Opinion
Bankruptcy Court Case No. IP 99-3364-AJM-11, District Court Cause No. IP 00-496-C; In Joint Administration.
July 5, 2001
ENTRY ON APPEAL FROM BANKRUPTCY COURT
This appeal from an order of the United States Bankruptcy Court for the Southern District of Indiana presents a dispute between secured creditors and unsecured creditors of a failed steel mill. As explained below, the court affirms the decision of the bankruptcy court holding that the secured creditors are entitled to a "replacement lien" of at least $30 million on the debtors' post-petition assets. The replacement lien was designed to compensate for a diminution in the value of the secured creditors' pre-petition collateral.
The Parties and the Issues Presented on Appeal
Qualitech Steel Corporation ("Qualitech") built two new steel facilities in the mid-1990s, one in Pittsboro, Indiana, and the other in Corpus Christi, Texas. The projects generated significant losses. On March 22, 1999, Qualitech and its parent company, Qualitech Steel Holdings Corp., filed for protection under Chapter 11 of the Bankruptcy Code. At the time of the bankruptcy filing, Qualitech's estate was subject to over $350 million in secured claims alone. The Bank Group, also called the "pre-petition senior lenders" (and appellee here), was Qualitech's primary secured lender and held a priority lien against nearly all of Qualitech's assets. As of the petition date, Qualitech owed the pre-petition senior lenders an aggregate principal amount of approximately $265 million.
Under the supervision of the bankruptcy court, Qualitech continued to operate the facilities as a debtor-in-possession for several months in the hope that maintaining the business as a going concern would enhance its total value. The continued operation of the facilities after the petition date required $30 million of new financing. To induce lenders to provide that post-petition financing, the bankruptcy court approved an arrangement whereby a group of lenders obtained a super-priority interest in Qualitech's assets. At the same time, the bankruptcy court's financing order granted the pre-petition senior lenders a "replacement lien" as a form of adequate protection for being bumped from their priority status and for the debtor's ongoing use of the pre-petition collateral. The replacement lien was secured, in part, by Qualitech's few post-petition assets (the "post-petition collateral") and was "limited in amount to the aggregate diminution in value following the Petition Date as a result of the utilization of Cash Collateral and the granting of Senior Liens." Final Financing Order ¶ 17.
The appellant here is the Official Committee representing Qualitech's unsecured creditors. The Official Committee's claims against Qualitech's post-petition assets are in line behind any claims allowed under the replacement liens granted to the secured creditors. That is, the Official Committee asserts an interest in the post-petition collateral to the extent that the secured creditors' replacement liens are worth less than the total value of that collateral. After a hearing to determine the extent of the pre-petition senior lenders' replacement lien, Bankruptcy Judge Anthony J. Metz, III, determined that the lien was worth an amount in excess of $30,000,000. See Appellee App., Ex. 9 ¶ H (Mar. 14, 2000, Order Determining the Extent of the Prepetition Senior Lenders' Replacement Lien).
In this appeal, the unsecured creditors' Official Committee challenges the evidentiary support for the bankruptcy court's valuation of the pre-petition senior lenders' replacement lien. The Official Committee also contends that the bankruptcy court improperly shifted to the unsecured creditors the burden of proving the value of the secured creditors' replacement lien. This court finds no error and affirms Judge Metz's decision.
Standard of Review
On appeal the bankruptcy court's findings of fact are upheld unless clearly erroneous; legal conclusions are reviewed de novo. See In re Frain, 230 F.3d 1014, 1017 (7th Cir. 2000); Matter of A-1 Paving and Contracting, Inc., 116 F.3d 242, 243 (7th Cir. 1997). The relevant questions on this appeal are (1) the value of the pre-petition senior lenders' collateral on the petition date of March 22, 1999; and (2) the value of the pre-petition senior lenders' collateral on August 25, 1999, the closing date for the sale of Qualitech's assets. These are questions of fact, so the court reviews the bankruptcy court's findings for clear error. See Matter of Wabash Valley Power Ass'n, Inc., 72 F.3d 1305, 1323 (7th Cir. 1995) (holding that the valuation of a secured claim is a question of fact).
