In re Sonicblue Incorporated, Cases No. 03-51775, 03-51776, 03-51777, and 03-51778-MM, Jointly administered (Bankr. N.D. Cal. 3/26/2007)
| Decision Date | 26 March 2007 |
| Docket Number | Cases No. 03-51775, 03-51776, 03-51777, and 03-51778-MM, Jointly administered. |
| Court | U.S. Bankruptcy Court — Northern District of California |
| Parties | In re: SONICBLUE INCORPORATED, DIAMOND MULTIMEDIA SYSTEMS, INC., REPLAYTV, INC., and SENSORY SCIENCE CORPORATION, Chapter 11 cases, Debtors. |
When claims traders entered this case and started asking hard questions, circumstances came to light that implicated at least debtor's counsel, committee counsel and certain members of the committee, and resulted in the complete breakdown of creditor confidence. The genesis of the problem arose from the pre-petition issuance of an opinion letter, undisclosed by debtor's counsel, assuring payment to certain bondholders who effectively controlled the creditors' committee. Years later, when debtor's counsel objected to these bondholders' claims because of an original issue discount approximating $43 million, the bondholders demanded indemnification from the law firm. The problem was compounded when debtor's counsel attempted to solve its disabling conflict by "handing off" these claims objections to committee counsel, who accepted the awkward assignment. Incredibly, these same bondholders somehow were also able to insert a provision in the settlement of estate litigation without disclosing that it arguably may provide them with millions more in distributions, at the expense of general unsecured creditors.
A more complete statement of the background is set forth below in the analysis of the motions by the United States Trustee to disqualify Pillsbury Winthrop Shaw Pittman LLC as counsel for the debtor and for disgorgement of attorneys' fees, its motion for the appointment of a chapter 11 trustee, and the motion of SONICblue Claims, LLC for conversion of the case to one under chapter 7. For the reasons explained, the motion for disqualification is granted, and the court finds that the appointment of a chapter 11 trustee is warranted as being in the best interests of the creditors and other interested parties.
SONICblue Incorporated and three operating subsidiaries, Diamond Multimedia Systems, Inc., ReplayTV, Inc., and Sensory Science Corporation (collectively, SONICblue), designed and marketed consumer electronic products. Pillsbury Winthrop Shaw Pittman LLP ("PWSP") served as SONICblue's longtime general corporate and litigation counsel. On January 3, 2001, SONICblue formed S3 Graphics Co., Ltd., a joint venture with VIA Technologies, Inc., to operate SONICblue's graphics chip business. Among the assets that SONICblue contributed to the joint venture was its graphics intellectual property, specifically including rights under a 1998 patent cross-license with Intel Corporation. The rights to use Intel's graphics patents were so important that the joint venture agreement included a liquidated damages clause at article 5.6 entitling the joint venture and VIA each to damages of up to $70 million if the joint venture were ever enjoined from using the Intel cross-license. From the inception of the joint venture, there were serious disputes, including the threat of litigation, between SONICblue and VIA. In the context of settlement proposals in 2002, the parties negotiated a $15 million loan from VIA to SONICblue. However, neither a settlement nor the loan were consummated pre-petition.
In April 2002, SONICblue raised financing in a private placement issuance of $75 million in 7¾% senior secured subordinated convertible debentures. Three institutional bondholders, Portside Growth & Opportunity Fund Ltd., Smithfield Fiduciary LLC, and Citadel Equity Fund Ltd., acquired the senior debentures at a discount for $62.5 million. The senior debentures were also partially secured by SONICblue's interest in shares of United Microelectronic Corporation ("UMC"), a Taiwanese company. Importantly, the indenture provided for the subordination of the senior debentures to certain obligations at Section 4.1:
The payment of the principal of, premium, if any, and interest on all Debentures . . . issued hereunder shall, to the extent and in the manner hereinafter set forth, be subordinated and subject in right of payment to the prior payment in full of all Senior Indebtedness, whether outstanding at the date of this Indenture or thereafter incurred.
