SECTION 506_C_ SURCHARGE REQUESTED by Boxer47

VIEWS: 73 PAGES: 19

									Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 1 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

FENNEMORE CRAIG, P.C. Laurel E. Davis (NV Bar No. 3005) Jon T. Pearson (NV Bar No. 10182) 300 South Fourth Street, Suite 1400 Las Vegas, Nevada 89101 Telephone: (702) 692-8000 E-mail: ldavis@fclaw.com Counsel for Debtor and Debtor-in-Possession

E-filed August 25, 2008

UNITED STATES BANKRUPTCY COURT DISTRICT OF NEVADA In re XYIENCE INCORPORATED, a Nevada corporation, Debtor. Date of Hearing: August 26, 2008 Time of Hearing: 1:30 p.m. Location: 300 Las Vegas Blvd. South Courtroom #2 Las Vegas, Nevada 89101 DEBTOR’S MEMORANDUM OF POINTS AND AUTHORITIES IN SUPPORT OF THE SECTION 506(C) SURCHARGE REQUESTED BY ITS PLAN OF REORGANIZATION Xyience Incorporated, the debtor and debtor-in-possession in the above-captioned voluntary chapter 11 case (the “Debtor” or “Xyience”), submits this Memorandum of Points and Authorities in support of the Section 506(c) surcharge contained in its Plan of Reorganization (the “Plan”), Docket No. 191.1 The Debtor relies upon the following memorandum of points and authorities, the pleadings, declarations, papers and other records on file herein, and the argument and any further evidence presented to this Court at the time of the Plan Confirmation Hearing. Chapter 11 No. BK-S-08-10474-MKN

1

26
FENNEMORE CRAIG, P.C.
LAS VE GAS

All Defined terms in these Points and Authorities shall have the meaning set forth in the Plan and/or Disclosure Statement, unless otherwise stated herein.

24525.3/23805.001

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 2 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

MEMORANDUM OF POINTS AND AUTHORITIES I. PRELIMINARY STATEMENT The Plan imposes a Section 506(c) surcharge on the Kay Management Secured Claim which is secured to the extent of the $200,000 Manchester Sale Proceeds. A surcharge is imposed to partially pay the Class 2 Allowed Zuffa Agreement Claim (Dkt. No. 187), a superpriority Administrative Claim in the amount of $675,000, which arises from a post-petition licensing and loan agreement that was essential to the continued operation of the Debtor’s Business and the preservation of the Debtor’s Assets. Based upon the particular facts and

circumstances of this case and the relevant case authority, this Court should approve the Section 506(c) surcharge of Key Management as set forth in the Plan. II. JURISDICTION AND VENUE 1. The Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157 and 1334.

This is a core proceeding pursuant to 11 U.S.C. § 157(b)(2)(A), (B), (L) and (O). Venue is proper before this Court pursuant to 28 U.S.C. §§ 1408 and 1409. 2. and 1129. III. STATEMENT OF RELEVANT FACTS A. 3. Relevant Procedure On January 18, 2008, the Debtor filed its voluntary petition for relief under chapter The statutory bases for the relief sought herein is 11 U.S.C. §§ 506(c), 1123(5)(E)

11 of the Bankruptcy Code. [Dkt. No. 1]. Pursuant to an order entered January 31, 2008, Docket No. 55, this Court dismissed, with prejudice, an involuntary petition for relief under chapter 11 of the Bankruptcy Code filed against the Debtor on January 3, 2008, as Case No. 08-10049-MKN. 4.
24525.3/23805.001

Since January 18, 2008, the Debtor has been operating and managing its business 2

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 3 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

affairs as a debtor-in-possession pursuant to Sections 1107 and 1108 of the Bankruptcy Code. 5. No trustee or examiner has been appointed herein. On February 19, 2008, an

Official Committee of Unsecured Creditors was appointed. [Dkt. No. 106]. B. 6. Key Management Secured Claim Pre-petition, the Debtor had a number of Secured Creditors. See Schedule D and

the Declaration of Omer Sattar, Dkt. No. 89. The highest in priority was the Zyen Secured Claim, which was satisfied by the closing of the Manchester Sale Agreement. Next in priority is the Key Management Secured Claim. 7. Key Management is the holder of the Brush Monroe, L.P. note in the original

amount of $10,000,000 dated July 7, 2006, evidenced by a Revolving Loan Note (“Key Management Note”), with a non-default interest rate equal to twelve percent (12%) per annum and a default interest rate of fourteen percent (14%) and payable in full on the Maturity Date as provided for in the Note. (See Declaration of Omer Sattar, Dkt. No. 89, at ¶8(a).) Pursuant to a February 21, 2007 Agreement, Key Management received 6.75 Million shares of Xyience stock, 3.5 Million Xyience Warrants and agreed to accept $5 Million in full satisfaction of the unpaid principal and interest. (Id.) 8. The Key Management Note is secured by a Revolving Loan and Security

