Lee S. Attanasio Hearing Date: September 1, 2010 at 8:30 a.m. SIDLEY AUSTIN LLP 787 Seventh Avenue New York, New York 10019 (212) 839-5300

Counsel for Appaloosa Investment L.P. I UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ------------------------------------------------------x In re : Chapter 11 : Innkeepers USA Trust, et al., : Case No. 10-13800 (SCC) :

Debtors. : Jointly Administered ------------------------------------------------------x

APPALOOSA INVESTMENT L.P. I’S OBJECTION TO: (I) DEBTORS’ MOTION FOR THE ENTRY OF INTERIM AND FINAL ORDERS (A) AUTHORIZING THE DEBTORS TO (I) USE THE ADEQUATE PROTECTION PARTIES’ CASH COLLATERAL AND (II) PROVIDE ADEQUATE PROTECTION TO THE

ADEQUATE PROTECTION PARTIES PURSUANT TO 11 U.S.C. SEC. 361, 362, AND 363, (B) TO THE EXTENT APPROVED IN THE FINAL ORDER, GRANTING

SENIOR SECURED, PRIMING LIENS ON CERTAIN POSTPETITION INTERCOMPANY CLAIMS, (C) TO THE EXTENT APPROVED IN THE FINAL

ORDER, GRANTING ADMINISTRATIVE PRIORITY STATUS TO CERTAIN POSTPETITION INTERCOMPANY CLAIMS, AND (D) SCHEDULING A FINAL HEARING PURSUANT TO BANKRUPTCY RULE 4001(B); AND (II) DEBTORS’ MOTION FOR AN ORDER (A) AUTHORIZING THE DEBTORS TO ASSUME

THE PLAN SUPPORT AGREEMENT AND (B) GRANTING RELATED RELIEF

Appaloosa Investment L.P. I (“Appaloosa”), a party in interest in these cases,

objects to certain relief requested by the debtors and debtors in possession in the above-captioned

cases (the “Debtors”) in the following motions: (i) Debtors’ Motion for the Entry of Interim and

Final Orders (A) Authorizing the Debtors to (I) Use the Adequate Protection Parties’ Cash

Collateral and (II) Provide Adequate Protection to the Adequate Protection Parties Pursuant to 11

U.S.C. Sec. 361, 362, and 363, (B) to the Extent Approved in the Final Order, Granting Senior

Secured, Priming Liens on Certain Postpetition Intercompany Claims, (C) to the Extent

Approved in the Final Order, Granting Administrative Priority Status to Certain Postpetition

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Intercompany Claims, and (D) Scheduling a Final Hearing Pursuant to Bankruptcy Rule 4001(b)

[Docket No. 13] (the “Cash Collateral Motion”); and (ii) Debtors’ Motion for an Order (A)

Authorizing the Debtors to Assume the Plan Support Agreement and (B) Granting Related Relief

[Docket No. 15] (the “PSA Motion” and together with the Cash Collateral Motion, the

“Motions”). As grounds, Appaloosa respectfully states as follows:

INTRODUCTION

1. These cases have just begun. At this juncture, the Debtors need two things to

ensure their continued stability and to preserve the value of these estates. First, the Debtors need

access to cash claimed by their lenders as collateral in order to operate their businesses in the

ordinary course. Second, in order to satisfy their property improvement programs or “PIP”

obligations and maintain their “flags,” they require the financing contemplated by the two

debtor-in-possession facilities that were prenegotiated before these cases filed (collectively, the

“DIPs”).1 On these points, all parties in interest agree.

2. The Debtors’ prepetition and postpetition lenders have a big incentive to permit

the Debtors to use their cash claimed as collateral and to move forward with the DIPs. They, like

everyone else, know that absent this consent and new financing, collateral values would plummet

to their detriment. Midland Loan Services, Inc. and Five Mile Capital Partners LLC,2 the

prepetition and postpetition lenders to the 45 Fixed Rate Debtors have indicated their willingness

to consent, with appropriate protections, to the Debtors’ use of cash and to extending new credit

1 Neither the DIP facilities nor the Debtors’ agreement with Marriot International, Inc. (the “Marriott Agreement”) is linked to any plan of reorganization. Appaloosa does not object to the Debtors’ entry into the Marriot Agreement, nor to approval of the DIPs.

2 Midland Loan Services, Inc. (“Midland”) is the special servicer to the CMBS trusts which hold the Fixed Rate Mortgage (as defined below). An affiliate of Five Mile Capital Partners LLC is providing a DIP to the Debtors who are borrowers under the Fixed Rate Mortgage (the “Fixed Rate Debtors”).

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to protect their prior investments with no extraneous requirements. Despite current protestations

to the contrary, Lehman ALI, Inc. (“Lehman”), who has $220 million of its creditors’ money

invested in Innkeepers, will do the same.3, 4 Common sense and their business judgment require

it. See Motion of Lehman Commercial Paper Inc. Pursuant to Section 363 of the Bankruptcy

Code for Authority to (I) Consent to its Non-Debtor Affiliate Lehman ALI Inc. (A) Entry Into

Plan Support Agreement Related to the Restructuring of Innkeepers USA Trust; and (B)

Consummation of the Transactions Set Forth in the Plan Term Sheet; and (II) Provide Funds to

Solar Finance Inc., a Non-Debtor Affiliate, to Provide Debtor-In-Possession Financing [Lehman

Docket No. 10465] at p. 38 (“Marriott’s entry into the Marriott Agreement, pursuant to which it

has agreed to forbear from exercising its potential rights to terminate its franchise agreements is

conditioned on, among other things, Innkeepers securing debtor-in-possession financing and

completing the property improvement work plan. The proposed DIP Facilities, in turn, are

conditioned on Marriott’s willingness to support the proposed transaction and to forbear from

“de-flagging” substantially all of Innkeepers’ properties in accordance with the Marriott

Agreement.”).

