United States v. State St. Bank & Trust Co.

• Decision Date: 15 October 2014
• Docket Number: Adv. No. 01–4605KJC
• Parties: United States of America, et al., Plaintiffs, v. State Street Bank and Trust Co., As Trustee for Junior Subordinated Secured PIK Notes, et al., Defendants
• Court: U.S. Bankruptcy Court — District of Delaware

520 B.R. 29

United States of America, et al., Plaintiffs

v.State Street Bank and Trust Co., As Trustee for Junior Subordinated Secured PIK Notes, et al., Defendants

Adv. No. 01–4605KJC

United States Bankruptcy Court, D. Delaware.

Signed October 15, 2014

Joseph J. Bodnar, Esq., Law Offices of Joseph J. Bodnar, 2101 North Harrison Street, Wilmington, DE, for Scott Cable Communications, Inc. and State Street Bank and Trust Company.

Karen Barris Bragman, Neil C. Gordon, Heather S. Michael, Arnall Golden Gregory LLP, 171 17th Street NW, Atlanta, GA, Kathleen M. Miller, Smith, Katzenstein & Jenkins LLP, 800 Delaware Avenue, Wilmington, DE, for Ronald I. Chorches, Chapter 7 Trustee of Scott Cable Communications, Inc.

Mary Caloway, Buchanan Ingersoll & Rooney PC, Kerri K. Mumford, Landis Rath & Cobb LLP, 919 North Market Street, Wilmington, DE, Abid Qureshi, Akin Gump Strauss Hauer & Feld, LLP, 590 Madison Avenue, New York, NY, for Scott Cable Communications, Inc.

Teresa K.D. Currier, Saul Ewing, 222 Delaware Ave Ste, Wilmington, DE, Mitchell P. Hurley, Akin gump Strauss Hauer & Feld LLP, 590 Madison Avenue, New York, NY, for Scott Cable Communications, Inc.

Lydia D. Bottome, John V. Cardone, Heather L. Richtarcsik, Alan Martin Shapiro, Peter Sklarew, U.S. Department of Justice, Tax Division, Washington, DC, for United States of America.

Kevin J. Mangan, Francis A. Monaco, Jr., Womble Carlyle Sandridge & Rice, LLP, 222 Delaware Avenue, Wilmington, DE, for State Street Bank and Trust Company.

OPINION¹

KEVIN J. CAREY, UNITED STATES BANKRUPTCY JUDGE

Before the Court is an adversary complaint in which the United States of America, on behalf of the Internal Revenue Service (the “Government” or “IRS”), asks this Court to recharacterize or equitably subordinate certain secured notes issued in 1996 as part of a chapter 11 reorganization plan. The secured notes were issued to two classes of creditors and known as Series A Junior PIK Notes and Series B Junior PIK Notes. For the reasons that follow, the request to recharacterize the Series A Junior PIK Notes is denied, but the request to equitably subordinate the Series A Junior PIK Notes is granted. The requests to recharacterize or equitably subordinate the Series B Junior PIK Notes are both denied.

I. BACKGROUND

Scott Cable Communications, Inc. (the “Debtor” or “Scott Cable” or the “Company”) filed a chapter 11 bankruptcy petition in the United States Bankruptcy Court for the District of Connecticut (Bridgeport) (the “Connecticut Bankruptcy Court”) on October 1, 1998 (the “1998 Bankruptcy Case”). This 1998 Bankruptcy Case followed closely on the heels of a 1996 chapter 11 bankruptcy filing by Scott Cable and its affiliated holding companies in the United States Bankruptcy Court for the District of Delaware (the “1996 Bankruptcy Case”).

The 1998 Bankruptcy Case included a prepackaged liquidation plan and contemplated a sale of substantially all of the Debtor's assets. On December 11, 1998, the Connecticut Bankruptcy Court denied confirmation of the prepackaged liquidation plan after determining that (i) the capital gains tax owing to the Internal Revenue Service as a result of the proposed sale (which was scheduled to occur post-confirmation) was an administrative expense claim; and (ii) that the principal purpose of the prepackaged plan was to avoid payment of taxes. See In re Scott Cable Commc'n, Inc., 227 B.R. 596 (Bankr.D.Conn.1998).

On November 19, 1998, the Government filed an adversary complaint in the Connecticut Bankruptcy Court against State Street Bank & Trust Co., as Indenture Trustee to the holders of Junior Subordinated Secured PIK Notes (the “Junior PIK Notes”), seeking to disallow the Indenture Trustee's secured claim under Bankruptcy Code § 502(a) on the grounds of recharacterization or, in the alternative, equitable subordination.² In 2001, the Connecticut Bankruptcy Court transferred the adversary proceeding to the Delaware Bankruptcy Court. United States v. State Street Bank and Trust Co. (In re Scott Cable Commc'n, Inc.), 263 B.R. 6 (Bankr.D.Conn.2001).