Agreement dated July 7, 2006, and a UCC-1 recorded with the Secretary of State of Nevada on June 29, 2005. (Id.) B. 9. The Zuffa Agreement Zuffa Marketing, LLC (“Zuffa Marketing”) promotes, sponsors and presents a

variety of mixed martial arts events, centered around live ULTIMATE FIGHTING CHAMPIONSHIP® (“UFC”) productions of mixed martial arts competitions and exhibitions. (See Omnibus Declaration of Omer Sattar, Dkt. No. 8, at ¶78.) 10. Prior to filing for voluntary chapter 11 bankruptcy, the Debtor had entered into

two Sponsorship Agreements with Zuffa Marketing, LLC (the “Zuffa Sponsorship Agreements”).
24525.3/23805.001

3

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 4 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

(Id. at ¶79.) 11. In conjunction with the Zuffa Sponsorship Agreements, the Debtor was permitted

to place the UFC label on each can of its energy drink, Xenergy™. The Zuffa Sponsorship Agreements also provided the Debtor with certain advertising and promotional rights in conjunction with UFC events. (Id. at ¶80.) Among other advertising and promotional items, the Debtor was entitled to have its logo placed on the center of the UFC canvas and on two banners placed on bumpers around the UFC canvas. (Id.) The Zuffa Sponsorship Agreements were terminated pre-petition. (Id. at ¶79.) 12. Although the Zuffa Sponsorship Agreements were terminated pre-petition, after

filing for voluntary chapter 11 bankruptcy, the Debtor had an existing inventory of Xenergy™ drinks which contained the UFC logo on each can. (Id.) 13. The Debtor was informed by Zuffa Marketing, LLC (“Zuffa Marketing”) that it

was not permitted to continue to use the UFC label on its Xenergy™ drink cans unless the Debtor entered into another agreement with Zuffa Marketing regarding the use of Zuffa Marketing’s property in the form of the UFC logo. (Id. at ¶81.) 14. The Zuffa Agreement was essential to the continued success of the Debtor’s

business because the prior Zuffa Sponsorship Agreements had expired, pre-petition, and the “UFC” logo still appeared on: (1) the Debtor’s existing inventory of products and energy drinks; (2) the Debtor’s products already on the shelves in retail outlets for sale to the public; and (3) the existing inventory of energy drinks in the possession of Cott, the company that manufactured Xenergy™ beverages, and the cans manufactured by Cott. (See Declaration of Omer Sattar, Dkt. No. 89, at ¶17.) 15. Absent a new Zuffa Agreement, the Debtor would have: (1) lost revenue of over

$8 Million; (2) been forced to destroy: (a) its existing inventory that had a value of $2,360,000; (b) the 169,599 case inventory that was being held by Cott, the company that manufactured Xenergy™ beverages, pre-petition, and would have resulted in lost gross revenue of $3,816,000;
24525.3/23805.001

4

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 5 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

(c) the 9.4 million cans worth $1.1 Million; and (d) the 26,400 cases of beverages presently under manufacture by Cott and lose gross revenue of about $800,000. (Id.) It would have been

extremely detrimental to the Debtor, the estate, its creditors, and parties-in-interest had the Debtor been forced to destroy its valuable products and lose revenue of over $8 Million. (Id.) The

Debtor could not have preserved the value of its assets post-petition without the Zuffa Agreement. 16. Indeed, the cumulative dollar amount of the projected losses that would have been

incurred had the Zuffa Agreement not been approved would have exceeded the value of the Debtor’s assets. In fact, the Debtor’s business would not have survived such a loss. (Id.) 17. In January of 2008, the Debtor filed a Motion seeking approval of a post-petition

non-exclusive limited licensing agreement between the Debtor and Zuffa Marketing, pursuant to which Xenergy™ would continue its status as the official energy drink of the UFC (the “Zuffa Agreement”). [Dkt. Nos. 28 and 42]. The Motion came on for hearing on January 23, 2008, at which time the Bankruptcy Court approved the Motion on an interim basis and authorized the Debtor to continue to collect and use Zuffa’s trademarks pursuant to the Zuffa Agreement. [Dtk. No. 77]. The Zuffa Agreement came on for final approval on February 12, 2008, at which time the Zuffa Agreement was approved on a final basis. [Dkt. No. 128]. 18. The Zuffa Agreement contained both a post-petition licensing agreement and a

post-petition loan to the Debtor to finance the post-petition licensing fees. Repayment of the post-petition licensing fees was secured by a lien on any unencumbered assets pursuant to Section 364(c)(2) and a super-priority administrative expense pursuant to Section 364(c)(1). Id. 19. On May 2, 2008, Zuffa Marketing filed a Stipulation for Allowance of Super-