3 Indeed, in the recent deposition of Michael Lascher, the Lehman employee who was principally responsible for negotiating the Innkeepers restructuring on behalf of Lehman, Mr. Lascher stated, “[A]s long as there were funds available, whether it be from a DIP or cash flow, in order to do the PIP work, we [Lehman] wouldn’t stand in the way of their [the Debtors] doing that….” Transcript of Deposition of Michael Lascher Held on Aug. 19, 2010 (“Lascher Dep. Tr.”) (excepts attached as Exhibit A), 24:16-20.

4 If Lehman will not proceed with the DIP, which is highly doubtful (especially given that the DIP Lehman is providing is essentially a roll-up that doesn’t require Lehman to commit new capital), there is no evidence that another party would not provide the Floating Rate Debtors (defined below) with debtor-in-possession financing. As set forth in the Debtors’ motion to approve Lehman’s DIP, as of the Petition Date, the Debtors had not yet “shopped” the DIPs. See Debtors’ Motion for the Entry of an Order Authorizing the Debtors to Obtain Postpetition Financing from an Affiliate of Lehman ALI Inc. on a Priming Basis Pursuant to Sections 364(c)(1), 364(c)(2), 364(d)(1), and 364(e) of the Bankruptcy Code [Docket No. 23] at 20.

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3. By this objection, Appaloosa seeks to separate what is critical to the preservation

of these estates from what is tactical, controversial and contentious. To be clear, as long as it is

done in good faith and consistent with their fiduciary duties, the Debtors may propose any plan

they want and may select any plan sponsor as a suitor. That plan will either survive the rigors of

the chapter 11 process or it won’t. If it doesn’t, however, it shouldn’t be so inexplicably linked

to the Debtors’ lifeline that it risks the Debtors’ very foundation. For the interests of all, the

Debtors should be free to proceed with their plan process without both arms tied behind their

backs.

4. The Debtors have failed to demonstrate how their proposed plan support

agreement (the “PSA”) will promote a successful reorganization. By seeking to assume the

PSA, as opposed to just filing a plan (even the same plan as is contemplated by the PSA) on the

timetable currently proposed (i.e., on or before September 2, 2010; the day after this hearing), the

Debtors are gambling the welfare of these estates on the plan being ultimately approved by this

Court. This is a problem.

5. While Appaloosa does not believe the restructuring transaction proposed by the

PSA can ultimately be confirmed under the requirements of section 1129 of title 11 of the United

States Code (the “Bankruptcy Code”), that is not an issue for today. Today, the Debtors cannot

demonstrate an adequate business justification for agreeing that:

• Lehman can terminate the use of its cash collateral upon any PSA termination event without further court approval. See PSA § 8(a).

• Lehman can force a sale under section 363 of the Bankruptcy Code of its collateral upon certain PSA termination events, or foreclose on its collateral without further need for court approval upon certain termination events. See PSA § 8(b).

• Lehman can terminate the PSA if, among other things, a material adverse change in financial markets occurs (whether or not it affects the Debtors), or Lehman determines after completion of its tax due diligence that the

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transaction contemplated by the PSA cannot be structured in a manner acceptable to Lehman, when such events could lead to the termination of the use of Lehman’s cash collateral. See PSA §§ 6(p) and 6(q).

• The Debtors will not discuss any other restructuring options with any other parties, or potentially lose the use of Lehman’s cash collateral. See PSA §§ 5(c) and 6(r).

• The Debtors will only exercise a fiduciary out if they receive a binding written commitment of an alternate transaction that will provide Lehman with a higher and better recovery. See PSA § 25(c).

6. The Debtors have not and cannot demonstrate that the PSA will hasten their

emergence from chapter 11. To the contrary, it has spurred extensive discovery requests and a

motion for an examiner. And unlike most plan support agreements, the PSA doesn’t “lock-up” a

critical mass of creditors. Here, the Debtors have signed up only one of the creditors needed to

complete a comprehensive restructuring. And that “support” comes at a great price. It risks the

loss of Lehman’s cash collateral — an unconscionable hammer held over the heads of all parties

in interest in these cases.5 It prohibits the Debtors from negotiating with the numerous

constituents who will be required to vote on their respective Debtor’s chapter 11 plan and

requires the Debtors to shelve their fiduciary duties. For what? Absent the PSA, virtually

nothing prevents the Debtors, Lehman and Apollo from filing their exact same plan on the exact

same timetable.

