In re Enterprises, Inc., Case No. 08-11474 (MG) (Bankr. S.D.N.Y. 6/16/2008), Case No. 08-11474 (MG).

• Decision Date: 16 June 2008
• Docket Number: Case No. 08-11474 (MG).
• Parties: IN RE BARBARA K ENTERPRISES, INC., Chapter 11 Debtor.
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York

Page 1

IN RE BARBARA K ENTERPRISES, INC., Chapter 11 Debtor.

Case No. 08-11474 (MG).

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

June 16, 2008.

PLATZER, SWERGOLD, KARLIN, LEVINE, GOLDBERG & JASLOW, LLP, Attorneys for the Debtor, New York, NY, By: Sherri D. Lydell.

SILVERBERG, STONEHILL, GOLDSMITH & HABER, P.C., Attorneys for Level 10 Capital, LLC, By: Jay L. Silverberg Mitchell L. Kaplan.

OFFICE OF THE UNITED STATES TRUSTEE, REGION 2 New York, NY, By: Susan D. Golden Paul Schwartzberg.

MEMORANDUM OPINION AND ORDER DENYING MOTION TO APPROVE POST-PETITION FINANCING

MARTIN GLENN, Bankruptcy Judge.

Debtor Barbara K. Enterprises, Inc. seeks approval pursuant to 11 U.S.C. §§ 105(a) and 364(c)(1)-(c)(3) of a three-month interim debtor-in-possession ("DIP") financing agreement with BK Acquisition, LLC ("BKA") that would grant BKA liens and superpriority administrative expense status. Level 10 Capital, LLC ("Level 10"), one of Debtor's pre-petition secured creditors, objects to further interim and final approval of the DIP loan on various grounds, including that the proposed DIP facility would improperly prime its validly-asserted liens on certain post-petition assets of the estate. The proposed DIP loan would grant BKA senior liens on property of the estate acquired post-petition under 11 U.S.C. § 364(c)(2) and junior liens on pre-petition property of the estate under 11 U.S.C. § 364(c)(3), but Level 10 argues that BKA may only obtain senior liens on certain post-petition property of the estate under 11 U.S.C. § 364(d)(1), since Level 10 asserts liens on any royalties obtained by post-petition licenses of Debtor's pre-petition patents, trademarks and trade names. As Debtor states it is unable to obtain DIP financing without granting BKA these liens, both Debtor and Level 10 agree that a determination as to the scope and validity of Level 10's liens on post-petition assets is a "threshold" issue for ruling on the interim DIP loan request.

For the reasons explained below, the Court finds that Level 10 may validly assert liens on certain post-petition assets in accordance with 11 U.S.C. § 552(b)(1), and that Debtor's request for a three-month interim financing must be denied.

INTRODUCTION

Debtor first made its request for post-petition financing on May 5, 2008, approximately two weeks after the petition was filed. ECF Doc. # 7. The motion was initially a request for interim financing totaling $21,000 with a final request of $500,000 to be addressed at a final hearing on May 22, 2008. Level 10 appeared at the first hearing on May 9, 2008 and orally objected to the Debtor's request. The Court granted approval of the DIP facility on an interim basis on May 9, allowing Debtor to draw up to $21,000 prior to the final hearing. ECF Doc. # 19. Exhibit C to the original motion included a budget only covering the interim period. During this first interim period, Debtor actually drew $17,704.

On May 20, 2008, Level 10 filed a written objection to the DIP financing proposal. ECF Doc. # 24. On May 22, 2008, Debtor appeared at the hearing and requested, with Level 10's consent, that the matter move forward as a second interim request for financing as opposed to the originally-noticed final hearing. At the May 22 hearing, the Court approved the second interim request, but indicated that Debtor must provide a budget and further elaborate on plans for the business's reorganization in order to gain final approval of the $500,000 DIP facility. The second interim request was supported by a second interim budget through the week of June 2, allowing Debtor to draw down an additional $8,405. The final hearing was scheduled for June 4, 2008. However, prior to June 4 the parties requested that the final hearing be adjourned to June 13, 2008 to give Level 10 time to brief the issues raised by Debtor in reply papers filed on June 2, 2008. Level 10 filed its brief on June 11, 2008. ECF Doc. # 36.

When the motion was originally filed, Debtor stated it had no funds or any working capital whatsoever, and that without emergency funds, Debtor would be unable to make payroll or pay overhead and other necessary business expenses. In the latest interim proposal (made in Debtor's reply papers prior to the June 4, 2008 hearing, see ECF Doc. # 29, with a revised budget submitted on June 11, 2008, ECF Doc. # 35), Debtor seeks approval of a three-month loan (through the end of August), providing for payment of expenses (including wages, insurance, office rent and overhead, travel, and other items) totaling $77,001, as well as a $70,000 payment to Debtor's counsel in August. Debtor states that it is unable to obtain secured credit without granting BKA liens and superpriority administrative expense status.

