room store-895-motion of the offical committee of unsecured creditors for entry of an order...
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Tyler P. Brown (VSB No. 28072)Justin F. Paget (VSB No. 77949)
Eric W. Flynn (VSB No. 78488)
HUNTON &WILLIAMS LLP
Riverfront Plaza, East Tower
951 East Byrd Street
Richmond, Virginia 23219-4074
Telephone: (804) 788-8200
Telecopier: (804) 788-8218
Counsel for the Official
Committee of Unsecured Creditors
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE EASTERN DISTRICT OF VIRGINIA
RICHMOND DIVISION
In re:
ROOMSTORE, INC.
Debtor.
Chapter 11
Case No.: 11-37790-DOT
MOTION OF THE OFFICIAL COMMITTEE OF UNSECUREDCREDITORS FOR ENTRY OF AN ORDER DIRECTING
THE APPOINTMENT OF A CHAPTER 11 TRUSTEE
The Official Committee of Unsecured Creditors (the Committee) of RoomStore, Inc.,
(the Debtor) hereby moves this Court (the Motion) for entry of an order pursuant to sections
105(a), 1104(a)(1),1104(a)(2) and 1104(c) of title 11 of the United States Code (as amended, the
Bankruptcy Code) and Rules 2007.1 and 9014 of the Federal Rules of Bankruptcy Procedure
(the Bankruptcy Rules), appointing a chapter 11 trustee. In support of the Motion, the
Committee respectfully states as follows:
Preliminary Statement
The current situation for unsecured creditors is dire. On July 18, 2012, the DIP lender
served notice on the Committee that it has declared defaults under the DIP loan and intends to
exercise its rights against its collateral, which is comprised of the Debtors remaining assets. It
did so in part because it just learned, as did the Committee, that, despite collecting sales taxes
from customers, the Debtor did not pay those sales taxes to the taxing authorities as it had
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represented to the DIP lender that either it had done or was going to do in its borrowing
certificates. Instead, it used those funds to pay other expenses. Upon information and belief, the
DIP lender has not agreed to fund the Debtors wind-down because, similar to the Committee, it
has lost all faith and confidence in the Debtors Board of Directors (the Board) due to this and
other transgressions.
Throughout this bankruptcy proceeding the Committee has been concerned that the
Board, dominated by the heavy hand of the Chairman of the Board, Steven L. Gidumal (the
Chairman), was pursuing a motive other than maximizing the recovery for unsecured creditors.
The Debtors proposed plan of reorganization and disclosure statement have confirmed what the
Committee suspected, that the Board was adopting a risk it all strategy for an unachievable
distribution to the holders of equity security interests, including the hedge fund run by its
Chairman. Sadly, it is only now, after the Board has piloted the Debtor to complete and utter
financial ruin, that the Committees suspicions have been confirmed.
The Court should order the immediate appointment of a chapter 11 trustee in order to
protect the value remaining in the Debtors substantial non-operating assets for unsecured
creditors for the following reasons. First, the appointment of a chapter 11 trustee represents what
may be the last hope for convincing the DIP lender to fund an orderly wind-down. The
Committee, and upon information and belief, the DIP lender, have lost all faith and confidence in
the abilities of the Board to manage the Debtors remaining affairs, which has caused the current
standstill over funding, as a result of the following indiscretions of the Debtor:
Failure to pay sales taxes of up to $2 million despite collecting those taxes fromcustomers and using those funds to pay other expenses, despite representing to theDIP lender that those taxes were being paid;
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Filing a disclosure statement and chapter 11 plan just prior to the Court-approvedextension of exclusivity that proposes to distribute money to equity securityholders before unsecured creditors are to be paid in full;
Seeking approval of a chapter 11 plan that would maintain control of the Debtorin designees of the current Board, while simultaneously attempting to retaincontrol over fiduciary duty claims that the Committee believes the Debtors estatehas against members of the Board;
Filing a disclosure statement that recklessly suggests to creditors they mayachieve an 80% return on their claims, when the Debtor knew at the time of filingthat such a result was unachievable;
Burning close to $10 million in operating cash and incurring significantlyincreased administrative claims at a time when the Debtor was wildly missing itssales and cash forecasts and knew it soon would be out of cash;
Running the retail operations to the point of absolute illiquidity, despite knowingby April 2012 that even hitting unachieved sales targets would lead to continueddeterioration of liquidity without a cash infusion;
The Chairmans refusal to allow the Debtor to honor its agreement with theCommittee to permit the Debtors financial advisor to prepare by February 1,2012, an outline and timeline for a going concern sale process of the retail storesand MDG to be put in place in advance of a liquidation;
The Boards failure to market for sale the Debtors 65% interest in MattressDiscounters Group LLC (MDG) before running out of cash, including its failure
to hire an investment banker acceptable to the DIP lender and the Committee,despite the Debtors obligation to do so in a stipulation and Court Order for thepurpose of marketing those assets as soon as possible.
The willful failure of the Chairman and the outside directors on the Board tocomply with the Rule 2004 Order by their repeated delay and refusal to turn overto the Committee the documents requested;
Despite repeated demands for the Debtors compliance, the Debtors willfulviolation of the Final DIP Orders requirement that the Debtor establish and funda Professional Fee Escrow Account, which the Committee specifically negotiated
as part of its consent to the DIP Loan;
Collecting payments earmarked for rent from the acquirer of the Dallas GOBinventory and lease designation rights and then, risking default under that sale,diverting those payments from the intended landlords to fund other expenses; and
Allowing its retail stores to accept deposits, and, in some cases, full payment,from customers for merchandise to be delivered in the future when the Debtors
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Board must have concluded previously that delivery of the merchandise wasunachievable.