STANDING

7. As a preferred shareholder of Innkeepers USA Trust, Appaloosa is a party in

interest in these cases under section 1109 of the Bankruptcy Code. As such, Appaloosa has

5 Even the Debtors were troubled, on the eve of filing, by the prospect of giving Lehman the right to terminate cash collateral, although they acquiesced in the end. As recent discovery has revealed, as late as the day before their petitions were filed, the Debtors expressed to Lehman that they were “[n]ot inclined” to give Lehman the right to terminate cash collateral based on a breach of the PSA because it would give potential opponents a “real hook” to challenge the deal. See Exhibit 6 to Lascher Dep. Tr. (attached hereto as Exhibit B); Lascher Dep. Tr. (Exh, A), at 53:22 - 54:12.

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standing to bring this objection. In addition to owning a modest amount of preferred shares,

Appaloosa has hundreds of millions of dollars invested in the Fixed Rate Mortgage (defined

below) which is serviced by Midland as special servicer. While this interest is not direct and, in

and of itself, arguably might not afford Appaloosa standing, disclosure of these investments is

important to explain the significant weight of Appaloosa’s interest in seeing that the Debtors

successfully restructure. Put simply, Appaloosa has a lot of skin in the game.

8. The purpose of the party in interest standing requirement under section 1109 of

the Bankruptcy Code, which provides that any “party in interest . . . may raise and may appear

and be heard on any issue . . .,” is to ensure that those parties with a significant stake in the

outcome of a bankruptcy case, or whose interests are being compromised, are heard on matters

important to the outcome of a case. See In re Stone Barn Manhattan LLC, 405 B.R. 68, 74

(Bankr. S.D.N.Y. 2009) (“The basic test under section 1109(b) is whether the prospective party

in interest has a sufficient stake in the outcome of the proceeding so as to require representation.

It is generally understood that a pecuniary interest directly affected by the bankruptcy proceeding

provides standing under §1109(b).”) (internal citations and quotations omitted). Thus,

Appaloosa meets the requirement for technical standing, but also has a significant economic

stake in the successful outcome of these cases.

BACKGROUND

9. These cases were filed on July 19, 2010 (the “Petition Date”). The Debtors own

and operate a portfolio of 72 upscale and mid-priced extended-stay and select-service hotels

located in 20 states across the United States. See Amended Declaration of Dennis Craven, Chief

Financial Officer of Innkeepers USA Trust, In Support of First-Day Pleadings [Docket No. 33]

(the “Innkeepers Declaration”) ¶ 6.

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10. As of the Petition Date, the Debtors had incurred approximately $1.29 billion of

secured debt, consisting of (a) a securitized mortgage loan in the face amount of $825 million

(the “Fixed Rate Mortgage”), collateralized by 45 of the Debtors’ hotel properties and divided

into two CMBS pools, each of which is serviced by Midland as special servicer, (b) a floating

rate senior mortgage loan in the face amount of $250 million (the “Floating Rate Mortgage,”

the borrowers under such loan the “Floating Rate Debtors”) for which Lehman is the sole

lender, collateralized by 20 hotel properties, plus a junior mezzanine loan in the face amount of

$118 million secured by the equity interests in the entities that own those 20 hotels, and (c) seven

additional secured mortgage loans (the “Individual Mortgages”) ranging in amounts from

approximately $24 to $48 million, each secured by individual properties, with one additional

mezzanine loan related to one of the Individual Mortgages. See Innkeepers Declaration ¶¶ 8, 25-

37. The Floating Rate Mortgage, Fixed Rate Mortgage, and Individual Mortgages are each

secured by distinct hotel properties, and such mortgages are the liabilities of distinct debtors,

such that the borrowers under the Floating Rate Mortgage, the Fixed Rate Mortgage and the

Individual Mortgages do not overlap. See Innkeepers Declaration ¶¶ 24-37. In 2007, Apollo

Investment Corporation (“Apollo”) acquired the membership interests of debtor Grand Prix

Holdings LLC, the direct or indirect parent of all of the Debtors. See Innkeepers Declaration ¶¶

8, 23. However, Debtor Innkeepers USA Trust has approximately 5.8 million shares of

outstanding publicly traded preferred stock, and there are two other series of preferred stock

issued by the Debtors that are not held by Apollo. See Innkeepers Declaration ¶¶ 38-40.

11. On the Petition Date, the Debtors moved for approval of two separate debtor-in-

possession financing facilities, consisting of (a) an approximately $50.75 million facility

provided by an affiliate of Five Mile Capital Partners LLC, which will be secured by the 45

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properties securing the Fixed Rate Mortgages and two of the properties securing the Individual

Mortgages, and (b) an approximately $17.5 million term facility funded by an affiliate of

Lehman, secured by the properties securing the Floating Rate Mortgages (the “Lehman DIP”).

See Debtors’ Motion for the Entry of an Order Authorizing the Debtors to Obtain Postpetition

Financing from Five Mile Capital Partners on a Priming Basis Pursuant to Sections 364(c)(1),

364(c)(2), 364(c)(3), and 364(e) of the Bankruptcy Code [Docket No. 24] pp. 5-10.

12. The Debtors also filed a motion to obtain this Court’s approval to enter into the

PSA with Lehman. Other than the Debtors, the only party to the PSA is Lehman. The PSA and

its attached term sheet (the “Plan Term Sheet”)6 outline proposed terms for the Debtors’

restructuring (the “Proposed Restructuring”), which includes the distribution of 100% of the

new equity of reorganized Innkeepers (the “New Equity”) to Lehman in full and final

satisfaction of the Floating Rate Mortgage and a drastic reduction of the Fixed Rate Mortgage

and the Individual Mortgages. See PSA Motion ¶ 8. Lehman has then entered into an agreement

to sell half of the New Equity back to Apollo. See Motion of Lehman Commercial Paper Inc.