Priority Administrative Claim of Zuffa Marketing, LLC (the “Zuffa Stipulation”). [Dkt. No. 187]. Because the Debtor owns no unencumbered Assets, the Zuffa Stipulation approved on a final basis the super-priority administrative claim arising from the Zuffa Agreement in the amount of $675,000 (the “Allowed Zuffa Agreement Claim”). (Id.) On May 9, 2008, the Court entered an Order approving the Zuffa Stipulation and granting the Allowed Zuffa Agreement Claim.
24525.3/23805.001

5

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 6 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

[Dkt. No. 190]. C. 20. Sale of the Debtor’s Assets By entering into the Zuffa Agreement, the Debtor was able to preserve the value of

its Assets which were then sold, free and clear of liens in April of 2008, for an amount in excess of $15 million. 21. On February 22, 2008, the Debtor filed a Motion for Order (1) Approving Sales

Protections to Manchester Consolidated Corp.; (2) Approving Procedures for Soliciting Higher and Better Offers, and Determining Highest and Best Offer; (3) Setting Hearing to Select Highest and Best Offer, and to Approve Sale of Assets; and (4) Granting Other Relief (“Sale Procedures Motion”). [Dkt. No. 109]. The Sale Procedures Motion came on for hearing on March 6, 2008, at which time the Bankruptcy Court approved the Sale Procedures Motion. [Dkt. No. 147]. 22. On March 6, 2008, the Debtor filed a Motion for Order Approving the Sale of

Property Free and Clear of Liens, Claims, et al. (“Sale Motion”). [Dkt. No. 149]. The Sale Motion came on for hearing on April 1, 2008, at which time the Bankruptcy Court approved the Sale Motion and Manchester Consolidated Corp. (“Manchester”) acquired the Debtor’s Assets free and clear of all liens and claims. [Dkt. No. 178]. Manchester acquired the Assets for a total consideration of $15,017,000, which consisted of a cash payment of the Manchester Sale Proceeds to the Debtor in the amount of $200,000, and assumption of more than $14.8 Million in secured debt – the secured claim held by Zyen – which included Zyen’s post-petition claim for the Zyen DIP Financing Loan. 23. After the closing of the Manchester Agreement and Manchester’s assumption of

the Zyen pre- and post-petition debt, all remaining liens secured by the Assets attached to the Manchester Sale Proceeds. The Key Management Secured Claim is next in priority after the Zyen Secured Claim. Because the Manchester Sale Proceeds of $200,000 are not sufficient to satisfy the Key Management Secured Claim, there are no other Secured Claims. IV.
24525.3/23805.001

6

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 7 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13
A.

LEGAL ARGUMENT Overview of Section 506(c) of the Bankruptcy Code

Traditionally, administrative expenses have not been charged against secured creditors, and it is the general rule that the unsecured creditors (or the unencumbered assets of the estate) to some extent assume the costs of administering the estate. Matter of Trim-X, Inc., 695 F.2d 296, 301 (7th Cir. 1982). An exception to that general rule has been recognized, however, when expenses of preservation are incurred primarily for the benefit of the secured creditor, or where the creditor caused or consented to such expenses. Id. That exception has been codified in Section 506 of the Bankruptcy Code: The trustee [or debtor-in-possession] may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim. See 11 U.S.C. § 506(c). That is, a trustee or debtor-in-possession (“DIP”) may recover from the holder of an allowed secured claim reasonable and necessary expenses incurred by the debtor in

14 15

the preservation or disposition of the secured collateral.2 See Compton Impressions, Ltd. v. Queen City Bank, N.A. (In re Compton Impressions, Ltd.), 217 F.3d 1256, 1260 (9th Cir. 2000).

16
Section 506(c) of the Bankruptcy Code has its origins in the equitable principle that where a court

17
has custody of property, administration and preservation expenses are a dominant charge against

18
the property. Hartford Underwriters Ins. Co., 530 U.S. at 9.

19
B. Distribution of a Section 506(c) Surcharge

20
Although only a trustee or DIP has standing to seek a Section 506(c) surcharge, courts

21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

The Supreme Court of the United States has held that only a trustee or DIP has standing to seek a Section 506(c) surcharge. Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1, 6 n.3, 120 S. Ct. 1942, 147 L. Ed. 2d 1 (2000). It is important to also note that a trustee or a DIP do have fiduciary obligations to the estate and to the debtor’s creditors and, therefore, because of these fiduciary obligations, trustees and DIPs have obligations to pursue viable Section 506(c) surcharge claims that would benefit the estate. In re Suntastic USA, Inc., 269 B.R. 846, 849-50 (Bankr. D. Ariz. 2001).
24525.3/23805.001