The Bankruptcy Court Proceedings
Shortly after Qualitech and its parent company filed their bankruptcy petitions, they represented to the bankruptcy court that their start-up operations were generating cash losses of approximately $10 million per month. See Appellee App., Ex. 1 at 3-4. In the face of these mounting losses, the parties to the bankruptcy and the bankruptcy court had to decide quickly whether the debtors' business should be reorganized, sold as a going concern, or simply liquidated. Qualitech and the pre-petition senior lenders favored approval of post-petition financing in order to maintain the business as a going concern until the company could be sold pursuant to 11 U.S.C. § 363. Qualitech and the pre-petition senior lenders represented to the bankruptcy court that the company had determined, as a matter of business judgment, that funding additional losses in the period between the petition date and the anticipated sale date was preferable to an immediate shut-down and/or liquidation. Continuing the start-up operations offered a means of at least maintaining the going concern value of the company, including preserving its labor force. See, e.g., Appellant Desig. Ex. 11 at 5-25 (transcript of May 13, 1999, hearing on the Final Financing Order).
After hearings and various amendments to the proposed post-petition financing plan, the bankruptcy court approved additional funding for Qualitech's start-up operations — almost certainly losses — until the debtors' business could be sold by auction. The terms and conditions of the post-petition financing were set forth in the bankruptcy court's Final Financing Order of May 13, 1999. The bankruptcy court initially approved post-petition borrowing of up to $16.1 million, see Final Financing Order ¶ 3, but later extended the cap to $30 million. The post-petition loans were secured by a super-priority lien against 1 essentially all of the debtors' pre-petition and post-petition assets. See Final Financing Order ¶¶ 10-13; id., Ex. A § 5. In other words, with a few exceptions not relevant to this appeal, the Final Financing Order placed the post-petition lenders "first in line" among the many parties with claims against the debtors' estates.
The post-petition lenders were primarily the same group of banks that comprised the appellee Bank Group of pre-petition senior lenders.
The new super-priority loans and Qualitech's ongoing use of the pre-petition collateral had the effect of displacing the pre-petition secured creditors' claims to Qualitech's pre-petition assets. In such situations, the Bankruptcy Code provides that a secured party must be granted "adequate protection." See generally 11 U.S.C. § 361, 363(e), 364(d). The bankruptcy court therefore ordered:
As adequate protection for (a) the use by the Borrower of Cash Collateral and any other property upon which security interests and liens previously have been granted by the Debtors to the Prepetition Senior Lenders and Prepetition Subordinated Lenders, (b) the granting of senior security interests and liens to the Banks pursuant to the Credit Agreement and this Order, and (c) the imposition of the automatic stay, the Prepetition Senior Lenders; (i) are granted (limited in amount to the aggregate diminution in value following the Petition Date as a result of the utilization of Cash Collateral and the granting of Senior Liens) a replacement security interest in and lien upon all the Collateral, subject and subordinate only to the Senior Liens granted to the Banks pursuant to this Order and the Credit Agreement [and several other interests not relevant here], and (ii) are granted (limited in amount to the aggregate diminution in value following the Petition Date as a result of the utilization of Cash Collateral and the granting of Senior Liens) a priority claim pursuant to section 507(b) of the Bankruptcy Code, subject and subordinate only to the Superpriority Claims granted to the Banks pursuant to this Order.
Final Financing Order ¶ 17; see also id., Ex. A (the "Credit Agreement" incorporated by reference into the Final Financing Order).
The Official Committee has properly conceded on this appeal that the terms of the Final Financing Order control whether the pre-petition senior lenders' replacement lien extends to any of the debtors' post-petition assets. See Appellant Reply Br. at 3. Thus, it is undisputed that the pre-petition senior lenders have a valid replacement lien against "all the Collateral" to the extent that there was an "aggregate diminution in value following the Petition Date as a result of the utilization of Cash Collateral and the granting of Senior Liens."
The unsecured creditors' Official Committee objected to a provision in an 2 earlier proposed financing order that would have granted the pre-petition senior lenders an unqualified replacement lien against post-petition assets. In successfully opposing that proposed order, the Official Committee argued that if 2 the replacement lien were not limited to the post-petition diminution in value of the pre-petition lenders' secured collateral, the replacement lien would improperly collateralize pre-petition obligations with post-petition assets. In other words, an unqualified replacement lien that reached post-petition assets would have been "tantamount to giving a creditor additional collateral it would not have had if the debtor had not filed a bankruptcy petition or had a petition filed against it." In re Tek-Aids Industries, Inc., 145 B.R. 253, 256 (Bankr.N.D.Ill. 1992). In response to this objection, the bankruptcy court's Final Financing Order limited the extent of the replacement lien to the "aggregate diminution in value following the Petition Date," the calculation of which is the central issue in this appeal.