The DIP facility originally proposed provided for a maximum of $500,000 at 12% interest per annum. The maturity date for all funds was to be the earlier of (i) one year, (ii) Debtor's confirmation of a plan, or (iii) conversion or dismissal of this chapter 11 case. Debtor states that two prepetition liens are asserted on estate assets. The first lien is held by Jonathan Segal and Level 10 Capital, LLC (each party holding a separate claim for $432,000), extending to substantially all of Debtor's assets. A second lien for $50,000 is held by BKDM Holdings, LLC, also extending to substantially all of Debtor's assets.¹ Under the draft order seeking approval of the DIP Facility, funds extended by BKA will have priority over any and all administrative expenses under 11 U.S.C. §§ 503(b) and 507(b), subject to a carve-out for fees paid to professionals retained by the Debtor and any appointed Committee, and subject to U.S. Trustee fees under 28 U.S.C. § 1930(a)(6). BKA will also obtain a lien on property of the estate acquired post-petition under 11 U.S.C. § 364(c)(2), and a junior lien on pre-petition property of the estate pursuant to 11 U.S.C. § 364(c)(3).

Level 10 objects to extending any further financing to Debtor's business. Level 10 asserts that it holds a 50% interest in the Second Amended and Restated Promissory Note with a face value of $864,424.30, and a corresponding Amended and Restated Security Agreement dated September 15, 2006. Based on the Amended and Restated Security Agreement (Objection, Exh. C), Level 10 asserts it has a security interest in all of the Debtor's inventory, equipment, contract rights, rights to payment, receivables, and general intangibles (including goodwill, trade names, and other intellectual property rights). After Debtor defaulted on the terms of the note in or around June 30, 2007, Level 10 commenced a replevin action against the Debtor to recover its collateral in New York County Supreme Court. Summary judgment in the case was granted in favor of Level 10 on April 4, 2008 (Exh. E). After the Supreme Court directed Level 10's counsel to settle a notice of proposed judgment, this chapter 11 case was filed on April 23, 2008.

Level 10's primary objection is that this bankruptcy case, and additional financing to fund the business through the bankruptcy case, cannot lead to a successful reorganization. Level 10 stated in its first objection (ECF Doc. # 24) that "[t]he Debtor's business has been a total failure from its inception," and that Debtor's counsel has admitted that Debtor presently has no product sourcing, no customer orders and no inventory to speak of. Level 10 also argues that Debtor cannot account for the destruction of over $15 million in shareholder value over the last six years, money which Level 10 says Debtor has raised through approximately 80 separate shareholders and numerous offerings. Moreover, Level 10 asserts Debtor has failed to file financial statements and corporate tax returns for the past 15 months, and that Debtor's books and records from 2006 and 2008 are incomplete and contain significant gaps, making it impossible for Level 10 or other creditors to ascertain where this money went. The objection also asserts that there are no supporting ledgers, trial balances, sales journals, cash disbursement and receipt journals, or any inventory of equipment or patents and trademarks supporting Quickbooks entries.² From August 2007 through April 2008, Level 10 states that Debtor failed to post a general ledger or to keep any books and records whatsoever. Questions are also raised in the objection regarding allegations by Test-Rite International Co., Ltd. ("Test-Rite") that Debtor diverted funds in violation of a manufacturing and services agreement; use of entities named "BKI Publishing" or "BKI Publishing, LLC" to conduct certain business for Debtor; and Ms. Kavovit's use of her own personal credit card for business expenses. Under the circumstances, Level 10 states that it would be inappropriate to approve any further funding for the Debtor's business. Level 10 further objects to granting BKA a first priority lien on all "post-petition assets" to the extent this would prime their existing rights under the Amended and Restated Security Agreement, and requests that any financing be limited to a defined budget and remain an interim facility until an evidentiary hearing can take place for a future lift-stay motion or motion to appoint a trustee to be filed by Level 10. Level 10 did agree to the second interim draw on the DIP while preserving its rights to object again at the final DIP hearing.

Debtor filed lengthy reply papers on June 2, 2008. ECF Doc. # 29. Debtor notes that BKA is unwilling to extend financing unless it is granted superpriority status, and as a result Debtor requests that the Court first decide the threshold issue whether Level 10 has a valid first priority lien on any future revenue generated through post-petition licensing agreements. Debtor concedes that Level 10's collateral includes proceeds from pre-petition accounts receivable and proceeds from the sale of pre-petition inventory but disputes that Level 10 has any valid lien on post-petition assets.³

Debtor proposed...