2

7

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 8 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

disagree whether distribution of the surcharge may be provided directly to a third-party that provided the benefit to the secured creditor. Some courts have held that the surcharge can only be recovered for the benefit of the bankruptcy estate, while other courts have held that the surcharge may be provided directly to the party that provided the benefit to the secured creditor. The Ninth Circuit has held that the surcharge may be provided directly to a third-party that provided the benefit to the secured creditor. Debbie Reynolds Hotel & Casino, Inc. v. Calstar Corp., Inc. (In re Debbie Reynolds Hotel & Casino, Inc.), 255 F.3d 1061, 1067 (9th Cir. 2001). Therefore, conceivably a DIP may seek a Section 506(c) surcharge on behalf of another creditor.3 The Ninth Circuit based its decision, in part, on the fact that a Section 506(c) surcharge is not an administrative claim, but an assessment against a secured party’s collateral. In re Debbie

Reynolds Hotel & Casino, Inc., 255 F.3d at 1067. As such, it does not come out of the debtor’s estate, but rather comes directly from the secured party’s recovery. Id. Consequently, Section 506(c) expenses do not fall within the priority scheme of the Bankruptcy Code. Id. Instead, such expenses “are paid first out of the proceeds of the sale, before a secured creditor is paid.” Id. Thus, the proceeds of a Section 506(c) surcharge may directly pass “to the claimant with no gain to the estate.” Id.; N. County Jeep and Renault, Inc. v. Gen. Electric Capital Corp. (In re Palomar Truck Corp.), 951 F.2d 229, 232 (9th Cir. 1991). The Ninth Circuit went on to note that although the Supreme Court of the United States overruled In re Palomar Truck Corp. on the issue of who has standing to pursue a Section 506(c)
3

Collier on Bankruptcy provides that: [I]n any instance in which a trustee has incurred an expense on credit to preserve or dispose of a secured creditor’s collateral, and the expenses remains unpaid (e.g., because the estate has no unencumbered funds to pay it), any recovery under section 506(c) by the trustee or the unpaid party on the account of the unpaid claim properly belongs to the third party whose provision of goods or services provided the benefit, and therefore generated entitlement under section 506(c) to receive priority payment from the secured creditor’s collateral.

4 COLLIER ON BANKRUPTCY, ¶506.05[1] (15th ed. rev. 2008) (emphasis added).
24525.3/23805.001

8

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 9 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

surcharge, the Supreme Court specifically refused to decide how a surcharge recovered by the trustee (or DIP) should be distributed. In re Debbie Reynolds Hotel & Casino, Inc., 255 F.3d at 1067; Hartford Underwriters Ins. Co., 530 U.S. at 11 n.4. Consequently, that aspect of In re Palomar Truck Corp. (i.e., that a surcharge may pass directly to the claimant with no gain to the estate) survived Hartford Underwriters Ins. Co., and remains the binding precedent of the Ninth Circuit. In re Debbie Reynolds Hotel & Casino, Inc., 255 F.3d at 1067. In this case, the Debtor’s Plan provides for the imposition of a Section 506(c) surcharge on the Key Management Secured Claim, which consists of the $200,000 Manchester Sale Proceeds, in order to pay the Allowed Zuffa Agreement Claim. (See Plan at Sections 4.2 and 4.3; see also Dkt. Nos. 190 and 238.) As will be demonstrated below, the Zuffa Marketing Agreement provided a benefit to all creditors and parties in interest because it allowed the Debtor to preserve the value of its assets in which which Key Management held a security interest. Thus, because Zuffa Marketing provided a benefit to Key Management, the Debtor is seeking to impose a Section 506(c) surcharge on the Key Management Secured Claim and have the surcharged funds paid directly to Zuffa Marketing. Moreover, the Ninth Circuit’s decision in In re Debbie

Reynolds Hotel & Casino, Inc., permits the Debtor to seek a Section 506(c) surcharge and have the surcharged amounts funds paid directly to a third-party, which in this case is Zuffa Marketing. In the event that this Court does not allow surcharged funds to be paid directly to Zuffa Marketing, once the Debtor recovers the $200,000 from Key Management based upon a Section 506(c) surcharge, under the Plan and the Bankruptcy Code’s priority scheme, the Debtor would be required to disburse the surcharged funds to pay the Zuffa Marketing Allowed Claim. Zuffa Marketing4 is next in priority to receive payment of any surcharged funds regardless of whether the payment is direct to Zuffa Marketing or pursuant to the Plan. By imposing a Section 506(c) surcharge on the Key Management Secured Claim and applying it directly to payment of the The Zuffa Agreement recognizes the Administrative Carve Out of $225,000 which will be paid to Professionals.
24525.3/23805.001
4

9

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 10 of 19

1 2 3 4 5 6 7 8

Zuffa Marketing Allowed Claim, all other Administrative, Priority and Unsecured Claims will benefit from partial satisfaction of the Zuffa Marketing Allowed Claim because the surcharge will pay a claim which is higher in priority to than their Claims. Accordingly, this Court should approve the Section 506(c) surcharge on the Key Management Secured Claim and allow the Debtor to directly pay those funds Zuffa Marketing. C. The Debtor Meet The Necessary Requirements to Impose a Section 506(c) Surcharge on the Key Management Secured Claim.