The term "Collateral" is defined in the Credit Agreement to include nearly all of Qualitech's pre-petition and post-petition assets. See Final Financing Order, Ex. A §§ 1 5.2 (defining the terms "Prepetition Collateral," "Postpetition Collateral," "Cash Collateral," and "Collateral"). The term "Collateral" embraces the single post-petition asset in which the unsecured creditors' Official Committee claims an interest as part of this appeal: all proceeds from Qualitech's "avoidance claims." See id., Ex. A § 1 (defining "Avoidance Claim" as "Any claim of either the Borrower or the Parent to avoid a transfer by either of the Borrower or the Parent under the Bankruptcy Code, including, without limitation, any claim for avoidance arising under sections 542, 544, 546, 547, 548, 549, 550, 551 or 553 of the Bankruptcy Code or otherwise").
An attorney for the debtor represented to the bankruptcy court that the 3 avoidance claims were worth between $2.6 million and $4 million. See Appellee App., Ex. 7 at 23-24 (transcript of December 8, 1999, hearing on appellant's Motion to Determine Rights Under the Postpetition Financing Orders to Proceeds from Avoidance Actions). The exact value of the avoidance claims does not affect the amount of the pre-petition senior lenders' replacement lien. However, if the avoidance claims are the only post-petition asset of significant value and are worth something less than $5 million, the bankruptcy court's finding that the replacement lien was worth at least $30 million effectively nullifies any interest the unsecured creditors might have had in the post-petition assets.
In an effort to enforce the terms of the Final Financing Order, the Official Committee filed a motion on November 3, 1999, to determine the parties' rights to the (as yet uncollected) proceeds from the avoidance claims. The bankruptcy court held a hearing on the motion on December 8, 1999. The dispositive issue at the hearing was whether the pre-petition senior lenders' original collateral had increased or decreased in value between March 22, 1999, and August 25, 1999. If the pre-petition senior lenders' original collateral had increased in value, the replacement lien would not reach the proceeds from the avoidance claims (or any post-petition assets). If the original collateral had declined in value, however, the pre-petition senior lenders would have a priority claim to those proceeds to the extent of the decline in value.
At the hearing, Judge Metz stated his oral findings on the record. The court found that there was "a diminution of value with respect to the assets or the collateral of this company that exceeded the 30 million dollar [debtor-in-possession] financing that was put in by the senior lenders, and therefore any recoveries that exist with respect to the avoidance actions, et cetera, would go to the senior lenders to help satisfy the amounts that they expended in the [debtor-in-possession] financing." Tr. 127-28. In a later written order issued on March 14, 2000, the bankruptcy court ruled:
H. Between the Petition Date and the Sale Date, as a proximate result of the utilization of Cash Collateral and the granting of the Senior Liens there was a diminution in the value of the collateral of the Prepetition Senior Lenders in an amount exceeding $30,000,000.
I. The Creditors' Committee failed to adduce admissible or probative evidence in support of the essential factual assertions contained in the Motion, including such evidence establishing an increase in the value of the Collateral from the Petition Date through the Sale Date.
IT IS THEREFORE ORDERED, ADJUDGED AND DECREED THAT:
1. The Motion hereby is denied in all respects.
2. The aggregate diminution in the value of the Collateral of the Prepetition Senior Lenders from the Petition Date through the Sale Date as the result of the use of Cash Collateral and the granting of senior security interests and liens in the Collateral exceeds $30,000,000 and the Replacement Lien . . . has attached to the assets of the Debtors comprising the Collateral, including the Avoidance Recovery Property, other than those assets transferred pursuant to the Sale Order.
3. As a result, the extent of the Replacement Lien granted to the Prepetition Senior Lenders pursuant to the Final Financing Order in all Collateral, including the Avoidance Recovery Property, be and hereby is fixed in an amount of not less than $30,000,000.
