In re Nutritional Sourcing Corp., 07-11038 (PJW).

• Decision Date: 23 December 2008
• Docket Number: No. 07-11038 (PJW).,07-11038 (PJW).
• Citation: 398 B.R. 816
• Parties: In re NUTRITIONAL SOURCING CORPORATION, et al., Debtors.
• Court: U.S. Bankruptcy Court — District of Delaware

398 B.R. 816

In re NUTRITIONAL SOURCING CORPORATION, et al., Debtors.

No. 07-11038 (PJW).

United States Bankruptcy Court, D. Delaware.

December 23, 2008.

COPYRIGHT MATERIAL OMITTED

Michael B. Solow, Harold D. Israel, Matthew J. Micheli, Kaye Scholer LLC, Chicago, IL, David B. Stratton, David Fournier, James C. Carignan, Pepper Hamilton LLP, Wilmington, DE, for Nutritional Sourcing Corporation, Pueblo International, LLC and FLBN, LLC.

Felicia Gerber Perlman, Skadden, Arps, Slate, Meagher & Flom LLP, Chicago, IL, Mark S. Chehi, Kimberly A. LaMaina, Skadden, Arps, Slate, Meagher & Flom LLP, Wilmington, DE, for Official Committee of Unsecured Creditors.

Joseph H. Huston, Jr. Stevens & Lee, P.C., Wilmington, DE, Steven E. Lewis, Dunnington, Bartholow & Miller LLP, Chester B. Salomon, Stevens & Lee, P.C., New York, N.Y., for Badillo Nazca S & S, Inc. as successor in interest to Badillo Nazca S & S Co.

Donna L. Harris, Pinckney, Harris & Weidinger, LLC, Wilmington, DE, for Liquidity Solutions, Inc.

Adam G. Landis, Kerri K. Mumford, J. Landon Ellis, Landis Rath & Cobb LLP, Wilmington, DE, for ASM Capital LP & ASM Capital III LP.

Marla R. Eskin, Kenneth Dorsney, Campbell & Levine, LLC, Wilmington DE, Jon C. Vigano, Patricia J. Fokuo, Schiff Hardin LLP, Chicago, IL, for El Dia, Inc. and El Nuevo Dia, Inc.

Mark Minuti, Jeremy W. Ryan, Saul Ewing LLP, Wilmington, DE, for Puerto Rico Electric Power Authority.

Jami B. Nimeroff, Brown Stone Nimeroff LLC, Wilmington, DE, Barbra R. Parlin, Arthur E. Rosenberg, Peter A. Zisser, Holland & Knight LLP, New York, N.Y., for Rio Grande Investment, LLC and Plaza San Francisco Investment, LLC.

Eric Lopez Schnabel, Robert W. Mallard, Dorsey & Whitney (Delaware) LLP, Wilmington, DE, for Empresas de Gas Co., Inc.

MEMORANDUM OPINION

Peter J. WALSH, Bankruptcy Judge.

To: Counsel listed in the attached on Exhibit A

This opinion is with respect to Debtors', Nutritional Sourcing Corporation ("NSC"), Pueblo International, LLC ("Pueblo") and FLBN, LLC ("FLBN"), Joint Chapter 11 Plan of Liquidation filed on September 4, 2008 (the "Plan"). (Doc. # 1528.) A number of parties have filed objections to the Plan, including objections to the confirmation of the Plan. See, e.g., Doc. # 1629. At the confirmation hearing on October 14, 2008, Debtors and the Official Committee of Unsecured Creditors (the "Committee" and together with Debtors, the "Plan Proponents") presented evidence in support of confirmation of the Plan. The objectors also presented evidence and cross examined the Plan Proponents' witnesses. (Doc. # 1675, 1678.) For the reasons stated below, the Court will deny confirmation of the Plan.

BACKGROUND

NSC and its subsidiaries, Pueblo and FLBN, operated a chain of supermarkets in Puerto Rico and the U.S. Virgin Islands. Debtors also operated a chain of in-home movie and game entertainment outlets in Puerto Rico and the U.S. Virgin Islands through franchise rights with Blockbuster, Inc. (Doc. # 1499, p. 5.) On August 3, 2007, Debtors filed a voluntary petition for relief under chapter 11 of title 11 of the Bankruptcy Code, 11 U.S.C. §§ 101 et seq.

This is not the first bankruptcy proceeding for NSC; it filed for chapter 11 bankruptcy in 2002 and emerged from chapter 11 on June 5, 2003. (Case #02-12550(PJW).) Pueblo and FLBN were not debtors in the 2002 bankruptcy case. However, NSC's reorganization in that bankruptcy case impacted all Debtors and many of their creditors in the instant bankruptcy proceeding. An integral part of NSC's 2003 reorganization was the issuance by NSC of Senior Secured Notes dated June 5, 2003. These Senior Secured Notes were issued in exchange for certain other Senior Secured Notes due August 1, 2003 (the "Old Senior Notes"). (Doc. # 1499, pp. 7-8.) According to the declaration of William T. Keon, III—the CEO and President of each of the Debtors until his recent death—which was filed in support of Debtors' request for approval of the Plan, the holders of the Old Senior Notes requested that the Senior Secured Notes be supported by guarantees secured by a pledge of all of NSC's subsidiaries. NSC resisted this request and instead the Restated Subordinated Intercompany Real Estate Note dated June 5, 2003 was executed by Pueblo in favor of NSC (the "Mirror Loan Note"). (Doc. # 1676, ¶ 24-26.) In brief, because NSC, as a holding company, does not have assets of its own to make payments on the Senior Secured Notes, the Mirror Loan Note provides for a transfer of funds from Pueblo to NSC and is secured by certain of Pueblo's real estate. (Doc. # 1715, p. 12.)