Some holders of the Junior PIK Notes moved to intervene as defendants in the adversary proceeding, including Media/Communications Partners, L.P., Chestnut Street Partners, Inc., Milk Street Partners, Inc., TA Investments, and Allstate Insurance Company.³ Scott Cable also intervened as a defendant (United States v. State Street Bank & Trust Co. (In re Scott Cable Commc'n, Inc.), 2002 WL 417013 (Bankr.D.Del Mar. 4, 2002) ), but after the 1998 Bankruptcy Case was converted to a chapter 7 case, the chapter 7 trustee filed a motion to, among other things, substitute himself for the Debtor in the adversary proceeding and realign himself as a plaintiff. The chapter 7 trustee's motion was granted, in part, allowing the trustee to be realigned as a plaintiff in this litigation.

This adversary case has been in the hands of four judges and three courts in two jurisdictions. There have been years of discovery and countless motions. A bench trial was held, spanning approximately 34 days over the course of nine months. A lengthy post-trial briefing process and numerous post-trial motions followed. The record is complete and this matter is ripe for adjudication.

II. JURISDICTION

This Court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C. § 1334(b) and § 157(a). The Government's claims for recharacterization and equitable subordination of claims against the Debtor's bankruptcy estate are core matters pursuant to 28 U.S.C. § 157(b)(2)(B), the equitable subordination claim directly arises under Bankruptcy Code § 510(c), and both claims require this Court to determine the priority among entities asserting claims against a bankruptcy estate. Resolution of such claims by final order are integral to the objectives set by Congress when enacting the Bankruptcy Code.⁴

III. FINDINGS OF FACT

A. The Leveraged Buyout of Scott Cable

Scott Cable, founded by Jim Scott, was a multi-system cable operator (“MSO”) that was publicly traded before it was acquired in a leveraged buyout (“LBO”) in 1988. (Government Negotiated Facts, D.I. 739, (“Stip. Facts—Gov.”) ¶ 1.)⁵ In 1984, the federal government deregulated the rates that MSOs and other cable operators could charge their subscribers, which had been previously regulated at the local level. (Pl. Ex. 114 at 1317.) The deregulation of these rates made MSOs like Scott Cable more enticing to investors.

One such investor was Steven Simmons (“Simmons”), owner and officer of Simmons Communications, Inc., an entity that acquired and operated cable television companies. Simmons sought to acquire underperforming MSOs, expecting to increase their value by offering a greater selection of programs, improving management and marketing, and increasing the customer base. (Stip. Facts—Gov. ¶¶ 21–23.) The capital that Simmons Communications used to acquire cable systems was supplied primarily by investment funds and institutional investors. (Id. at ¶ 24.)

On April 17, 1987, Simmons sent a letter about his interest in acquiring Scott Cable to Richard Churchill (“Churchill”) of T.A. Associates. (Pl. Ex. 2 at 871.) T.A. Associates was a venture capital firm that invested in technology oriented companies and media or communications companies. (Tr. 10/27/06, D.I. 777 (“Tr. D.I. 777”) at 8:21—9:3 (Churchill Test.)).⁶ On June 4, 1987, Churchill sent a letter to Simmons containing a prospective term sheet for T.A. Associates' and Allstate Insurance Company's (“Allstate”) commitment to provide $22.5 million for the acquisition of the stock of Scott Cable. (Def. Ex. 1.) The financing would be divided into two parts: $18 million to be invested in a junior subordinated note with an interest rate of 15 5/8%, and $4.5 million to be invested as equity through Class B non-voting stock. Id. The junior subordinated notes would be subordinate to all other debt raised as part of the LBO.

On September 25, 1987, Scott Cable filed a Proxy Statement with the Securities and Exchange Commission (the “SEC”), which provided notice that a Special Meeting of Shareholders was to be held on October 23, 1987, to consider and vote on a proposal to approve the Agreement and Plan of Merger, dated as of June 12, 1987, as amended (the “Merger Agreement”), pursuant to which Simmons Communications Merger Corp. (“SCM” or the “Merger Corp.”), a Texas corporation formed for the purpose of acquiring Scott Cable, would be merged with and into Scott Cable. (Pl. Ex. 15 at 2.) The Proxy Statement provided that the transaction would be structured as a sale of stock, stating, in part, as follows:

The Company's investment bankers had requested that bidders submit proposed definitive agreements and that the agreements be structured in such a way as to involve the sale of all the capital stock of the Company.

....

After considering the prices, financing, compliance with the bidding process, timing, prospects for closing and all other relevant matters, the Board concluded that the terms of the Merger with SCM offered the alternative that was in the best interests of the Company's shareholders because the SCM bid offered more favorable terms, including a higher per share consideration for the shareholders, and that the Company should pursue the SCM offer. The proposal from the unsuccessful group involved structuring the transaction as an asset sale which, because of the taxes that would have been incurred by the Company upon the sale, would have resulted in less cash available for distribution to the Company's shareholders. After further negotiations with SCM involving the price and terms of the Merger, the Merger Agreement was executed on June 15, 1987.

(Pl. Ex. 15 at 12.)

The Proxy Statement stated that the debt of Scott Cable, post-merger, would be increased significantly, and “in order to generate sufficient funds to satisfy its obligations, including interest and principal payments, and to meet its working capital and capital expenditure requirements, the...