To impose a Section 506(c) surcharge, a DIP must establish that a secured creditor’s claim is both “allowed” and “secured.” Poonja v. Alleghany Prop. (In re Los Gatos Lodge Inc.), 278

9
F.3d 890, 893 (9th Cir. 2001); Bear v. Coben (In re Golden Plan of Cal., Inc.), 829 F.2d 705, 712

10
(9th Cir. 1986). A DIP must also establish the extent to which the claim is to be treated as

11
secured by establishing the value of the collateral. In re Los Gatos Lodge Inc., 278 F.3d at 893.

12
Moreover, a DIP must establish that the costs and expenses for which recovery is sought were

13
either: (1) incurred for the benefit of the secured creditor, and were reasonable and necessary, Id.;

14
Cent. Bank of Mont. v. Cascade Hydraulics & Util. Serv., Inc. (In re Cascade Hydraulics & Util.

15
Serv., Inc.), 815 F.2d 546, 548 (9th Cir. 1987); or (2) the secured creditor caused or consented to

16
such costs and expenses, In re Compton Impressions, Ltd., 217 F.3d at 1260.

17
Key Management has a claim in the amount of $5,191,666.66. [Dkt. No. 238.] Key

18
Management’s claim is secured only to the extent of the Manchester Sale Proceeds, which is

19
$200,000. (Id.) Thus, pursuant to Section 506(a), Key Management has a secured claim in the

20
amount of $200,000, and an unsecured claim in the amount of $4,991,666.66. (Id.) There is not a

21
valuation issue because the collateral is $200,000 in cash. Only one inquiry remains, whether the

22
costs and expenses for which recovery is sought were either: (1) incurred for the benefit of Key

23
Management and such expenses were reasonable and necessary; or (2) caused or consented to by

24
Key Management.

25
///

26
FENNEMORE CRAIG, P.C.
LAS VEG AS

24525.3/23805.001

10

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 11 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

1.

Necessity and Reasonableness of the Debtor Entering Into the Zuffa Agreement.

As a threshold matter, in order for Section 506(c) to apply, the relevant expenses that are sought to be charged to the secured creditor’s collateral or claim must be “necessary” to preserve or dispose of the secured creditor’s property. In the Ninth Circuit, courts measure the necessity and reasonableness of a debtor’s incurred expenses against (1) the benefits obtained for the secured creditor; and (2) the amount that the secured creditor would have necessarily incurred through foreclosure and disposal of the property. In re Compton Impressions, Ltd., 217 F.3d at 1260; In re Chicago Lutheran Hosp. Ass’n, 89 B.R. 719, 727 (Bankr. N.D. Ill. 1988). Thus, the proper inquiry is whether the services for which a surcharge is sought were necessary to the secured creditor. In re Compton Impressions, Ltd., 217 F.3d at 1260-61. Uncontroverted evidence and final orders of this court establish that it was necessary for the Debtor to enter into the Zuffa Agreement in order to preserve the assets of the estate. The pre-petition Zuffa Sponsorship Agreements had expired, and the “UFC” logo appeared on the: (1) Debtor’s existing inventory of products and energy drinks; (2) Debtor’s products that were already on the shelves in retail outlets for sale to the public; and (3) standing inventory of energy drinks that were in the possession of Cott and the cans manufactured by Cott. Absent a new agreement with Zuffa Marketing, the Debtor had no right to continue to use the “UFC” logo on its products and, therefore, the Debtor was prohibited from selling or distributing these products. Indeed, without the Zuffa Agreement, the Debtor would have been required to destroy valuable estate assets and manufacture new products without the “UFC” logo, resulting in associated business losses caused by losing the Debtor’s shelf placement to its competitors. In fact, the Debtor would have been required to destroy most of its Assets, all to the detriment of the estate and its creditors. In addition, the Debtor would have lost more than $8 Million in revenue. Thus, the Zuffa Agreement was necessary to preserve the Debtor’s Assets, which was beneficial to Key Management who held a lien on the Debtor’s Assets.
24525.3/23805.001

11

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 12 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

The Bankruptcy Court’s interim and final approval of the Zuffa Agreement and the Court’s Order approving the Zuffa Marketing super-priority claim establish the reasonableness of the dollar amount of the proposed surcharge. Furthermore, Key Management did not object to the the terms of the Zuffa Agreement on either an interim or final basis, nor did it object to allowance of the Zuffa Marketing super-priority claim. Accordingly, based on this Court’s final approval of the Zuffa Agreement and its Order Allowing the Zuffa Marketing super-priority claim, the license agreement expense incurred by the estate by entering into the Zuffa Agreement were necessary and reasonable for the preservation of the Debtor’s Assets and they were incurred for the benefit of Key Management a creditor with a claim secured by those Assets. 2. Key Management Benefited from the Zuffa Agreement.