Pursuant to Section 363 of the Bankruptcy Code for Authority to (I) Consent to its Non-Debtor

Affiliate Lehman ALI Inc. (A) Entry Into Plan Support Agreement Related to the Restructuring of

Innkeepers USA Trust; and (B) Consummation of the Transactions Set Forth in the Plan Term

Sheet; and (II) Provide Funds to Solar Finance Inc., a Non-Debtor Affiliate, to Provide Debtor-

In-Possession Financing [Lehman Docket No. 10465].

13. The PSA prohibits the Debtors from negotiating, supporting, or engaging in any

discussions relating to any alternate chapter 11 plan or other transaction. See PSA § 5(c) and

6 The Plan Term Sheet is attached as Exhibit A to the PSA, which in turn is attached to the PSA Motion as Exhibit B.

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Plan Term Sheet p. 5. If the Debtors were to engage in discussions regarding an alternate

transaction, they could lose the use of Lehman’s cash collateral. See PSA §§ 6(r) and 8(a).

ARGUMENT

A. Entry Into the PSA Does Not Satisfy the Requirements of Section 365.

14. In order to justify their entry into the PSA, the Debtors must show that such entry

is supported by their sound business judgment, which judgment must be exercised fairly, and

without prejudice to parties in interest. See In re Nat’l Oil Company, 80 B.R. 525, 526 (Bankr.

D. Colo. 1987) (in explaining the requirement for court approval of a debtor’s decision to assume

or reject a contract, the court noted that such requirement “operates as a safeguard to protect

against a unilateral decision by the debtor that could be prejudicial to the creditors”); In re

Grayhall Resources, Inc., 63 B.R. 382, 384 (Bankr. D. Colo. 1986) (debtor may assume contracts

under section 365 where “assumption represents a sound business judgment on the part of the

Debtor and will not be prejudicial to the interest of the creditors”); see also Trak Auto Corp. v.

Ramco-Gershenson, Inc. (In re Trak Auto Corp.), 2002 WL 32129975, at *2 (Bankr. E.D. Va.

Jan. 9, 2002) (when reviewing a section 365 motion, bankruptcy court must “evaluate debtor’s

business judgment by considering the impact of the debtor’s decision on a variety of parties as

well as the impact on the debtor’s estate”). As discussed below, due to a multitude of

extraordinary provisions in the PSA, the Debtors have not adequately justified their entry into the

PSA.

i. The Debtors Have Not Adequately Justified the Need for the PSA.

15. The PSA does not provide the Debtors with the votes needed to confirm an

enterprise-wide reorganization and, as demonstrated by the events of the last few weeks, will not

spare these estates costly and contentious litigation. While there are a total of 92 Debtors, all of

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whom have signed the PSA, Lehman is the creditor of only 20 of the Debtors. There is no basis

for substantive consolidation in this case. There are separate asset pools, and separate lenders for

the Floating Rate Mortgage, the Fixed Rate Mortgage and the Individual Mortgages, with no

cross-collateralization. See Innkeepers Declaration ¶¶ 24-37. Accordingly, the Debtors must

secure at least one accepting class of impaired claims for each of the Debtors in order to confirm

a plan of reorganization in each of the 92 cases. 11 U.S.C. § 1129(a)(10). The PSA, which

comes with a hefty price, does not help accomplish that.

16. The PSA is not necessary to stabilize the Debtors’ businesses. As long as the two

critical components, cash collateral and the DIPs, remain available — as they should,

irrespective of what happens to the PSA — these cases will not be at risk of being a “free fall”

bankruptcy. As a result, the Debtors have never been able to articulate a valid justification for

entering into the PSA.

ii. The Termination Events and the Restrictions on the Debtors’ Ability to Negotiate With Other Parties in Interest Are Imprudent and Not Supported by Business Judgment.

17. Because the Debtors have coupled the PSA with their use of Lehman’s cash

collateral, the real question is not whether the termination events in the PSA (the “Termination

Events”) are reasonable for a PSA, but whether they are reasonable termination events for the

use of cash collateral.

18. The many Termination Events are more fully set forth in Section 6 of the PSA,

but they include:

• Certain plan milestones (the “Plan Milestones”) including the confirmation of a plan consistent with the Plan Term Sheet by 240 days after the Petition Date; See PSA § 6(a);

• Lehman having executed definitive documentation with respect to the sale of 50% of the equity in the reorganized Debtors by no later than September 2, 2010; See PSA § 6(b);

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• Lehman having consummated the sale of 50% of the equity by no later than 270 days after the Petition Date; See PSA § 6(c);

• The entry of any order of this Court granting relief from the automatic stay (i) to permit any exercise of remedies by the lenders or special servicer under the Fixed Rate Mortgage, the Individual Mortgages or certain other debt, other than limited relief solely to permit the delivery of default notices under the terms of the applicable credit agreements; or (ii) to permit termination of any franchise agreement; See PSA § 6(e);

• The filing by the Debtors of any motion or other request for relief seeking to (i) dismiss any of these cases, (ii) convert any of these cases to a case under chapter 7 of the Bankruptcy Code or (iii) appoint a trustee or an examiner with expanded powers pursuant to section 1104 of the Bankruptcy Code in any of these cases; See PSA § 6(f);