Discussion I. Appellee's Evidence Argument Before the Bankruptcy Court
At the December 8, 1999, hearing on the Official Committee's motion to determine the parties' rights to the proceeds of the avoidance actions, the pre-petition senior lenders relied primarily on two sets of numbers to show a decrease in the value of their collateral between March 22, 1999 (the petition date), and August 25, 1999 (the sale date). First, they relied on the difference between (1) the value of the secured portion of their claims as stated in schedules the debtors filed with their bankruptcy petition, which was $225 million; and (2) the amount of the pre-petition senior lenders' successful credit bid for the assets, which was $180 million — $30 million of which went to satisfy the post-petition super-priority liens. See Tr. 39-41, 47-49, 58-59; see also Appellee App., Ex. 2 at Schedule D (showing the total amount and unsecured portion of the pre-petition senior lenders' claims as of March 1, 1999); Appellee App., Ex. 6 ¶ H (Sale Order of August 13, 1999, stating that the credit bid of $180 million "represents the highest or otherwise best offer for the Assets").Second, the pre-petition senior lenders presented testimony from Frederick Slamin, Qualitech's chief financial officer during the bankruptcy period. Slamin testified that from March 22 to August 25, the book value of Qualitech's assets decreased, and that, during the same period, the company incurred $30 million in additional liabilities due to the post-petition super-priority financing. See Tr. 60-73; Appellee App., Ex. 10 (balance sheets prepared by Qualitech's financial department and admitted into evidence during the December 8, 1999, hearing).
Using the first set of numbers, the pre-petition senior lenders argued that the value of their collateral decreased in value by $45 million dollars ($225 million minus $180 million) even before repayment of the $30 million post-petition loans. Using the balance sheets presented through Slamin, the pre-petition senior lenders argued that the value of the collateral decreased by $43 million (totaling the decrease in the book value of the assets plus the effect of the $30 million dollars it would take to repay the post-petition super-priority loans). See Tr. 73. Under either scenario, the value of the pre-petition senior lenders' original collateral decreased in an aggregate amount of over $30 million dollars. Judge Metz referred to both sets of numbers when stating his findings orally. See Tr. 125-28.
II. Appellant's Arguments
A. Criticism of the Figures Relied Upon by Appellee
The unsecured creditors' Official Committee contends that the pre-petition senior lenders presented no evidence that the market value of their collateral diminished in value. In support of this position, the Official Committee criticizes both sets of figures that the senior lenders and the bankruptcy court relied upon to support the finding of at least a $30 million diminution in value.
As to the $45 million difference between the debtors' $225 million estimate of the secured portion of the pre-petition senior lenders' claims and the successful $180 million credit bid for the debtors' assets, the Official Committee first contends that the value of the successful credit bid was actually $227 million. The Committee derives its valuation of the credit bid from a statement made during the auction by the representative of the pre-petition senior lenders:
I would like to clarify, if I could, that the credit bid of the banks is $180 million in gross terms and subject to the reservations previously stated and that the banks have determined that the value of [a competing bid] is less than $180 million, but in the event that it is determined and only in the event that it is determined that the value [of that competing bid] exceeds $180 million, the banks will clarify their credit bid to be at a number of $227 million. So for purposes of the [competing] bid only and only in the event that a subsequent determination is that the value exceeds 180, the credit bid is $227 million.
Appellant Desig. Ex. 15 at 32-33 (transcript of auction held on June 30, 1999).
The Official Committee argued before the bankruptcy court that this expression of willingness on the part of the pre-petition senior lenders to pay $227 million (in credit, not cash) if they had to was the best indicator of the true market value of the assets. The bankruptcy court disagreed and found that it had already resolved the issue of the proper value of the credit bid as part of the August 13, 1999, Sale Order. As mentioned above, the Sale Order expressly states that the successful credit bid was in the amount of $180 million, and that the credit bid represented the "highest or otherwise best offer" for the debtors' assets. The bankruptcy court adhered to this earlier finding, reaffirming that the market value of the debtors' assets at the time of the sale was $180 million. Tr. 126. Appellant has not shown this court any factual basis for treating the bankruptcy court's finding as clearly erroneous.
