Qmect, Inc.

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UNITED STATES BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
In re No. 04-41044 T
Chapter 11
QMECT, INC., etc.,
Debtor-in-Possession.
________________________________/
MEMORANDUM OF DECISION RE CASH COLLATERAL MOTION
The above-captioned debtor’s (the “Debtor”) motion for
authorization to use cash collateral for the first six months of
2006 came on for hearing on December 19, 2005. The Debtor also
requested a determination that the senior liens on the Debtor’s
personal property were undersecured and thus not entitled to post-
petition interest. If the Court were to so determine, the Debtor
requested a reduction in the adequate protection payments being
made to the senior lender on a monthly basis as well as
disgorgement of the overpayments previously made. Finally, the
Debtor sought authorization to pay the Debtor’s and the Creditors’
Committee’s professionals a pro rata share of $100,000 and $7,500
Signed: December 22, 2005
________________________________________
LESLIE TCHAIKOVSKY
U.S. Bankruptcy Judge
________________________________________
Entered on Docket
December 23, 2005
GLORIA L. FRANKLIN, CLERK
U.S BANKRUPTCY COURT
NORTHERN DISTRICT OF CALIFORNIA
Case: 04-41044 Doc# 451 Filed: 12/22/05 Entered: 12/23/05 10:44:04 Page 1 of
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1The Court has allowed on an interim basis the fee
applications of the Debtor’s counsel and the Creditors’
Committee counsel. The Court denied approval of the Debtor’s
accountant’s fee application without prejudice due to formatting
problems.
2
per month thereafter with respect to allowed fees and expenses.1
For the reasons stated below, the Debtor is authorized to use cash
collateral in accordance with its budget for the months of January
and February 2006. The Court will determine whether to permit the
Debtor’s use of cash collateral thereafter after the trial is
concluded in A.P. No. 04-4190 AT.
DISCUSSION
A debtor may only use a secured creditor’s cash collateral if
the secured creditor consents or the use will not deprive the
secured creditor of adequate protection of its interest in its
collateral. 11 U.S.C. § 363(e). The Debtor has two secured
creditors, referred to herein as Burlingame and Burlingame
Funding. Burlingame and Burlingame Funding are affiliates. The
liens securing the claims held by Burlingame are junior to the
liens securing the claims held by Burlingame Funding. The claims
held by Burlingame Funding were originally held by Comerica Bank-
California. They were purchased by Burlingame and then
transferred to Burlingame Funding shortly before the bankruptcy
was filed.
Neither of the two secured creditors in this case consent to
the use. To the contrary, they strenuously object. Thus, the
Case: 04-41044 Doc# 451 Filed: 12/22/05 Entered: 12/23/05 10:44:04 Page 2 of
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Court may only authorize the use if it finds that the secured
creditors’ positions are adequately protected.
Adequate protection may be provided by an “equity cushion.”
This phrase means that the value of the secured creditor’s
collateral is sufficiently in excess of the secured creditor’s
claim that the secured claim is sure to be paid in full at some
time in the future, including accrued interest. It is undisputed
that the secured claim of Burlingame, the holder of the junior
liens on the Debtor’s assets, is undersecured. Thus, Burlingame’s
liens are not adequately protected by an equity cushion.
Adequate protection may also be provided by periodic payments
and/or replacement liens in previously unencumbered collateral.
This is the adequate protection offered by the Debtor. The Debtor
has been making payments of $14,000 to Burlingame Funding which is
the amount of the interest accruing on the claims secured by the
senior liens. This prevents accruing interest on the senior liens
from rendering the junior liens more unsecured even if the value
of the collateral base remains stable. In addition, both secured
creditors are offered replacement liens on the newly acquired
collateral: i.e., inventory and accounts receivable. The Debtor
contends that these two forms of protection are adequate.