• The filing by the Debtors of a request to extend any of the Plan Milestones or to alter any of the remedies available upon termination of the PSA, or the failure of the Debtors to oppose any motion from any other party to obtain such extension; See PSA § 6(g);

• The entry of an order by this Court (i) dismissing any of these cases, (ii) converting any of these cases into a case under chapter 7 of the Bankruptcy Code, (iii) appointing a trustee or an examiner with expanded powers pursuant to section 1104 of the Bankruptcy Code in any of the cases, or (iv) making a finding of fraud, dishonesty or misconduct by any office or director of the Debtors, regarding or relating to the Debtors; See PSA § 6(h);

• The withdrawal, amendment or modification by the Debtors of, or the filing by the Debtors of a pleading seeking to amend or modify, the plan proposed under the PSA, or the PSA, which withdrawal, amendment, modification or pleading is materially inconsistent with the terms set form in the Plan Term Sheet or the related plan or is materially adverse to Lehman; See PSA § 6(i);

• The filing of any motion to approve a disclosure statement or plan by the Debtors that incorporates a pro forma capital structure or any terms inconsistent with the terms and conditions set for the in the Plan Term Sheet; See PSA § 6(j);

• The granting by this Court of relief that is inconsistent with the terms set forth in the Plan Term Sheet, or the related plan, in any material respect; See PSA § 6(k);

• The issuance by any governmental authority, including the Bankruptcy Court or any other regulatory authority or court of competent jurisdiction, of any ruling, determination or order making illegal or otherwise restricting, preventing or enjoining the consummation of a material portion of the Proposed Restructuring, including an order denying confirmation of the plan and such ruling,

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determination or order has not been vacated or reversed within five (5) business days; See PSA § 6(l);

• The occurrence and continuation of a default under either of the DIPs; See PSA §§ 6(m) & 6(n);

• The occurrence and continuation of a default in connection with the use of Lehman’s cash collateral; See PSA § 6(o);

• The occurrence of a material disruption or material adverse change in the financial, real estate, banking or capital markets (regardless of its affect on the Debtors); See PSA § 6(p);

• Lehman having determined by September 2, 2010, in its sole discretion, after completion of its tax due diligence, that the transaction contemplated by the Plan Term Sheet cannot be structured in a manner acceptable to Lehman; See PSA § 6(q); and

• The material breach by any party of any of their undertakings, representations, warranties or covenants set forth in the PSA. See PSA § 6(r).

19. Further, Section 5(c) of the PSA provides that neither Lehman nor the Debtors:

shall, directly or indirectly, seek, solicit, negotiate, support or engage in any discussions relating to or enter into any agreements relating to, any restructuring, plan of reorganization, dissolution, winding up, liquidation, reorganization, merger, transaction, sale or disposition (or [sic] all or substantially all of their assets or equity) other than as set forth in the Plan Term Sheet and the Plan, nor shall either Party solicit or direct any person or entity, including, without limitation, any member of any of the Parties’ board of directors or, as to the Company, any holder of equity in the Company, to undertake any of the foregoing . . .

See PSA § 5(c) (emphasis added) (capitalized terms as defined in the PSA). This provision,

when combined with the Termination Event in Section 6(r) of the PSA, will allow Lehman to

terminate the use of its cash collateral if the Debtors even discuss an alternate restructuring with

other parties in interest.

20. As discussed above, the Debtors need to recruit many additional votes in order to

confirm their proposed enterprise-wide transaction. But since they cannot propose any alternate

restructuring without triggering a Termination Event, the only way they could confirm a plan for

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each of the Debtors would be to convince voting classes at each of the remaining 72 Debtors to

sign on to this restructuring, all without the option of negotiating with such constituencies.

21. If the Termination Events merely triggered the loss of Lehman’s “support” for the

Proposed Restructuring, Appaloosa would not object to the PSA, as Lehman may condition its

support of a plan on any terms that it wishes. However, when such Termination Events and

restrictions also trigger a termination of the use of cash collateral, and in certain events, a lifting

of the automatic stay and allow for foreclosure by Lehman on its collateral, in each case, without

further order of this Court, they cannot be sustained.

22. The termination of the use of Lehman’s cash collateral is a serious threat, which,

if it occurred, would harm all parties in interest, not just the Floating Rate Debtors and their

creditors. Such cash collateral termination will leave the other secured creditors in these cases to

fund not only all business operations, but also these reorganization cases. This is particularly

true since the Cash Collateral Order (defined below) does not contemplate compartmentalizing

the cash of each Debtor or asset pool, but instead utilizes a consolidated cash management

system with hindsight reconciliation of each Debtor’s cash. Transcript of Hearing Held on July

20, 2010 (“7/20/10 Hr’g Tr.”) (excerpts cited herein attached as Exhibit C), at 72:1-22, 94:23-

95:15.

