In re Best Products Co., Inc.

• Decision Date: 25 May 1994
• Docket Number: Bankruptcy No. 91 B 10048 (TLB).
• Citation: 168 BR 35
• Parties: In re BEST PRODUCTS CO., INC., et al., Debtors.
• Court: U.S. Bankruptcy Court — Southern District of New York

168 B.R. 35 (1994)

In re BEST PRODUCTS CO., INC., et al., Debtors.

Bankruptcy No. 91 B 10048 (TLB).

United States Bankruptcy Court, S.D. New York.

May 25, 1994.

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Weil, Gotshal & Manges by Harvey Miller, Kenneth Steinthal, Lori Fife, Kevin Barrett and Judith Siegel, Orans, Elsen & Lupert by Sheldon Elsen, Robert Plotz and Melissa Cohen, New York City, for debtors.

Simpson Thatcher & Bartlett by Melvin Cantor, Lillian Kraemer, Robert Bourque and Mary Beth Forshaw, New York City, for Bank Group.

Wachtell Lipton Rosen & Katz by Chaim Fortgang and Eric Roth, New York City, for Chemical Bank.

Kronish, Lieb, Weiner & Hellman by Richard Lieb, Robert Feinstein, Tara Hannon and Sara Krauss, New York City, for Resolution Trust Corp.

Milbank, Tweed, Hadley & McCloy by Stephen Blauner and Susanne Toes, New York City, for Rockefeller Group Capital Corp. and Royal Hawaiian Shopping Center.

Resolution Trust Corp., As Receiver, Complex Litigation Section by Joseph Guzinski and Joseph Patchan, Washington, DC.

Brown & Wood by James Yellen and Charles Klink, New York City, for First Fidelity Bank.

Stroock & Stroock & Lavan by Lawrence Handelsman and David Botter, New York City, for Creditors' Committee.

Latham & Watkins by Robert Rosenberg and James Brandt, New York City, for Metropolitan Life Ins. Co Kirkland & Ellis by James Gale, New York City, for Adler & Shaykin.

Seward & Kissel by Catherine Kortlandt, New York City, for Mut. Life of New York.

McGuire, Kehl & Nealon by Arthur Nealon, New York City, for Kellner DiLeo and Alpine Associates.

Whitman Breed Abbott & Morgan by Norman Kinel, New York City, for Principal Mut. Life Ins. Co.

OPINION ON CONFIRMATION OF DEBTORS' JOINT PLAN OF REORGANIZATION AND APPROVAL OF RELATED COMPROMISES AND SETTLEMENTS

TINA L. BROZMAN, Bankruptcy Judge.

Best Products, Inc. and its affiliates (whom I will refer to together as "Best"), seek to confirm a joint plan of reorganization which has garnered the overwhelming support of all its creditor classes except for those ("Objectants") which hold claims that are contractually subordinated to the claims of Best's lenders. Best's chapter 11 petition was filed in the wake of a failed leveraged buyout ("LBO") which was commenced in late 1988 and consummated in early 1989. Best's plan embodies, among other things, settlements of adversary proceedings which it brought in December, 1992, against various LBO constituencies seeking to unwind the LBO under state fraudulent conveyance doctrines imported into federal bankruptcy law (the "LBO Action") and seeking to recover certain preferences. The plan represents the product of extended negotiations among Best, the banks who participated in the LBO and hold its senior debt ("the Banks"), the creditors' committee (on which the subordinated creditors are represented), two of the three Objectants and purchasers of a substantial amount of trade claims. The Objectants oppose confirmation of the plan on various grounds, foremost of which is that the proposed settlement with the Banks, who are defendants in the LBO Action, is unreasonable and lacking in good faith. The Resolution Trust Corporation ("RTC")¹ also asserts that I am unable to confirm this plan until I resolve a pending adversary proceeding which it recently commenced against the Banks seeking to invalidate the subordination agreement which renders its claims junior to those of the Banks. Much like the RTC, certain subordinated creditors led by Rockefeller Group Capital Corporation (the "Rockefeller Group") contend that I must resolve their cross-claims in the LBO Action before I may consider confirmation of the plan.

I.

A. Background

Best is in the business of operating catalog showrooms in twenty-two states located primarily in the Mid-Atlantic states and portions of the Midwest, the Northwest and the Southwest. Debtors' Exh. 175 at 12-13. In addition, Best operates a nationwide mailorder service as well as a chain of jewelry and giftware stores in seven states. Best's targeted market niche is the discount sale of jewelry, housewares, electronics and other brand-name merchandise. With roughly 160 or so showrooms², Best ranks as one of the nation's largest catalog showroom retailers.

