In re Valley Media, Inc.

• Citation: 279 B.R. 105
• Decision Date: 25 April 2002
• Docket Number: No. 01-11353(PJW).,01-11353(PJW).
• Parties: In re VALLEY MEDIA, INC., Debtor.
• Court: U.S. Bankruptcy Court — District of Delaware

279 B.R. 105

In re VALLEY MEDIA, INC., Debtor.

No. 01-11353(PJW).

United States Bankruptcy Court, D. Delaware.

April 25, 2002.

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Karen Jacobs Louden, Robert J. Dehney, Eric D. Schwartz, Jason W. Staib, Morris, Nichols, Arsht & Tunnell, Wilmington, DE, for Valley Media, Inc.

William P. Bowden, Ashby & Geddes, Wilmington, DE, Jonathan N. Helfat, Houston & Rosen, P.C., New York City, to Congress Financial Corporation (Northwest).

Teresa K.D. Currier, Klett, Rooney, Lieber & Schorling, Wilmington, DE, Michael A. Bloom, Morgan, Lewis & Bockius, LLP, Philadelphia, PA, Counsel to the Committee.

Carl N. Kunz, III, Morris, James, Hitchens & Williams, LLP, R. Karl Hill, Seitz, Van Ogtrop & Green, P.A., Charles J. Brown, William D. Sullivan, Elzufon, Austin, Reardon, Tarlov & Mondell, P.A., Francis A. Monaco, Jr., Rachel M. Mersky, Brian J. McLaughlin, Walsh, Monzack & Monaco, P.A., Wilmington, DE, Michael L. Moskowitz, Richard E. Weltman, Weltman & Moskowitz, LLP, Christopher R. Whent, Christopher R. Whent, New York City, Counsel to Objecting Vendors.

OPINION

PETER J. WALSH, Chief Judge.

This is with respect to the January 10, 2002 motion of Valley Media, Inc. ("Valley" or the "Debtor") to sell its inventory at auction¹ ("Auction Motion") (Doc. 118) and the objections made by certain consignment vendors ("Objecting Vendors")² to the Auction Motion ("Auction Objections")³. The Auction Objections were primarily filed by vendors who, prepetition, provided the DNA division of Valley ("DNA") with consignment goods under the terms of certain distribution agreements ("Distribution Agreements"). The Objecting Vendors seek to exclude inventory which they provided to DNA on a consignment basis ("Contested Inventory") from sale ("Auction Sale") under the Auction Motion. Motions have also been filed requesting relief from the automatic stay to recover the Contested Inventory held by the Debtor ("Relief Motions")⁴. Discovery was conducted, the various parties submitted briefs⁵ on the matter and a hearing was held on February 26 and 27, 2002 at which both live and deposition witness testimony⁶ was presented regarding Valley's and DNA's operations. The primary issue in this matter is whether DNA can be considered a "merchant" under revised Uniform Commercial Code ("U.C.C.") § 9-102(a)(20) or a "person conducting business" under former U.C.C. § 2-326(3)(b). Subsequently, the parties⁷ simultaneously submitted proposed findings of fact and conclusions of law⁸ and, finally, objections to the proposed findings of fact and conclusions of law⁹. For the reasons discussed below, I will overrule the Auction Objections and grant the Auction Motion as to the Contested Inventory provided that such sale complies with the scope of the permission to sell the Contested Inventory granted in the Distribution Agreements. I will also deny those Relief Motions related to recovery of the Contested Inventory by the Objecting Vendors. However, I find that the situations of The Music Cartel, Inc., Beatville Records and Rotten Records, Inc. are unique in that their Distribution Agreements may have terminated pre-petition and the final section of this opinion will discuss the applicability of this decision to the Contested Inventory claimed by these three Objecting Vendors. The following will serve as this Court's findings of fact and conclusions of law on this matter.

BACKGROUND

Valley Media, Inc. ("Valley") filed a voluntary petition for relief under chapter 11 of title 11 of the United States Code, 11 U.S.C. §§ 101 et seq. (the "Bankruptcy Code") on November 20, 2001. Prior to filing, Valley was the largest full-line supplier of entertainment software products (primarily CDs, DVDs, and VHS tapes) in the United States. (RAS Ex. 34 at 1); (Tr. 2/27/02 Garrett at 95:23-24)¹⁰. Valley was a "one-stop" distributor (Tr. 2/26/02 Dickinson 54:10-11)(Tr. 2/27/02 Lawlor 21:25; Garrett 100:2-5) and as such carried a wide variety of materials including materials from every major record company as well as hundreds of import and independent labels. (Tr. 2/26/02 Dickinson 55:21-24); (Tr. 2/27/02 Lawlor 22:2-6; Garrett 100:2-5). Valley had over 600 product vendors who supplied inventory. (Tr. 2/27/02 Garrett 121:17, 168:15-17.)