23. By definition, the multitude of Termination Events render Lehman’s support of

the Proposed Restructuring highly contingent. In fact, the Honorable Judge James Peck, the

Bankruptcy Court judge presiding over Lehman’s chapter 11 cases, recently cited the “highly

contingent” nature of Lehman’s support for the Proposed Restructuring as one of the reasons that

the Court was willing to authorize Lehman to enter into the PSA. See In re Lehman Brothers

Holdings Inc., et al., Case No. 08-13555 (JMP), Transcript of Hearing Held on Aug. 18, 2010

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(excerpts attached as Exhibit D) at 113:8-12 (“[This transaction] is, instead, approval of an

agreement which is highly contingent and subject, ultimately, to the judgment of my colleague,

Judge Chapman, as well as to the vagaries of the Innkeepers bankruptcy case itself, the future

course of which is unpredictable.”).7 Given these “outs”, the Debtors cannot forgo the ability to

negotiate with every other creditor, and make any breach of its PSA an opportunity for Lehman

to do significant harm to these estates. While Lehman can walk from the deal with impunity at

many different turns, if the Debtors were to walk, they and their estates and creditors could be

irreparably harmed.

iii. Fiduciaries Cannot Elect Not to Fulfill Their Duties.

24. The fiduciary out provisions of Section 25 of the PSA (the “Fiduciary Out”) are

impermissible. Section 25(c) of the PSA provides that:

The Company agrees that the Fiduciary Out shall not apply, and may not be used, to annul, modify, amend, or otherwise alter any of the Plan Milestones or any of the remedies in respect thereof; provided, however, that if the Company secures a binding and firm written commitment with respect to an alternative transaction that will provide Lehman with a higher and better recovery than the recovery proposed under the Plan (a “Firm Alternative Transaction”), the Company shall provide Lehman with at least ten (10) Business Days to determine whether Lehman will consent to such Firm Alternative Transaction. If Lehman does not consent to such Firm Alternative Transaction, the Company may only exercise the Fiduciary Out after it has obtained an order from the Bankruptcy Court authorizing the Company to exercise the Fiduciary Out in accordance with the terms hereof.

See PSA § 25(c) (capitalized terms as defined in the PSA).

25. At least 72 of the 92 Debtors cannot agree to this provision and fulfill their

fiduciary duties. It is undisputed that each of the Debtors owes fiduciary duties to its own

7 Appaloosa holds a significant claim in the bankruptcy case of Lehman Commercial Paper Inc., and appeared in that case to oppose approval of Lehman’s entry into the PSA and its sale of proposed recoveries from these cases to Apollo.

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creditors, including both their secured and unsecured creditors. In re Enron Corp., 2003 WL

1889040, at *8 (Bankr. S.D.N.Y. Apr. 17, 2003) (“[T]he duty of the trustee or debtor-in-

possession is to gather estate assets for pro rata distribution to all creditors. As such it has a

fiduciary duty to all creditors and must seek to protect the interests of all creditors collectively.”)

(internal citations omitted) (emphasis added); In re Ngan Gung Rest., 254 B.R. 566, 570 (Bankr.

S.D.N.Y. 2000) (“A trustee also owes a fiduciary duty to each creditor of the estate. As such, he

has a duty to treat all creditors fairly…”) (internal citations and quotes omitted) (emphasis

added); In re Centennial Textiles, Inc., 227 B.R. 606, 612 (Bankr. S.D.N.Y. 1998) (“A debtor in

possession owes the same fiduciary duty as a trustee to the creditors and the estate . . . . As

fiduciaries, the debtor in possession and its managers are obligated to treat all parties to the case

fairly, maximize the value of the estate, and protect and conserve the debtor’s property.”)

(internal citations and quotes omitted); In re Whitney Place Partners, 147 B.R. 619, 620-21

(N.D.Ga.1992) (“In a Chapter 11 case, the debtor in possession has a fiduciary duty to act not in

its own best interest, but rather in the best interest of the entire estate, including secured and

unsecured creditors.”).

26. It is well established that an agreement that involves committing a breach of

fiduciary duty is illegal and unenforceable on the grounds of public policy. See RESTATEMENT

(SECOND) OF CONTRACTS § 193 (2010) (“A promise by a fiduciary to violate his fiduciary duty

or a promise that tends to induce such a violation is unenforceable on grounds of public

policy.”); Kessler v. Jefferson Storage Corp., 125 F.2d 108, 110 (6th Cir. 1941) (“[W]here the

object or tendency of a contract is to constitute a breach of duty on the part of one who stands in

a confidential or fiduciary relation, it is illegal and void, as tending to be, or being, a fraud on

third persons.”). Bankruptcy courts honor this principle by refusing to approve or enforce

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agreements which would result in a violation of the debtor in possession’s fiduciary duties to the

estate. See In re U. S. Lines, Inc., 103 B.R. 427, 431 n.1 (Bankr. S.D.N.Y. 1989) (refusing to

enforce an agreement by a debtor in possession to abstain from objecting to fee applications

because “[a] promise by a fiduciary tending to violate his fiduciary duty is unenforceable on

grounds of public policy.”); In re Tenney Vill. Co., Inc., 104 B.R. 562, 569 (Bankr. D.N.H.

1989) (refusing to approve DIP facility on the basis “that the execution of the Financing

Agreement violates the Debtor’s fiduciary obligations to the estate”).

27. Even if this provision could somehow be justified for the 20 Debtors who count

Lehman as one of their creditors, 72 other Debtors cannot be allowed to forsake their duties to

their separate creditors in order to placate a single secured creditor of an affiliate. Even if a duty

could be bought (it can’t), here, 72 Debtors are receiving no consideration for Lehman’s

“support.” Such Debtors are procuring their own financing, using their own cash and facing a

highly contested valuation fight to determine if the Floating Rate Mortgage pool is claiming a

disproportionate amount of their enterprise value.