The Debtor concedes that, given the seasonal nature of its
business, it will be operating on a negative cash flow basis for
the next six months. However, the Debtor contends that the
secured position entitled to adequate protection is the position
at the time the bankruptcy case was filed, not at the time the
Case: 04-41044 Doc# 451 Filed: 12/22/05 Entered: 12/23/05 10:44:04 Page 3 of
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motion for authorization to use the cash collateral is made. The
Court agrees. The Debtor contends that the fair market value of
the secured creditors’ collateral, both the real property and the
personal property, has increased from the petition date to the
present date. The Debtor bases this contention on a valuation of
its assets on a piecemeal basis, albeit based on their fair market
value.
The secured creditors contend that, because they hold “blanket
liens” on all the Debtor’s assets, the value of their collateral
is the value of the Debtor’s business sold as a “turn-key”
operation. They based this contention on In re Kim, 130 F.3d 863
(9th Cir. 1997). The secured creditors presented an expert witness
at the hearing on the motion. The witness testified that, using
the Debtor’s cash flow figures, the value of the Debtor’s business
sold as a “turn-key” operation had decreased by over a million
dollars since the filing of the petition. The Court found the
witness’s testimony completely persuasive.
The Court has previously stated that, if the secured
creditors hold a “blanket lien,” In re Kim, 130 F.3d 863 (9th Cir.
1997) requires the secured creditors’ collateral to be valued
based on a sale of the business as a “turn-key” operation. The
Court has not previously determined whether the secured creditors
hold “blanket liens.” In a related adversary proceeding, the
Court denied the Creditors’ Committee’s motion for a summary
adjudication that Burlingame Funding did not have a “blanket
lien.”
Case: 04-41044 Doc# 451 Filed: 12/22/05 Entered: 12/23/05 10:44:04 Page 4 of
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The Court previously held that a secured creditor could assert
a “blanket lien” even though it lacked a perfected security
interest in some of the Debtor’s assets if the assets could be
easily replaced without any disruption of the business operations.
For example, the secured creditors have conceded that they do not
hold perfected security interests in the Debtor’s trucks.
Burlingame Funding executed lien releases with respect to
certain items of leased equipment (the “Released Equipment”).
However, it does hold a perfected security interest in the leases
of the Released Equipment and it also has a security interest in
the Debtor’s real property. Thus, if the leases are “true leases”
or if the Released Equipment are fixtures in the real property,
Burlingame Funding’s lack of a perfected security interest in the
Released Equipment would not deprive it of a “blanket lien.”
However, the Court has not yet determined whether the leases
are “true leases” or the Released Equipment are “fixtures.” One
of the items of Released Equipment is the “grid flooring.” If the
“grid flooring” is not subject to Burlingame Funding’s security
interest, Burlingame Funding cannot claim a “blanket lien,” if its
secured position is viewed in isolation from the interests of
Burlingame.
However, as the secured creditors have noted, Burlingame did
not execute releases of its liens with respect to the Released
Equipment. Burlingame and Burlingame Funding contend that, as
affiliates, they may combine their secured positions to cla i m a
“blanket lien” on the Debtor’s assets. The Debtor disagrees. It
Case: 04-41044 Doc# 451 Filed: 12/22/05 Entered: 12/23/05 10:44:04 Page 5 of
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contends that, having chosen to hold the claims in question
through separate entities, they may not now disregard that
separateness simply because it benefits them.
The Court agrees that the liens may be combined. The Debtor’s
position ignores reality. As a functional matter, Burlingame and
Burlingame Funding may act in concert. Alternatively, Burlingame
Funding could transfer its claims back to Burlingame. Thus, for
all practical purposes, they hold a “blanket lien” on the Debtor’s
assets. Having so concluded, as noted above, the Court also
concludes that the value of the secured creditors’ collataral must
be based on the value of the business as a whole, sold as a “turn-
key” operation. Furthermore, the Court concludes, based on the
testimony provided by the secured creditors’ expert, that the
value of the Debtor’s business has declined substantially since
the inception of the case.