"Senior Indebtedness" was defined in Section 1.1 of the indenture:
"Senior Indebtedness" shall mean the principal of, premium, if any, interest on . . . and any other payment due pursuant to any of the following, whether outstanding on the date of this Indenture or thereafter incurred or created:
* * *
(g) All indebtedness of the Company due and owing to Via Technologies, Inc. in an aggregate principal amount not to exceed $15,000,000 or the equivalent thereof in any other currency of composite currency (the "Via Indebtedness");
Existing debentures in the amount of $100 million issued in 1996 were also subordinated to the senior debentures. PWSP partner Jorge del Calvo was designated for notice purposes on the indenture on behalf of SONICblue.
In its capacity as counsel to SONICblue, on April 22, 2002, PWSP issued to the senior bondholders a written opinion as to the enforceability of the debentures. This opinion letter reads in pertinent part:
2. . . . Each of . . . the Purchase Agreement, the Registration Rights Agreement, the Indenture, the Pledge and Security Agreement and the Option Agreement, when duly executed and delivered by the Buyers, will each constitute a valid and binding agreement of the Company, enforceable against the Company in accordance with its terms * * *
3. The issuance and sale of the Debentures have been duly authorized. Upon issuance and delivery against payment therefor in accordance with the terms of the Indenture and the Purchase Agreement, the Debentures will constitute valid and binding obligations of the Company, enforceable against the Company in accordance with their terms.
* * *
9. . . . (b) Our opinion in paragraph 2 above is subject to and limited by (i) the effect of applicable bankruptcy, insolvency, reorganization, fraudulent conveyance, receivership, conservatorship, arrangement, moratorium or other laws affecting or relating to the rights of creditors generally. . . .
In what may have been a scrivener's error, the bankruptcy limitation in paragraph 9 referenced only paragraph 2 and not paragraph 3 of the opinion letter.
Just six months after the issuance of the senior debentures, SONICblue was unable to meet its maturing financial obligations and entered into a retainer agreement for PWSP to PWSP partner Jorge Del Calvo was copied on the retainer letter. SONICblue and the subsidiaries filed chapter 11 petitions on March 21, 2003. While the cases are jointly administered, they have not been substantively consolidated.
On April 11, 2003, PWSP filed an employment application accompanied by a verified statement pursuant to Bankruptcy Rule 2014, which disclosed:
3. The Firm has been engaged as the Debtors' corporate and litigation counsel since approximately 1989. During that time, the Firm has provided legal representation to the Debtors in a variety of areas, including corporate and securities matters, mergers and acquisitions, litigation, and intellectual property matters. The Firm has been working with the Debtors in connection with their restructuring since approximately October 25, 2002 when the Firm was retained to provide advice concerning the restructuring of the Debtor's liabilities and business operations.
The disclosure continued as follows:
6. As discussed below, I, the Firm, and certain of its partners, counsel, and associates may have in the past represented, and may presently and likely in the future will represent creditors or stockholders of the Debtors in matters unrelated to these Chapter 11 Cases. A preliminary conflicts search performed at my direction discloses that the Firm may have represented or represents entities that are involved in some capacity with one or more of the Debtors, or may have some other relationships with these entities, in matters unrelated to the Debtors. To the best of my knowledge, the Firm's relationships with these entities is as follows. . . .
However, PWSP failed to disclose its connection resulting from the issuance of the opinion letter to the senior bondholders one year earlier. It added, "The Firm will continue to monitor its relationship with the creditors and other parties in interest in these cases and, as it discovers additional information requiring disclosure, will promptly supplement this application with any appropriate disclosures." The court appointed PWSP as counsel for the debtors. Marcus Smith, the Chief Financial Officer of SONICblue, was designated its responsible individual. PWSP diligently filed supplemental disclosures on May 30, 2003, January 23, 2004, October 27, 2004, July 13, 2005, July 27, 2005, November 4, 2005, and June 5, 2006, none of which mentioned the opinion letter.
The Office of the United States Trustee appointed an Official Committee of Unsecured Creditors on March 21, 2003. The court authorized the employment of Ron Bender of the law firm Levene, Neale, Bender, Rankin & Brill LLP ("LNBRB") as counsel for the committee on April 11, 2003. As originally constituted, the committee was comprised of...
To continue reading
Request your trial