In re Musicland Holding Corp.

Decision Date22 May 2008
Docket NumberNo. 07 Civ. 8423.,07 Civ. 8423.
PartiesIn re MUSICLAND HOLDING CORP., et al., Debtors. Buena Vista Home Entertainment, Inc., a California corporation; Cargill Financial Services International, Inc., a Delaware corporation; Hain Capital Group, LLC, a Delaware limited liability company; Paramount Pictures Corporation, a Delaware corporation; Twentieth Century Fox Home Entertainment LLC, a Delaware limited liability company; UBS Willow Fund, LLC, a Delaware limited liability company; and Varde Investment Partners, L.P., a Delaware limited partnership, Appellants, v. Wachovia Bank, N.A., a national banking association, in its capacity as Agent; and Harris N.A., a national banking association, Appellees.
CourtU.S. District Court — Southern District of New York

Pachulski Stang Ziehl & Jones LLP, by: Robert J. Feinstein, Esq., New York, NY, for Appellants.

Otterbourg, Steindler, Houston & Rosen, P.C., by: Richard G. Haddad, Esq., New York, NY, for Appellee.

OPINION

SWEET, District Judge.

The Appellants, trade creditors of Musicland, have appealed from the August 24, 2007 Memorandum Decision and Order Granting Motion to Dismiss Complaint (the "Memorandum Order") of Chief Judge Stuart Bernstein of the Bankruptcy Court for the Southern District of New York ("Bankruptcy Court") dismissing their complaint in the above-captioned adversary proceeding (the "Complaint") pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure. This Court has jurisdiction pursuant to 28 U.S.C. § 158(a)(1).

The Complaint asserted seven causes of action, including a breach of contract claim arising out of an agreement (the "Intercreditor Agreement") between senior and junior secured creditors of the bankrupt debtor, Musicland Holding Corp. (together with its affiliates, "Musicland"). The Appellants, as junior creditors, alleged in their Complaint that Appellee Wachovia Bank, N.A. ("Wachovia"), as agent for the senior creditors, improperly amended the Intercreditor Agreement to include a term loan to Musicland by Appellee Harris N.A. ("Harris").

Upon the record presented and the conclusions set forth below, the Memorandum Order is affirmed.

Prior Proceedings

On January 25, 2007, Appellants filed a complaint (the "Original Complaint") in the United States District Court for the Southern District of New York (the "District Court") alleging the same claims as in this action. After Wachovia moved to dismiss the Original Complaint, the Appellants voluntarily dismissed the action and re-filed their claims as an adversary proceeding in the Bankruptcy Court, alleging federal question jurisdiction. The Complaint, filed in the Bankruptcy Court on May 15, 2007, asserts multiple claims for relief against Wachovia.

On June 15, 2007, Wachovia and Harris filed motions to dismiss the Complaint for failure to state a cause of action under Federal Rule of Civil Procedure 12(b)(6). The motions were heard on August 9, 2007, and on August 24, 2007, the Memorandum Order was issued. Final Judgment was entered against the Appellants on August 27, 2007.

This appeal from the Memorandum Order was heard on January 16, 2008.

The Complaint

Pursuant to a loan and security agreement dated August 11, 2003 (the "Revolving Credit Agreement"), Fleet Retail Finance, Inc. and Congress Financial Corporation (Wachovia's predecessor-in-interest) as the agent, for the Revolver Lenders, agreed to provide Musicland with revolving credit of, at that point, up to $200 million (the "Revolving Credit Facility"). The obligations thereunder were secured by a first priority lien in substantially all of Musicland's assets, including inventory and proceeds (the "Revolver Lien"). Compl. ¶ 23, Ex. A.

The Revolving Credit Agreement provided exclusively for revolving credit. It defines the "Credit Facility" as, in relevant part, the "Loans," and "Loans" are, in turn, defined as "the loans now or hereafter made by or on behalf of Lenders or by Agent for the account of Lenders on a revolving basis pursuant to the Credit Facility ...." Compl. Ex. A §§ 1.29, 1.70. The Revolver Lien secured the "Obligations," id. § 5.1, which are defined as "[a]ny and all Loans, Letters of Credit accommodations and all other obligations, liabilities and indebtedness of every kind, nature and description ... arising under this Agreement or any of the other Financing Agreements ....," id. § 1.80.

In 2003, Musicland was experiencing substantial financial difficulties. To induce Appellants to continue to supply music CDs, DVDs and similar inventory, Musicland granted them a lien on inventory and proceeds thereof (the "Inventory Lien"), pursuant to a security agreement dated November 5, 2003 (the "Security Agreement"). The Bank of New York acted as Appellants' collateral agent. Compl. ¶ 25, Ex. B.