Nevertheless, the Court concludes that the Debtor should be
authorized to use the secured creditors’ cash collateral for the
next two months for several reasons. First, the Court is in the
middle of a trial in which the Debtor asserts counterclaims
against the secured creditors which may equal or exceed the amount
of the secured claims. Alternatively, they may offset the secured
creditors’ claims sufficiently that the value of the Debtor’s
business would provide an equity cushion for any remaining debt.
The Court is unwilling to assume, mid-trial, that the Debtor will
not prevail in its claims. The Court has previously denied the
secured creditors’ motion for summary judgment in their favor on
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those claims, having concluded that they present material factual
issues.
Second, the secured creditors concede that they do not wish
the Debtor to cease operating. They believe that the Debtor’s
business has more value as a going concern than its assets would
have after business has ceased. They asked that the Court not
only deny use of cash collateral but also grant relief from the
automatic stay sua sponte although no such motion was on file.
The Court declined to do so.
If the Debtor does not prevail sufficiently on its
counterclaims to extinguish or sufficiently reduce the secured
creditors’ claims to change the Court’s adequate protection
analysis, it will still need to use cash collateral to continue to
operate the business so that the secured creditors may exercise
their rights in such a way as to minimize any disruption to the
Debtor’s business. The Court does not wish a motion for relief
from stay to be filed before the conclusion of the trial. Unless
the Debtor indicates that the motion will not be opposed, the
Court will not permit it to be noticed on an ex parte basis. In
addition, even if the Debtor does not prevail on its
counterclaims, it is still possible that competent evidence can be
provided showing that the value of the real property has increased
as much as the going concern value of the business has decreased.
The Debtor offered the opinion of its principal officer, Fred
Koelling (“Koelling”), that the value of the real property had
increased by approximately a million dollars during the case.
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However, the Court did not find this testimony persuasive.
Koelling based his opinion on a sale of nearby real property.
However, there was insufficient detail concerning the nature of
that real property to permit the Court to conclude that the real
property was sufficiently comparable to the Debtor’s real
property.
On the other hand, the Court did not find the testimony of the
secured creditors’ real estate appraiser persuasive either. Their
appraiser testified that the value had not increased at all since
the inception of the case (or shortly thereafter when the Court
valued it at $2.5 million). The Court finds this testimony
implausible based on its general knowledge of market trends in the
Bay Area during the period in question. However, it has no
competent evidence that the real property has increased in value
and if so, by how much.
The Debtor’s two other requests are denied. The Debtor’s
contention that the secured claim of Burlingame Funding in the
Debtor’s personal property is undersecured uses a liquidation
value methodology. The Court concludes that this methodology is
improper where the Debtor proposes to retain the personal property
and use it in its business. The Court is also unable to find at
present that the secured creditors’ position would be adequately
protected notwithstanding the payment of the Debtor’s
professionals.
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CONCLUSION
The Debtor’s motion for use of cash collateral is granted in
part and denied in part. The Debtor is authorized to use the cash
collateral in accordance with its budget for the months of January
and February 2006 except that it may not use cash collateral to
pay any professional fees. The Debtor’s request for a reduction
in the adequate protection payments being made to Burlingame
Funding and for disgorgement of a portion of the amounts
previously paid is denied. The Debtor’s request for authorization
to pay $100,000 pro rata on the allowed claims of the Debtor’s
professionals is also denied. Counsel for Burlingame and
Burlingame Funding is directed to submit a proposed form of order
in accordance with this decision.
END OF DOCUMENT
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COURT SERVICE LIST
Paul E. Manasian
Manasian & Rougeau, LLP
400 Montgomery St., Ste. 1000
San Francisco, CA 94104
Tobias S. Keller
Pachulski, Stang, Ziehl, Young,
Jones & Weintraub P.C.
Three Embarcadero Center, Ste. 1020
San Francisco, CA 94111-4023
Robert R. Moore
Allen Matkins Leck Gamble & Mallory LLP
Three Embarcadero Center, 12th Floor
San Francisco, CA 94111
Philip J. Nicholsen
Law Offices of Philip J. Nicholsen
221 Main St., #740
San Francisco, CA 94105
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