DNA, formerly known as Distribution North America, was a wholly owned, unincorporated division of Valley. (Tr. 2/27/02 Lawlor 36:23-37:1.) DNA was formed in September 1994 as an equal partnership between Rounder Records and Valley. (RAS Ex. 34 at 1); (Tr. 2/27/02 Lawlor 20:6-11). In January 1997, Valley acquired Rounder Records' interest in DNA and thus, 100% ownership of DNA. (RAS Ex. 34 at 1); (Tr. 2/27/02 Lawlor 20:11-12). The fact that DNA has been wholly owned by Valley for all times relevant to this dispute has not been challenged. After the first quarter of 2001, Valley produced a marketing brochure ("Marketing Brochure") (RAS Ex. # 34) and attempted to sell DNA. (Tr. 2/27/02 Garrett 138:8-14; Colson 61:24-62:5.) The brochure portrays DNA as a separable unit of Valley that could be sold apart from Valley. (Tr. 2/27/02 Garrett 139:14-17.) However, none of the scenarios listed in the Marketing Brochure suggest that DNA could stand on its own without some combination of significant financing in the form of a $7 million to $16 million equity investment and either a continued affiliation with Valley for distribution services or an affiliation with a distributor or label. (RAS Ex. 34 at 8-9.) The Marketing Brochure was distributed on a limited basis and only some competing independent distributors and select major labels received it. (Tr. 2/27/02 Garrett 139:1-13.)

DNA had no officers or directors of its own (Tr. 2/27/02 Lawlor 36:23-37:1; Garrett 112:2-6) and the CEO of Valley had ultimate responsibility for the DNA division (Tr. 2/27/02 Garrett 112:13-18). DNA had its own staff. (Tr. 2/27/02 Colson 69:22-23.) Although these employees may have considered themselves employees of DNA (Tr. 2/27/02 Lawlor 22:9-11), all employees working for the DNA division were employed and compensated by Valley (Tr. 2/27/02 Garrett 106:2-3,112:23-113:2). Although DNA was a division of Valley, the two had separate logos (Tr. 2/27/02 Colson 70:7-8), websites (Tr. 2/27/02 Colson 68:10-13) and registrations with the National Association of Recording Merchandisers (Tr. 2/26/02 Garrett 75:21-76:1-14). DNA had a separate profit and loss statement from Valley's which was generated using financial information provided by Valley. (Tr. 2/27/02 Garrett 135:19-22.)

DNA had supply relationships with approximately 150-200 vendors (the "DNA Vendors"). (Tr. 2/27/02 Garrett 104:12-105:9.) The DNA Vendors supplied inventory under either a terms relationship based on purchase invoices ("Terms Vendors") or a consignment relationship based on a Distribution Agreement ("Consignment Vendors"). (Tr. 2/27/02 Colson 76:2-6); (RAS Ex.19,21). The parties concur in their understanding of the primary difference between the terms and consignment models. Under a terms model, a distributor purchases inventory outright. The vendors invoice for products when shipped and the distributor pays based on the negotiated terms, usually 60-90 days from the date of invoice. (Tr. 2/27/02 Lawlor 28:20-29:22; Colson 52:9-25); (Tr. 2/26/02 Garrett 65:19-22). Under a consignment arrangement, the title to the inventory remains with the vendor and the goods are not paid for until the distributor sells the products. (Tr. 2/27/02 Lawlor 30:5-13; Colson 51:21-52:1, 52:19-53:6); (Tr. 2/26/02 Garrett 65:1-7). However, as will be discussed below, despite the intent of the parties, the legal effect of the consignment relationship may be determined by provisions of the Uniform Commercial Code in certain situations.

DNA did not perform all the functions of a distributor and was dependent on Valley for many essential operational services. At trial Lewis Garrett, the current President of Valley, contrasted the capacities of the Valley and DNA operations by reviewing the twelve functions which he deemed necessary for a distributor to get product from a label that produces a music recording to an end user who purchases it for individual or retail use. (Tr. 2/27/02 Garrett 107:17-111:23.) Of the twelve operational functions which a distribution company must perform, DNA only performed two: sales and marketing. (Tr. 2/27/02 Garrett 110:18-20.)¹¹ The rest of the functions were performed for DNA by Valley through Valley employees with no connection to the DNA operations. These included: treasury and banking (Tr. 2/27/02 Garrett 108:17-21), product procurement (Tr. 2/27/02 Garrett 108:22-109:9), invoicing (Tr. 2/27/02 Garrett 109:10-18), customer service (Tr. 2/27/02 Garrett 109:19-20), warehousing and distribution (Tr. 2/27/02 Garrett 110:4-7), credit and collections (Tr. 2/27/02 Garrett 110:8-15) and various support functions including human resources, information technology ("I.T.") and financial reporting (Tr. 2/27/02 Garrett 110:16-18)(RAS Ex.34 at 6). DNA was assessed an overhead charge for the services Valley provided, including rent¹², and these charges were reflected in the DNA financial statements. (Tr. 2/27/02 Garrett 165:11-20.)

As a distributor, Valley obtained music product from vendors through purchasing and procurement, stored the procured inventory in one of two large distribution facilities, marketed and sold the inventory through three distribution lines and then shipped the purchased inventory. DNA was one of these three distribution lines and as such was just one part of the sales and distribution side of Valley's overall operation.

The purchasing and procurement functions for Valley's three distribution channels were performed by employees in Valley's buying department. (Tr. 2/27/02 Garrett 98:16-23.) Two employees working in the DNA division procured product from...