In its reply brief, the Official Committee also contests the probative value of the debtors' bankruptcy schedules as evidence of the value of the pre-petition senior lenders' collateral as of March 22, 1999. The Official Committee argues that the schedules are merely "boilerplate documents filed by every debtor in every bankruptcy case and are not persuasive evidence of valuation." Appellant Reply Br. at 9, citing In re Cobb, 56 B.R. 440, 442 (Bankr.N.D.Ill. 1985) (denying summary judgment on creditor's motion to lift automatic stay; treating statements of value in the schedules prepared by the individual debtors as evidentiary admissions and giving them "little weight").
Regardless of the weight that debtors' schedules might ordinarily deserve in a dispute like this one, in this case it was the Official Committee who, at the December 8, 1999, hearing, first relied on the schedules as evidence of the petition-date value of the pre-petition senior lenders' collateral:
In order to determine the value of the assets as of the petition date we turned first to the debtor's schedules, filed under penalty of perjury and after due examination of assets and things, and added up the value that the debtor had assigned to the collateral securing the senior lenders' claim. It adds up with a one-dollar error, which I assume — a one dollar excess which I assume to be for rounding — to 225 million dollars. That was the date that the — that was the value that the debtor ascribed to the collateral securing the senior lenders' claim as of the petition date. That's where we stand.
Tr. 39-40 (statement of Official Committee's attorney); see also id. at 41, 48-50.
It is clear from the remainder of the transcript that the unsecured creditors' Official Committee would have preferred to have had access to other valuations of the collateral. (The court discusses below the Official Committee's motion to compel discovery of the pre-petition senior lenders' valuation of their own collateral.) That point does not change the fact that the Official Committee itself introduced the $225 million figure from the debtor's schedules as a valuation of the collateral as of the petition date. See Tr. 57 (counsel for the Official Committee conceding that if the bankruptcy court denied the motion to compel, the bankruptcy court was free to make a decision based solely on the evidence offered in the hearing). The Official Committee cannot show that the bankruptcy court erred by relying on this evidence that the Official Committee itself introduced.
As for Slamin's balance sheet valuation, the Official Committee contends that because the balance sheets were prepared using "book values," they provide no indication of the market value of the assets. Slamin conceded that the balance sheets did not reflect the market value of the assets. Tr. 84-85. He also stated that he could not offer an opinion on the market value of the assets. Tr. 87. There is, however, a difference between direct and circumstantial evidence, and the balance sheet figures certainly provide circumstantial evidence of a decrease in the market value of the pre-petition senior lenders' collateral. For example, the balance sheets show that inventory was being consumed rather than being built up during the relevant period. That evidence supports the pre-petition senior lenders' argument that the post-petition loans were funding further operating losses. Thus, at least in the absence of any substantial evidence weighing in the opposite direction, the bankruptcy court did not err by relying on the balance sheet valuations as probative evidence of the change in market value of the senior lenders' collateral.
B. The Burden of Proof
The unsecured creditors' Official Committee also contends that the appellee had the burden to prove by a preponderance of the evidence both the extent of its lien and the value of the collateral securing its claim. See Appellant Br. at 7, citing 11 U.S.C. § 506(a); In re Fassinger, 246 B.R. 513, 520 (Bankr. W.D. Pa. 2000). The Official Committee argues that the bankruptcy court reversed this burden by holding that the "Committee failed to adduce admissible or probative evidence in support of the essential factual assertions contained in the Motion, including such evidence establishing an increase in the value of the Collateral from the Petition Date through the Sale Date." Appellee App., Ex. 9 ¶ I (Mar. 14, 2000, Order Determining the Extent of the Prepetition Senior Lenders' Replacement Lien).
This court does not read the bankruptcy court's order as having assigned the ultimate burden of proof to the Official Committee. Instead, the bankruptcy court's order — especially when read in light of the transcript from the December 8, 1999, hearing — indicates that the bankruptcy court found some credible evidence of at least a $30 million diminution in value of the pre-petition senior lenders' original collateral, and no evidence of an increase in the market value of that same collateral. See Tr. 125-28 (emphasizing the limited extent of the evidence presented and indicating that the burden of proof did not affect final result). Under these circumstances, the pre-petition senior lenders were entitled to prevail no matter which side bore the ultimate burden of proof. Even if the bankruptcy court had improperly assigned the burden of proof to the Official Committee, and this court does not believe it did, any such error would have been harmless. Cf., e.g., Wilk v. American Medical Ass'n, 895 F.2d 352, 366-67 (7th Cir. 1990) (holding that even though the district court wrongly placed the burden of persuasion on the defendant in deciding whether injunctive relief was appropriate, "the district court's ultimate findings leave no doubt that injunctive relief was appropriate").