Notwithstanding its current prominence, Best started out in 1956 in Richmond, Virginia, as a family-run, mail-order company that sold merchandise utilizing a published catalog. The catalog showrooms evolved some years later from a decision to include merchandise displays in the mail-order offices. It is in the showroom segment of its business that Best has experienced explosive growth. As a point of reference, in 1969, when it first became a public company, Best operated five showrooms along with its mail-order business; from then on, Best grew its showroom base both by acquisition and internal expansion. In 1982, Best nearly doubled in size when it acquired the catalog showroom businesses of Basco, Inc. and Modern Merchandising, Inc. Debtors' Exh. 159 at 16. During the early 1980s, Best also expanded the scope of its operations by purchasing Ashby's, Ltd., a specialty women's shop, and by starting a specialty retail jewelry chain known as Best Jewelry.

Not surprisingly in the face of a phenomenal and uninterrupted growth spurt, Best experienced operational setbacks in the mid-1980s which forced the company to retrench. In 1985, Best began what ended up being a three-year restructuring program as part of which Best disposed of seventeen of its unprofitable showrooms as well as the business of Ashby's Ltd. Debtors' Exh. 224 at F-15. In addition, Best renovated nearly half of its existing showrooms. It also streamlined and improved its operations by centralizing many of its staff functions and upgrading its cash register/inventory management systems (often referred to as point of sale terminals). By the end of 1987, Best had slimmed down to 194 catalog showrooms in twenty-seven states and thirty-five jewelry stores in eight states and in the District of Columbia.

As is the hope after implementation of a restructuring program, Best's financial performance soared. For example, Best's income before interest, taxes and restructuring charges increased from $47.3 million in fiscal year ("FY") 1985 to $63.5 million in FY1986 to $100.8 million in FY1987. This performance was aided in large part by an increase in the company's gross margin over the same period from 24.59% in FY1985 to 25.63% in FY1986 and to 27.43% in FY1987. Debtors' Exh. 159 at 13.

B. The Company In Play

Outside investors took notice of the company's improved operating performance and started accumulating large blocks of Best's common stock.³ By February, 1988, two entities had filed schedules with the Securities and Exchange Commission indicating that each was the beneficial owner of over 7% of the common shares of Best. By August of that year, a third entity reported that it owned nearly 10% of Best's common stock. In response to the mounting interest in the company, Best's board of directors appointed a special committee, which retained financial advisors and legal counsel, to evaluate the company's options and recommend to the board the strategy which would best promote the interests of the company and its stockholders. Debtors' Exh. 9 at 6. At least five investment firms communicated to the special committee an interest in the company. In late September, the special committee rejected one proposal which offered to pay common stockholders $21 per share. RTC Exh. 28. When the dust settled, Adler & Shaykin ("A & S") was declared the highest bidder at a price of $27.50 per share, a sum well above the average of the other bids considered. Tr. at 664, 1007. The board subsequently approved the A & S offer. Debtors' Exh. 24.

In making the winning bid, A & S relied on a financial analysis entitled "Project Jewel." Debtors' Exh. 198. The record establishes that Project Jewel derived its numbers from a report which was originally prepared by Best's management as part of its five year strategic planning process. In other words, this report was not generated to support the sale of the company. Project Jewel assumed: annual sales growth of 3.5%; a 1.7% increase in gross margins (from 27.5% in fiscal year 1988 to 29.2% in fiscal year 1991 and each year thereafter); an improvement in Best's inventory turn ratio from 2.4 times to 2.5 times in 1990 and 3.1 times in 1991 (and each year thereafter); and a capital budget of $15 million for two years, $20 million for one year and, for each succeeding year, a sum which exceeded the prior year's budget by 4%. Debtors' Exh. 198.

With the benefit of hindsight, it is apparent that the projections underlying Project Jewel, which A & S considered its "base case," were overly optimistic.⁴ Indeed, Arthur Young (who was retained by A & S to conduct due diligence in connection with the LBO) memorialized some concerns as early as October 5, 1988 that the assumptions in the A & S base case represented "a favorable case and not the most probable case scenario."⁵ RTC Exh. 73; Tr. at 1380. On the other hand, the record made in support of the compromises and the plan establishes that senior management of Best believed the projections were reasonable at the time. Debtors' Exh. 188 at 35, 39⁶. The financial expert, Arthur Newman, retained by one of the Banks, also testified that the projections were reasonable in light of the operational improvements achieved from the restructuring.⁷ Tr. at 1551, 1564, 1567. The asserted deficiencies in A & S's due diligence serve as one foundation for the Objectants' argument that Best could easily prove the LBO constituted a fraudulent conveyance.⁸

C. The Tender Offer & Merger Financing.

After the Board approved its bid at the October 7th board meeting, A & S set into motion a two-part plan to complete the LBO. In the first phase of the transaction, A & S formed two new entities, ...