Pursuant to the Security Agreement, the Inventory Lien was "subject only to the terms of that certain Intercreditor and Subordination Agreement, dated as of November 5, 2003 ...." Compl. Ex. B § 2. The Inventory Lien was junior only to "Permitted Encumbrances," id. § 4(b), which include only "the security interests and hens of Congress for itself and the benefit of the Lenders pursuant to the Congress Facility" and certain other limited, inapplicable liens, id. § l(i).

Concurrently with the Security Agreement, Wachovia, as agent for the Revolver Lenders, and Bank of New York, as Appellants' collateral agent, entered into the Intercreditor Agreement. Compl. ¶ 28, Ex. C.

The definitions of the Intercreditor Agreement provide for the subordination of the Inventory Lien solely to the loans made under the Revolving Credit Agreement. Section 2.2 of the Intercreditor Agreement states that the Inventory Lien is subordinated only to the "Liens of the Revolving Loan Creditors therein to the full extent of the Revolving Loan Debt." Compl. Ex. C. § 2.2. "Revolving Loan Creditors" are defined as parties to the Revolving Credit Agreement, id. § 1.15. "Revolving Loan Debt" is defined as "any and all obligations ... arising under the Revolving Creditor Agreements ...." Compl. Ex. C § 1.16.

"Revolving Creditor Agreements" are defined as the original revolving loan documents, as they "now exist or may hereafter be amended, modified, supplemented, extended, renewed, restated, refinanced, replaced or restructured (in whole or in part and including any agreements with, to or in favor of any other lender or group of lenders (which lenders or group of lenders shall not be affiliates of Debtors, except that Trade Agent and Trade Creditors shall have no objection to any Permitted Affiliate Refinancing) that at any time refinances, replaces or succeeds to all or any portion of the Revolving Loan Debt or is otherwise a party to the Revolving Creditor Agreements)." Id. § 1.11. Under Section 1.9, a "Permitted Affiliate Refinancing" is one in which an affiliate, inter alia, "makes Revolving Loan Debt available to the Debtors ... provided, that, (a) such affiliate does not own or hold more than twenty-five (25%) percent of the Revolving Loan Debt subject to such Refinancing. ..."Compl. ¶ 31, Ex. C§ 1.9.

"Lenders," as defined in the Revolving Credit Agreement, comprised (a) the original Revolver Lenders, and (b) lenders that acquired a participation interest in the Credit Facility from an original Lender. Compl. Ex. A §§ 1.66,13.6.

Finally, the Intercreditor Agreement provides, in relevant part, under the heading "Waivers":

The Trade Creditors also waive notice of, and hereby consent to, (a) any amendment, modification, supplement, extension, renewal, or restatement of any of the Revolving Loan Debt or the Revolving Creditor Agreements, including, without limitation, extensions of time of payment of or increase or decrease in the amount of the Revolving Loan Debt, the interest rate, fees, other charges, or any collateral, (b) the taking, exchange, surrender and releasing of Trade Collateral or guarantees now or at any time held by or available to Revolving Loan Agent or any of the Revolving Loan Creditors for the Revolving Loan Debt.... Any of the foregoing shall not, in any manner, affect the terms hereof or impair the obligations of Trade Creditors hereunder.

Id. § 4.3.

In the fall of 2005, Musicland asked the Revolver Lenders to increase availability under the Revolving Credit Facility, but they refused. Musicland's parent, Sun, also refused to provide additional capital on a subordinated debt or equity basis. Compl. ¶ 32.

Harris had a banking relationship with Sun. At Sun's request, Harris agreed to make a $25 million term loan to Musicland (the "Harris Term Loan"), on materially different terms from those of the existing credit facility: (i) it was a term loan, not revolving credit; (ii) Sun guaranteed repayment to Harris (but not to the Revolver Lenders); and (iii) it was short-term financing designed to meet Musicland's liquidity needs during the peak shopping season and would be repaid shortly, regardless of its stated maturity date, whether or not other Revolver Lenders were paid. Compl. ¶ 33.

The Security Agreement prohibited Musicland from granting any lien encumbering Appellants' collateral, other than the Revolver Lien. Compl. ¶ 34. Wachovia and Harris devised Amendment No. 8, dated August 31, 2005, to the Revolving Credit Agreement, to incorporate the Harris Term Loan into the Revolving Credit Facility for the purpose of affording it a senior lien, superior to Appellants' Inventory Lien. Compl. 1135, Ex, D.

The definition of "Obligations" in the Revolving Credit Agreement, which effectively limited the scope of the security interest to revolving loans, was amended so that "[a]ll references to the term `Obligations' herein and in the Loan Agreement and the other Financing Agreements shall be deemed ... to include ... indebtedness of Borrowers in respect of the Term Loan." Compl. ¶ 36, Ex. D. § 1(b)(ix). Whereas before there had been only "Lenders" and all...

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