In essence, it appears that the unsecured creditors tried to finesse the underlying issue by trying to put the burden of proof on the secured creditors and then attacking the probative value of the evidence the secured creditors presented, without presenting contrary evidence themselves. The secured creditors presented some probative evidence. Though that evidence did not necessarily have overwhelming persuasive force, the bankruptcy court was entitled to rely on that evidence, especially in the absence of contrary evidence. The evidence is sufficient to support the bankruptcy court's conclusion that the value of the pre-petition senior lenders' collateral decreased by an amount at least equal to the $30 million super-priority lien.
C. The Bankruptcy Court's Ruling on the Committee's Motion to Compel
The unsecured creditors' Official Committee argues for the first time in its reply brief that the bankruptcy court's decision should be reversed because the bankruptcy court "abused its discretion" in denying the Official Committee's motion to compel production of documents related to appellee's valuation of its own collateral. See Appellant Reply Br. at 8. The motion to compel was brought to the bankruptcy court's attention for the first time on the day of the December 8, 1999, hearing. At the hearing, the bankruptcy court denied the motion to compel as "moot," finding that it was filed too "late in the game." Tr. 93-94. In fact, the motion to compel had been served on opposing counsel only the day before the hearing on the underlying motion, Tr. 5, and counsel for the Official Committee later agreed that the bankruptcy court could properly rule based only on the evidence the Official Committee presented at the hearing, Tr. 57.
After a discussion of the Official Committee's desire to have additional information from the secured creditors, the bankruptcy court asked counsel for the Official Committee: "Okay. So then you can — then I am free to make my decision based on what you're offering me today." Counsel answered yes. Tr. 57.
Even if there were room to argue seriously that the bankruptcy court abused its discretion by denying a motion to compel served only the day before the hearing on the central motion, an appellant may not raise such an argument for the first time in its reply brief. See, e.g., Ippolito v. WNS, Inc., 864 F.2d 440, 455 n. 12 (7th Cir. 1988) ("Arguments that are raised for the first time in a reply brief are waived."). The appellant's failure to properly raise the argument forfeited the argument.
D. Appellant's Contention that Judicial Estoppel Bars Appellee from Arguing a Diminution in the Value of the Collateral
The Official Committee argues, primarily in its reply brief, that the pre-petition senior lenders are judicially estopped from arguing a diminution in the value of the collateral because the debtor and the pre-petition senior lenders induced the bankruptcy court to approve the $30 million dollars in post-petition financing by claiming that the financing would help maintain or increase the value of the collateral. This argument is baseless. The pre-petition lenders did not assert that their recommendation that the debtors take on post-petition financing was anything other than a product of business judgment in the face of uncertainty. They did not promise or guarantee that there would never be a need for a replacement lien. The Official Committee's judicial estoppel theory has no merit.
Even if the market value of the pre-petition senior lenders' collateral 5 simply remained constant between the petition date and the sale date, there would have been a $30 million diminution in value as a result of the need to pay off the super-priority lien of the post-petition lenders. This possible scenario was made clear to the bankruptcy court prior to approval of the Final Financing Order: "We made clear, as I've said at other hearings, that the replacement liens in a situation where no new value is being created through the use of the funding, will be limited to the diminution in value which we believe to be dollar for dollar. . . ." Appellant Desig. Ex. 11 at 17 (transcript of May 13, 1999, hearing on the Final Financing Order; statement of senior lenders' attorney) (emphasis added). See also id. at 11 ("As we discussed many times, virtually no post-petition cash collateral or new collateral is being generated. So what we would be doing with this initial step in the financing process would be to convert that cash collateral usage into lending under this maintenance budget.").
Accordingly, the judgment of the bankruptcy court determining the extent of the pre-petition senior lenders' replacement lien pursuant to the Final Financing Order is affirmed. The court will enter final judgment to that effect.
So ordered.