28. The Debtors have not articulated a sufficient business justification for entry into

the PSA and accordingly, this Court should deny the PSA Motion.

B. The Debtors Cannot Justify the Restrictions on Their Use of Cash Collateral on the Terms in the Cash Collateral Order.

i. The Debtors’ Authority to Use Cash Collateral Should Not Be Conditioned on the Success of the Proposed Restructuring.

29. The Debtors and Lehman seek to bind parties to a plan of reorganization through

a cash collateral order. As both the proposed cash collateral order (the “Cash Collateral

Order”) and the PSA provide that the Debtors’ use of cash collateral will terminate if the

Proposed Restructuring as set forth in the PSA does not proceed as planned, this gives Lehman

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the ability to do an end run around the chapter 11 process if the Proposed Restructuring is not

accomplished. See Cash Collateral Order, at ¶ 10(a)(xvii) (providing that a Termination Event

shall occur following applicable notice if “the Floating Rate Debtors breach any of their material

obligations arising in connection with the proposed restructuring of the Floating Rate

Obligations”); PSA, at ¶ 8(a) (Lehman may terminate use of its cash collateral upon occurrence

of any termination event, including the Debtors’ failure to meet certain plan milestones).

30. As the Debtors have acknowledged, “Use of the Cash Collateral is … of the

utmost importance to the preservation and maintenance of the value of the Debtors and essential

to the continued operations of the Debtors and the restructuring.” Cash Collateral Motion, at

¶ 26. Termination of the use of cash collateral would bring the Debtors’ business to an

“immediate halt” and have “disastrous consequences for the Debtors’ reputation, their business,

their ability to attract future customers, and their estates and creditors.”8 Id. By conditioning

such a critical function to the success or failure of the Proposed Restructuring, the Debtors have

essentially fashioned an agreement with Lehman that ties the Debtors’ fortunes, and

consequently the fortunes of all of their stakeholders, on a single plan formulated by and for the

benefit of Lehman and Apollo.9

8 Notably, the debtor-in-possession financing being provided in these cases may only be used for PIP work and other renovations, and cannot be used for ordinary course business expenses, making cash collateral the only source of funds to operate the Debtors on a day-to-day basis. See Lehman DIP Term Sheet, at 4; Five Mile DIP Term Sheet, at 5.

9 Although staged as a Lehman sponsored restructuring, recent discovery has confirmed that much of this restructuring is being driven by Apollo. The earliest versions of the PSA contemplated Apollo as a direct signatory and Michael Lascher of Lehman recently testified that Lehman has only and will only consider selling its interest in Innkeepers to Apollo. Lascher Dep. Tr. (Exh. A), at 71:20-72:8, 106:13-20, 127:2-7. For tactical reasons, these cases are being styled as a collaboration among the Debtors and Lehman, which are wholly separate from the “third party” transactions that may take place between Lehman and other parties. As will be explored later in these cases, this is an artifice.

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31. As articulated by the Second Circuit, “any agreement authorizing the use of cash

collateral under § 363(c)(2) must be approved by the bankruptcy court,” which “must satisfy

itself that the agreement complies with the Code.” In re Blackwood Assocs., L.P., 153 F.3d 61,

67 (2d Cir. 1998). The primary purpose of this review is to protect stakeholders who were not

parties to the agreement. Id. at 67-68 (“[T]here is seldom any need to protect the parties to the

agreement, who may be deemed to have waived their rights to the extent the agreement does not

comply with the Code.”) (quoting 9 Lawrence P. King, et al., COLLIER ON BANKRUPTCY (15th

ed. rev. 1998), ¶ 4001.07[4]).

32. Sections 363(c)(2) and (e) of the Bankruptcy Code authorize a debtor in

possession to use cash collateral if the secured party consents or the court authorizes such use

after concluding that the creditor’s interests in the cash collateral are adequately protected. See

Blackwood Assocs., 153 F.3d at 67; In re Vienna Park Props., 976 F.2d 106, 114 (2d Cir. 1992).

33. The Cash Collateral Order and PSA should be amended to eliminate Lehman’s

ability to terminate the use of its cash collateral based on a breach of the Debtors’ obligations

under the PSA or in connection with the Proposed Restructuring. Otherwise, waiver of the

Debtors’ right under the proposed Cash Collateral Order would be tantamount to presenting the

Debtors’ stakeholders with an ultimatum: support the Proposed Restructuring or watch the

Debtors’ value quickly and certainly erode along with any hope for restructuring.

34. Courts will refuse to approve terms in an agreement with secured creditors or

other constituents that would unduly restrict the Debtors, bias the course of the chapter 11

process or prejudice other stakeholders. See, e.g., In re Tenney Vill., 104 B.R. 562, 568 (Bankr.