To satisfy the benefit test of Section 506(c) of the Bankruptcy Code, a DIP must establish in quantifiable terms that it expended funds (or such expenses that were incurred) directly to protect and preserve the collateral. In re Compton Impressions, Ltd., 217 F.3d at 1261; In re Cascade Hydraulics & Util. Serv., Inc., 815 F.2d at 548. The amount the secured creditor benefits limits the DIP’s recovery of expenses. In re Compton Impressions, Ltd., 217 F.3d at 1261; In re Jensen, 980 F.2d 1254, 1260 (9th Cir. 1992). That is, a DIP’s recovery is limited to the amount the secured creditor benefited. The rationale being that Section 506(c) is not intended as a substitute for the recovery of administrative expenses that are normally the responsibility of the debtor’s estate. In re Cascade Hydraulics & Util. Serv., Inc., 815 F.2d at 548. A DIP does not satisfy its burden of proof by suggesting hypothetical benefits.5 In re Compton Impressions, Ltd., The Court in In the Matter of Iberica Mfg., Inc., 180 B.R. 707 (Bankr. D. P.R. 1995), noted the following: The costs must result in a direct and primary benefit to the creditor; expenses which result in improvement to the position of the debtor but only indirectly benefit the creditor are not recoverable. Thus, recovery is not permitted where the benefit derived from the actions of the trustee could have been obtained even in the absence of his acts.
24525.3/23805.001
5

12

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 13 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

217 F.3d at 1261 (quoting In re Cascade Hydraulics & Util. Serv., Inc., 815 F.2d at 548). In fact, to shift liability to the secured creditor would make “’it difficult, if not impossible, to induce new lenders to finance a chapter 11 operation.’” In re Cascade Hydraulics & Util. Serv., Inc., 815 F.2d at 549 (citations omitted). Indeed, it would discourage the DIP from taking reasonable steps to expedite the reorganization and encourage negligence. Id. Moreover, Section 506(c) of the Bankruptcy Code neither distinguishes between undersecured and oversecured creditors, nor does it state that oversecured creditors do not fall within the class of secured creditors subject to surcharge. See, e.g., In re Trim-X, Inc., 695 F.2d at 298. The Court in In re Trim-X, Inc., stated: Section 506(c) makes no reference to the relative values of the property securing an allowed claim and the claim itself. In contrast, section 506(b) . . . does contain such language . . . . We think that Congress’ omission of similar language from section 506(c) suggests that the relative values of the property and the secured claim are not relevant considerations under that section. Id.; see also In re North County Place, Ltd., 92 B.R. 437, 446 (Bankr. C.D. Cal. 1988) (rejecting an oversecured creditor's argument that it received no benefit by virtue of its status as an oversecured creditor and loss of an equity cushion); see also In re Debbie Reynolds Hotel & Casino, Inc., 238 B.R. 831, 837-38 (9th Cir. BAP 1999), rev’d on other grounds, 255 F.3d 1061 (9th Cir. 2001) (there is no per se rule that Section 506(c) never permits oversecured creditors to be surcharge). The facts of this case clearly establish that it was absolutely essential for the Debtor to enter into the Zuffa Agreement in order to preserve the Assets of the estate, and Key Management held a security interest in those Assets. Absent entering into the Zuffa Agreement, the Debtor would have been required to destroy valuable Assets of the estate consisting of Key Management’s collateral, incur significant costs to replace those Assets and lose more than $8 million in revenue. Entering into the Zuffa Agreement allowed the Debtor to sell those valuable

180 B.R. at 713 (internal citations omitted).
24525.3/23805.001

13

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 14 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

assets for the benefit if the estate and its creditors and to void significant costs and losses. Key Management may argue that it is improper to demonstrate that it was benefited by the Zuffa Agreement and then rely upon that benefit to surcharge Key Management to the full extent of its $200,000 collateral, resulting in 100% of Key management’s claim treated as a Class 4 General Unsecured Claim if the Debtor is permitted to surcharge the Key Management Secured Claim. (See Plan at Section 4.3.)6 This, however, is not the proper analysis of whether Key Management received any benefit from the Zuffa Agreement. Instead of focusing on how a Section 506(c) surcharge would affect Key Management, the proper focus is whether Key Management benefited at all from the Zuffa Agreement. In other words, regardless of the impact of a Section 506(c) surcharge on Key Management, did Key Management benefit from the Zuffa Agreement? The answer is a resounding “yes.” The Zuffa Agreement preserved and protected the value of the estate’s Assets, resulting in the successful sale of the Debtor’s Assets and the Manchester Net Proceeds. Without the Zuffa Agreement, the Debtor’s assets would have been worthless because the Debtor would have been required to destroy existing inventory and incur post-petition debt to manufacture replacement inventory. Even if Key Management had succeeded in obtaining relief from stay to recover and sell its collateral, unless Key Management entered into a licensing agreement with Zuffa Marketing to sell products bearing the “UFC” label, the collateral would have been worthless because Key Management would have been required to destroy its collateral. Thus, the Zuffa Agreement benefited Key Management because it preserved the value of the Debtor’s Assets, including Key Management’s collateral. Moreover, Key Management also benefited from the Zuffa Agreement because it allowed
6