As noted by Keon in his declaration, in order to assure Pueblo's trade creditors that they would be paid ahead of NSC's creditors, a subordination provision was added to the Mirror Loan Note. (Doc. # 1676, ¶ 27.) In particular, the Mirror Loan Note provides that payment is "subordinate to all claims of any trade creditors of [Pueblo]." (Doc. # 1676, ex. A, p. 2 (emphasis added)). Thus, by its terms, the Mirror Loan Note cannot be paid until all claims of any trade creditor of Pueblo are paid in full.

The Mirror Loan Note does not include a definition of "trade creditor," nor does the Senior Note Indenture executed in connection with the Senior Secured Notes and the Mirror Loan Note. The instant objections to the Plan stem from this lack of definition of trade creditor in the Mirror Loan Note and its subsequent defining in the Plan. The Mirror Loan Note is governed by New York law. (Id. at ex. A, p. 8.)

NSC's public filings with the Securities and Exchange Commission ("SEC") demonstrate that the term "trade creditor" continued to remain undefined in relation to the Mirror Loan Note following the execution of the Mirror Loan Note. Specifically, (1) NSC's Annual Report (Form 10-K) for the year ended November 2, 2002, (2) NSC's Form 10-K for the year ended November 1, 2003, (3) NSC's Form 10-K for the year ended October 30, 2004, and (4) NCS's Form 10-K for the year ended October 29, 2005 include references to the Mirror Loan Note and/or discuss the subordination provision therein. Each of NCS's 10-Ks contain language similar to the following regarding the Mirror Loan Note: "The inter-company notes[, including the Mirror Loan Note,] are subordinated to the obligations of the subsidiaries under the May 2003 Bank Agreement and to the trade creditors of Pueblo." Nutritional Sourcing Corporation, Annual Report (Form 10-K), at Part I, Item 7, "Liquidity and Capital Resources" (Dec. 23, 2004) (emphasis added). Also, NSC's Form 10-K notes that "as NSC is a holding company, indebtedness at the NSC level is effectively subordinated to indebtedness and other obligations at the operating subsidiary level." Id. at Part I, Item 1: "The Company is Highly Leveraged."

Despite the lack of definition of the term "trade creditor" in the Mirror Loan Note, in his declaration, Keon explained that:

While defining the term "trade creditor" was not specifically discussed at the time of the issuance of the Senior Secured Notes, the primary concern was to ensure that providers of grocery and other merchandise for resale to Pueblo, including any related shipping costs, would be paid ahead of the claims of NSC's creditors. Without trade credit from providers of grocery and other merchandise for resale, Pueblo would have encountered significant operating difficulties. These providers were very concerned about how Pueblo was to operate and meet its obligations to them once NSC emerged from its prior chapter 11 case in 2003.

(Doc. # 1676, ¶ 28 (emphasis added)). In his testimony on October 14, 2008, Keon added that Debtors did not have as urgent concerns about "non-trade creditors"— creditors who did not provide grocery and other merchandise for resale to Pueblo— as the goods and services those creditors provided were not perceived to be as important to Debtors' continued business operations. (Doc. # 1700, 103:5-21; see also Doc. # 1715, p. 16.)

In addition to the Senior Secured Notes and the Mirror Loan Note, Debtors' prepetition capital structure included an Amended and Restated Loan and Security Agreement dated as of January 28, 2005 between NSC as guarantor, and Pueblo and FLBN as borrowers, with Westernbank Puerto Rico (the "Loan and Security Agreement"); it is secured by first priority liens on substantially all of Debtors' assets. (Doc. # 1499, p. 6.) Debtors' obligations as of the current bankruptcy filing's petition date were approximately $95 million under the Loan and Security Agreement, approximately $37 million under the Senior Secured Notes, and approximately $37 million under the Mirror Loan Note. (Id. at pp. 7-8.) The Loan and Security Agreement $95 million obligation was paid in full following Debtors' sale of substantially all of their going concern assets.

Shortly after filing their bankruptcy petition, on October 5, 2007, Debtors filed their schedules of assets and liabilities. On Pueblo's Schedule F, Debtors listed all of Pueblo's general unsecured nonpriority claims, specifically identifying Pueblo's "trade creditors" on Pueblo's Schedule F-5. (Doc. # 537, ex. F-5.) The Schedules did not specify what was necessary to be included as a "trade creditor." Several of the parties that have filed objections to the Plan are listed among Pueblo's creditors holding "trade" claims. Pueblo's Schedule F-5 has not been materially amended or modified since it was sworn to on October 4, 2007.¹

On July 31, 2008, the Plan Proponents filed the Plan, which was amended on September 2, 2008. At issue here, the Plan divides Pueblo's general unsecured creditors into two sub-classes: Class 4A: Pueblo Trade Claims ("Pueblo Trade Claims") and Class 4B: Pueblo General Unsecured Claims ("Pueblo General Unsecured Claims"). The Plan defines "Pueblo Trade Claim" as:

[T]he Allowed Claims of trade creditors who provided (i) grocery and other merchandise to Pueblo for ultimate sale by Pueblo or (ii) services that were directly related...