D.N.H. 1989) (denying debtor authority to enter into financing agreement that provided stay

relief to permit secured creditors’ foreclosure without further court order upon termination events

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including the confirmation of a plan over the secured creditor’s objection or any other party in

interest taking any action against the lender on the basis that the overall effect of the agreement

“would disarm the debtor of all weapons usable against it for the bankruptcy estate’s benefit,

place the Debtor in bondage working for the Bank, seize control of the reins of reorganization,

and steal a march on other creditors in numerous ways. The Financing Agreement would pervert

the reorganizational process from one designed to accommodate all classes of creditors and

equity interests to one specially crafted for the benefit of the Bank and the Debtor’s principals

who guaranteed its debt.”); In re Ames Dept. Stores, Inc., 115 B.R. 34, 37, 40-41 (Bankr.

S.D.N.Y. 1990) (acknowledging, in the context of approving DIP financing only after

overreaching terms benefiting secured creditor were deleted, that “courts have focused their

attention on proposed terms that would tilt the conduct of the bankruptcy case; prejudice, at an

early stage, the powers and rights that the Bankruptcy Code confers for the benefit of all

creditors; or leverage the chapter 11 process by preventing motions by parties-in-interest from

being decided on their merits.”).

35. The Debtors are seeking to use the other Adequate Protection Parties’ (as defined

in the Cash Collateral Order) cash collateral without their consent based on the provision of

adequate protection in the form of expense reimbursements, adequate protection liens, section

507(b) claims, the “Cash Use Covenant” and other concessions. See Cash Collateral Motion at

¶¶ 23, 29-30. Since this very same adequate protection package is being provided to Lehman,

the Debtors have already argued that Lehman’s interests in its cash collateral will be adequately

protected regardless of whether it consents or not. Indeed, the Cash Collateral Motion and

Interim Cash Collateral Order both assert that the adequate protection package serves as

adequate protection for Lehman as well as the other Adequate Protection Parties. See Cash

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Collateral Motion, at ¶ 32 (“In light of the foregoing, the Debtors submit that the Proposed

Adequate Protection obligations are necessary and appropriate under the circumstances of the

Chapter 11 Cases to ensure the Debtors are able to continue to using Cash Collateral [which

includes Lehman’s cash collateral].”); Interim Cash Collateral Order, at ¶ 6 (“As adequate

protection for, and to the extent of, any diminution in the value of any Adequate Protection

Party’s [which includes Lehman] interest in the Prepetition Collateral [which includes Lehman’s

cash collateral]….”). Presumably Lehman would agree since its approval of the first day

motions, including the adequate protection package in the Cash Collateral Motion, is required

under the PSA. PSA, at § 5(b).

36. Since Lehman will be adequately protected under the Cash Collateral Order in

any event, no link to a plan should be approved.

ii. Cash Collateral Should Not Be Used to Finance Activities That Do Not Benefit the Estates.

37. Appaloosa further objects to the Cash Collateral Order to the extent that it

proposes to reimburse expenses of the Representatives (as defined therein) that do not benefit the

estate. A debtor’s use of cash collateral must be exercised on the basis of its sound business

judgment toward the goal of “maximizing the Debtors’ estates for the benefit of the Debtors’

creditors” to whom the debtor owes fiduciary duties. In re JTR Corp., 958 F.2d 602, 604 (4th

Cir. 1992); In re Enron Corp., 335 B.R. 22, 28 (S.D.N.Y. 2005) (court must, in considering a

request to approve use of estate property under Section 363(b), expressly find a “good business

reason” to grant such application, “act[ing] to further the diverse interests of the debtor, creditors

and equity holders.”) (citing In re Lionel Corp., 722 F.2d 1063, 1071 (2d Cir. 1983)).

38. Under the Cash Collateral Order, the Debtors propose to provide adequate

protection by, among other things, paying or reimbursing the fees and expenses of the

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Representatives’ attorneys and other professional advisors “in connection with matters relating to

this Order and to the obligations hereunder, and the plan support agreement among the Floating

Rate Lender and the Floating Rate Debtors.” Cash Collateral Order, at ¶ 6(a)(i). As an initial

matter, it is inappropriate to include these professional fees as adequate protection since the

Debtors have not established that the underlying loan documents would provide for such

reimbursement. See 11 U.S.C. § 506(b) (“To the extent that an allowed secured claim is secured

by property the value of which . . . is greater than the amount of such claim, there shall be

allowed to the holder of such claim… any reasonable fees, costs, or charges provided for under

the agreement or State statute under which such claim arose.”) (emphasis added). Further,

Appaloosa submits that, to the extent these professional services are rendered to terminate or

oppose the Debtors’ use of cash collateral based on the Debtors seeking to negotiate a

restructuring other than the Proposed Restructuring, reimbursement of such services would be

contrary to the best interests of these estates.

CONCLUSION

Appaloosa is not objecting to the Debtors’ use of cash collateral (as long as its use

is not conditioned upon the Proposed Restructuring), it is not objecting to the Debtors entry into

the DIPs, and Appaloosa is certainly not objecting at this stage to a plan that has yet to be filed.

However, Appaloosa is objecting to the Debtors’ attempt to bind themselves to an unnecessary

agreement which has not been shown to benefit these estates. For the foregoing reasons,

Appaloosa respectfully requests that this Court deny the Debtors’ request for authorization to

(a) enter into the PSA, and (b) to condition the use of cash collateral as described above.

Dated: New York, New York August 23, 2010

/s/ Lee S. Attanasio Lee S. Attanasio SIDLEY AUSTIN LLP 787 Seventh Avenue New York, New York 10019 (212) 839-5300 Counsel for Appaloosa Investment L.P. I

NY1 7379580v.2