate to the financial condition it would have enjoyed if the transfer had not occurred."); 2 Collier Bankruptcy Manual ¶ 550.02[3] at 550-4 (Henry J. Sommer et al., eds., 3d ed. rev. 2007). 25. Under sections 548 and 550, where property is not returned to the estate as a result of avoidance, but instead the value of the property is returned, the property transferred is valued as of the transfer date. See, e.g., R.M.L., Inc., 187 B.R. at 463; Gennrich v. Montana Sport U.S.A. (In re International Ski Service, Inc.), 119 B.R. 654, 659 (Bankr. W.D. Wis. 1990) (noting that under section 550 courts generally agree that the property should be valued at the time of transfer) (citation omitted). i. Value to eToys

26. When a corporation's failure and bankruptcy are imminent at the time of a transfer sought to be avoided under section 548, application of the liquidation premise of value is appropriate in determining the fair value of the property transferred. See, e.g., Rochez Bros., Inc., 326 B.R. at 588-89 (rejecting a going concern premise of value for avoided transfer of road salt because, absent the transfer, the salt "would merely have been subjected to the same forced liquidation sale that the Debtor ultimately conducted" and thus the appropriate section 550(a) value was the "forced sale" price); Active Wear, Inc. v. Parkdale Mills, Inc., 331 B.R. 669, 672 (W.D. Va. 2005) (holding that value under section 550 means "fair market value" and that fair market value in the liquidation context "refers to the value that the debtor/bankrupt could receive for the property in a liquidation sale."). 27. Given eToys' dire financial condition in February 2001, eToys would have been unable to enjoy any benefit from the 1999 Agreement even if it had not been terminated. (FOF 79-89) 25

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28. Under Virginia law, eToys' announcement in February 2001 that it would shut down its website and cease operations constituted a material breach of numerous ongoing obligations of eToys under the 1999 Agreement and the Amendment that were material to AOL. (FOF 34-39, 92-94) 29. Because eToys had no further ability to benefit from any performance by AOL under the terms of the 1999 Agreement, based on eToys' own actions and circumstances, the 1999 Agreement had no further value to eToys as of February 28, 2001. ii. Transferability to Third Party 1. Executory Contract

30. An executory contract is "a contract under which the obligation[s] of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other." See, e.g., Sharon Steel Corp. v. Nat'l Fuel Gas Distrib. Corp., 872 F.2d 36, 39 (3d Cir. 1989); 3 Collier on Bankruptcy ¶ 365.02[1] at 365-17 n.1 (Lawrence P. King et al., eds., 15th ed. rev. 2000). 31. In determining whether remaining obligations under a contract are material, applicable state law determines the consequences of breach. See Terrell v. Albaugh (In re Terrell), 892 F.2d 469, 471-72 (6th Cir. 1989) ("[F]ederal law defines the term executory contract but . . . the question of the legal consequences of one party's failure to perform its remaining obligations under a contract is an issue of state contract law.") (citation omitted). 32. In Virginia, contracts that form a relationship in the nature of a business partnership, where mutual obligations are expected to be continuous and ongoing, are executory contracts. See, e.g., Broyhill v. DeLuca (In re DeLuca), 194 B.R. 65, 77 (Bankr. E.D. Va. 1996) (applying Virginia law and holding that an operating agreement governing a limited liability company was an executory contract); RW Power Partners v. Virginia Elec. & Power Co., 899 F. Supp. 1490, 1496 (E.D. Va. 1995) (contract was executory since the parties both owed to each other obligations a material breach of which would have "`deprive[d] the injured party of the benefit that the party justifiably expected from the exchange.'" (quoting Farnsworth on Contracts § 8.16)); Horton v. Horton, 487 S.E. 2d. 200, 204 (Va. 1997) (holding that a material breach is one where "failure to perform [the contractual terms] defeats an essential purpose of the contract."). 26

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33. The 1999 Agreement was an executory contract as of February 28, 2001. (FOF 16-41, 92-95) 2. Assignability

34. Pursuant to section 365(c) of the Bankruptcy Code, a debtor may not assume or assign an executory contract if applicable state law excuses a party to the contract (other than the debtor) from accepting performance from or rendering performance to an entity other than the debtor. 11 U.S.C. § 365(c)(1)(A-B). 35. Under Virginia law, a contract is not assignable if the identity of the contracting parties is material to the ongoing performance of the contract. See, e.g., Stone Street Capital, Inc. v. Granati (In re Granati), 270 B.R. 575, 581-82 (Bankr. E.D. Va. 2001) ("[C]ontract rights are freely assignable unless the identity of the contracting parties is material."), aff'd, 307 B.R. 827 (E.D. Va. 2002); In re DeLuca, 194 B.R. at 77 (holding that an operating agreement governing a limited liability company was unassignable, since "the identity of the managers [of the company was] material to the very existence of the company."). 36. Under Virginia law, the identity of a party is material to the performance of a contract if the contract is founded on one of the parties maintaining trust or confidence in the ability to perform, judgment, or business experience of the other party. See, e.g., duPont de-Bie v. Vredenburgh, 490 F.2d 1057, 1060 (4th Cir. 1974) ("[E]xecutory contracts for personal services or involving a relationship of confidence are not assignable."); McGuire v. Brown, 76 S.E. 295, 297 (Va. 1912) (contract not assignable because the seller of certain real property "was prompted to enter into th[e] contract . . . by her confidence in [the counter-party's] judgment, ability, opportunity . . . and perhaps other considerations which then appeared sufficient."); Epperson v. Epperson, 62 S.E. 344, 346 (Va. 1908) ("[E]xecutory contract[s] for personal service, founded on personal trust or confidence, [are] not assignable."). 37. The AOL-eToys business relationship was founded on AOL's trust and confidence in eToys' unique attributes, as well as its ability and experience, all of which were relevant to eToys' ability to assure AOL that eToys would adequately serve and protect the interests of AOL Members as set forth in the 1999 Agreement. (FOF 16-41, 92-95, 173-79) 38. Under Virginia law, AOL would not have been required to accept performance under the 1999 Agreement from any party other 27

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than eToys, and the 1999 Agreement therefore was not assumable or assignable under section 365(c) of the Bankruptcy Code. 39. Because eToys had announced prior to February 28, 2001, that it would cease operations and file bankruptcy, because all of eToys' assets (including its contracts and contract rights) would be liquidated in that bankruptcy proceeding, and because it was not assignable under section 365(c), the 1999 Agreement had no value as of that date. Cf. Allan v. Archer-Daniels-Midland Co. (In re Commodity Merchants), 538 F.2d 1260, 1263 (7th Cir. 1976) ("The trustee argues . . . that the cancellation [of the contracts] deprived [the debtor] of its property right to resell the con