Section 4.3 of the Plan provides that the Key Management Secured Claim would become a Class 5 General Unsecured Claim. This is a typographical error. Key Management would not become a Class 5 General Unsecured Claim, but rather would become a Class 4 General Unsecured Claim. The Disclosure Statement clarified this point. (See Disclosure Statement, Dkt. No. 231, at Section VII.C.3.)
24525.3/23805.001

14

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 15 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

the Debtor to satisfy secured claims which had a higher priority than Key Management’s secured claim. The Manchester Purchase Agreement resulted in a satisfaction of Zyen’s Secured Claim and Zyen’s Secured DIP Financing Claim because Manchester assumed the Zyen debt in conjunction with the sale transaction. The Zuffa Agreement preserved the value of these assets which were sold to Manchester who assumed the Zyen secured debt, and resulted in the Key Management Secured Claim. The Debtor therefore asks this Court to impose a Section 506(c)

surcharge on the Key Management Secured Claim. 3. Key Management Consented to the Expenses.

If a DIP is unable to show that the expenses incurred were for the benefit of the secured creditor and that such expenses were reasonable and necessary, a DIP may argue that the secured creditor either caused or consented to the expenses.7 Consent may be expressed or implied. See, e.g., Daniel v. AMCI, Inc. (In re Ferncrest Ct. Partners, Ltd.), 66 F.3d 778, 782 (6th Cir. 1995) (“recovery may be had where the claimant establishes that the secured party directly or impliedly consented or caused the expense”) (citations omitted). Although a secured creditor may cause or consent to the imposition of a surcharge for certain expenses, the Ninth Circuit has held that “[m]ere cooperation with the trustee [or DIP] does not make the secured creditor liable for all expenses of [the] administration [of the estate].” In re Compton Impressions, Ltd., 217 F.3d at 1261. In fact, “[a] secured creditor’s consent to the payment of designated expenses, limited in amount, is not blanket consent to be discharged with additional expenses not included in the consent agreement.” Id.; cf. In re Nutri/Sys., Inc., 169 B.R. 854, 872 (Bankr. E.D. Pa. 1987) (“a

7

Collier on Bankruptcy has articulated that: If the holder of a secured claim expressly consents to the payment of a specific administrative claim from its collateral, then the secured creditor’s consent may be enforceable to ensure payment of the claim of the administrative claimant from the collateral.

4 COLLIER ON BANKRUPTCY, ¶506.05[6] (15th ed. rev. 2008).
24525.3/23805.001

15

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 16 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

secured lender should not be able to call upon a professional to perform services on its behalf, and then deny payment to the professional because hindsight proves that the services did not provide the anticipated benefit”). In this case, Key Management failed to object to the Zuffa Agreement, the Zuffa Stipulation or the Order approving the Zuffa Marketing super-priority claim. As amply

evidenced by the facts of this case, the Zuffa Agreement was critical to the preservation of the Debtor’s Assets and absent the Zuffa Agreement the Debtor would be required to destroy millions of dollars worth of inventory and it would be required to incur significant costs to replace that inventory. Additionally, without the Zuffa Agreement, the Debtor would lose revenues in excess of $8 million. By failing to object to the Zuffa Agreement, Key Management implicitly

consented to the licensing fees and loan evidenced by the Zuffa Agreement. Accordingly, the Debtor respectfully requests that this Court impose a Section 506(c) surcharge on the Key Management Secured Claim in order to pay the Allowed Zuffa Marketing Claim. 4. Key Management is Estopped from Arguing that It Did Not Benefit from the Zuffa Agreement.

Based upon the principles of quasi-estoppel, Key Management is estopped from arguing that it did not benefit from the Zuffa Agreement. Quasi-estoppel differs from garden-variety

17 18

equitable estoppel8 in that there is no requirement of a change in position in reliance upon another’s prior conduct. In re Guterl Special Steel Corp., 316 B.R. 843, 856 (Bankr. W.D. Pa.

19
2004). The doctrine, which has its basis in equity, precludes a party from asserting, to another’s

20
prejudice, a position that is inconsistent with a previously-held position. Id.; Erie Telecomm.,

21
Inc. v. City of Erie, 659 F. Supp. 580, 585 (W.D. Pa. 1987). The doctrine of quasi-estoppel

22
applies where it would be unconscionable to permit a person to maintain a position inconsistent

23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

8

To establish equitable estoppel a party must show that another party: (1) intentionally or negligently misrepresented a material fact; (2) knew or had reason to know that the other party would justifiably rely on the misrepresentation; and (3) induced the other party to act to its own detriment. Baker v. Upper Southampton Township Zoning Hearing Bd., 830 A.2d 600 (Pa. Cmwlth. 2003), appeal denied, 849 A.2d 1206 (2004).
24525.3/23805.001

16

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 17 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

with one in which he or she acquiesced or where they accepted a benefit. In re Guterl Special Steel Corp., 316 B.R. at 856. Thus, the “conscience of the court” is repelled by the inconsistency. Id.; Unruh v. Indus. Comm’n of the State of Ariz., 81 Ariz. 118, 301 P.2d 1029, 1031 (Sup Ct. 1956). In fact, in common parlance, quasi-estoppel translates into the maxim that “one cannot blow both hot and cold.” In re Guterl Special Steel Corp., 316 B.R. at 856; Erie Telecomm., Inc., 659 F. Supp. at 585. Put another way, it is but an application of the maxim that “one cannot eat his cake and have it too.” In re Guterl Special Steel Corp., 316 B.R. at 856 (citations omitted). By way of example, the Court In In re Guterl Special Steel Corp., held that a creditor was equitably estopped from taking a position that it received no benefit from the efforts of a trustee and his counsel. In In re Guterl Special Steel Corp., the debtor’s creditor, the United States Economic Development Administration (“EDA”) sought relief from the automatic stay in order to foreclose on certain property of the debtor. 316 B.R. at 848. EDA agreed to hold its motion in abeyance pending a public sale of the property and payment at the closing of all undisputed portions of the proceeds to EDA. Id. A public sale of the debtor’s property was held, and Allegheny Ludlum Steel Corporation (“ALSC”) was the highest bidder with an offer in the amount of $9,517,000. Before the closing could take place, however, it was discovered that 9.1 acres of the property was contaminated with radioactive waste left from when the previous owner, Simonds Steel & Saw Co. (“Simonds”) processed uranium and thorium metals under the aegis of the United States Atomic Energy Commission (“AEC”). Id. After learning of the radioactive contamination, ALSC baled at closing on the transaction and eventually sought to rescind the agreement of sale. Id. With the consent of EDA and the chapter 11 trustee, ALSC submitted an application to the City of Lockport to subdivide the 9.1 acres of contaminated land from the remaining sixty-one (61) acres that were free of contamination. The City of Lockport eventually approved the subdivision. Id. As such, ALSC closed on the transaction of the 61 acres of non-contaminated land. Id.
24525.3/23805.001

17

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 18 of 19

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

The case was eventually converted to a chapter 7. The chapter 7 trustee made many efforts to remediate the contaminated 9.1 acres of land, but all efforts were unsuccessful. The trustee and his counsel attempted to convince certain federal agencies to provide the funds to remediate the contaminated land in order to allow the trustee to find a willing buyer for the site. During this time, the EDA did not take the position that the trustee should not undertake such an effort. Id. at 856. To the contrary, EDA encouraged the effort. In fact, the sole beneficiary of these efforts was the EDA. Any net proceeds realized from such a sale would have been subject to the EDA’s secured interest. Id. The trustee sought to recover his costs along with his counsel’s cost by imposing a Section 506(c) surcharge. The EDA, however, opposed the request of the trustee and his counsel to be paid from EDA’s collateral and argued, in part, that it received no benefit. The Court held that it would be inappropriate to conclude that EDA has not directly benefited from the actions of the trustee and his counsel in attempting to procure funding from a federal agency to pay for cleaning up the radioactive contamination. The Court further held that EDA is estopped from denying that it has directly benefited from the actions of the trustee and his counsel to have the property cleaned up so that it can be sold to a third-party. Id. at 855. Here, Key Management chose not to object to the Debtor entering into the Zuffa Agreement with Zuffa Marketing, nor did it object to the Zuffa Stipulation or the Order approving the Zuffa Marketing super-priority claim. Like the creditor in In re Guterl Special Steel Corp., Key Management directly benefited from the Debtor entering into the Zuffa Agreement. It is therefore not appropriate for Key Management to now argue that it failed to benefit from the Zuffa Agreement. As a result, the Key Management Secured Claim should be surcharged

pursuant to Section 506(c). /// /// ///
24525.3/23805.001

18

Case: 08-10474-mkn

Doc #: 285

Filed: 08/25/2008

Page: 19 of 19

1 2 3 4 5 6 7 8 9

V.
CONCLUSION For the reasons set forth above, the Debtor respectfully requests that this Court approve the Section 506(c) surcharge of the Key Management Secured Claim to pay the Allowed Zuffa Marketing Claim as set forth in the Plan. DATED this 24th day of August, 2008. Respectfully submitted, FENNEMORE CRAIG, P.C. By: /s/ Laurel E. Davis Laurel E. Davis

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26
FENNEMORE CRAIG, P.C.
LAS VEG AS

Counsel for Debtor and Debtor-in-Possession

24525.3/23805.001

19


								
To top