Second, the interests of creditors would be best served by the appointment of a
professional to handle the Debtors wind-down who understands the importance of transparency
and fiduciary obligations to the Court and parties in interest, which the Board has failed to
achieve as evidenced by the following transgressions by the Debtor:
Interference by the Board, and particularly the Chairman, with the Debtor usingthe bankruptcy professionals retained by the Debtor to carry out the work theywere hired to do;
Failing to disclose the Chairmans secret $2 million bid for the minority interestin MDG early in the bankruptcy case, at a time when the Chairman was on theBoard and simultaneously was acting as one of the Debtors representatives on theboard of managers of MDG;
Failing to disclose that a current member of the Board was for many years, and upto one month before the bankruptcy filing, a licensed real estate agent with thefirm retained as the Debtors real estate professional and using that professionaloutside its scope of employment so that the Chairman could control the marketingprocess of the Debtors Dallas retail stores; and
Objecting to the fees of the Debtors and Committees professionals for thepurpose of managing cash flow and without proper grounds.
Any one of these indiscretions and events would, standing alone, support the appointment
of a trustee in the interests of creditors. When taken together, they demonstrate real concerns
about the Boards duties of care and loyalty, suggest, at a minimum, gross negligence in the
management of the Debtor, and compel the appointment of a chapter 11 trustee as being in the
best interests of creditors, who have completely lost confidence in the Debtors Board and
Chairman. Despite repeated requests of the Committee, the Board has refused to cede control
absent protection from the claims the Committee believes a trustee or other independent party
should investigate against the Board.
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The immediate appointment of a chapter 11 trustee may allow the major constituencies to
negotiate an agreement with the DIP lender for wind-down funding and an expeditious, but
appropriate, process for the marketing and sale of the Debtors remaining assets, including its
interest in MDG. The funding of such process is essential to preserving value for unsecured
creditors. As the Debtor has proven, it cannot hope to achieve a successful outcome because of
the lost confidence by all major constituents, and the current refusal of the DIP lender to fund
any wind-down process.
Allowing the Committee and other creditor constituencies a chance to reach an agreement
with a chapter 11 trustee for a fair wind-down process, without interference from the current
Board, is preferable to conversion of the case to chapter 7. Value to creditors will best be
preserved by allowing an independent professional to consider the options while the Debtor still
employs the back-office staff that supplies shared services to Mattress Discounters, of which the
Debtor is a 65% interest holder, and still has both the staff and retail employees that are needed
to support the ongoing retail store liquidation efforts being run by the Hilco JV and others. In
short, immediate conversion may increase administrative claims against the estate, while also
decreasing the value to creditors of the remaining assets if operations are completely shut down.
Having a chapter 11 trustee appointed will allow for consideration of all options.
Jurisdiction
1. This Court has jurisdiction over the Motion pursuant to 28 U.S.C. 157 and1334. This is a core proceeding pursuant to 28 U.S.C. 157(b)(2). Venue is proper before this
Court pursuant to 28 U.S.C. 1408 and 1409.
2. The statutory predicates for the relief requested herein are sections 105(a) and1104 of the Bankruptcy Code.
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Background
General Background
3. On December 12, 2011 (the Petition Date), the Debtor filed a voluntary petitionfor relief under chapter 11 of title 11 of the Bankruptcy Code. Pursuant to sections 1107 and
1108 of the Bankruptcy Code, the Debtor is continuing to operate its business and manage its
properties as a debtor in possession.
4. On December 19, 2011, the Office of the United States Trustee for the EasternDistrict of Virginia, Richmond Division (the UST) appointed the Committee to represent all
unsecured creditors of the Debtor pursuant to section 1102 of the Bankruptcy Code.
5. The Debtor initially obtained post-petition financing (the DIP Loan) from WellsFargo, N.A. (Wells Fargo), but the Debtor found a replacement lender in Salus Capital, LLC
(Salus), authorized pursuant to this Courts Order (I) Authorizing Debtor to Enter into
Amendment Agreement with Salus Capital Partners, LLC and (II) Supplementing Final
Financing Order(the Supplemental DIP Order) [Doc. No. 339], entered on February 8, 2012.
6. The Chairman is the founder and President of Virtus Capital LP, a hedge fund,which owns 487,338 shares in the Debtor, which equates to just under 5% of the equity security
interests, the threshold for public reporting of trades in the stock. He was appointed to the Board
in April 2011 at the request of Virtus and one or more other hedge funds who hold large blocks
of shares in the Debtor. He became Chairman in the month prior to the Petition Date, when the
prior chairman resigned.
The Failure to Secure Wind-Down Financing and Revelations of Misdirected Funds
7. On July 18, 2012, Salus sent a notice to the Debtor, the Committee, and theUnited States Trustee stating that it has declared defaults under the DIP loan and intends to
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exercise its rights against its collateral, which is comprised of the Debtors remaining assets.
After three business days, Salus will have the authority under the Final DIP Order to begin
exercising its rights, including foreclosing or commencing Article 9 liquidation sales of the
Debtors remaining assets. The Committee believes that appointing a chapter 11 trustee may
facilitate an agreement with Salus to fund an expeditious, but appropriate, marketing process of
the Debtors remaining assets in lieu of a foreclosure or fire sale.
8. The inability of the Debtor to secure funding for the wind-down has put atsubstantial risk the value of the MDG interests. While that asset is the most valuable asset of the
estate, it is being put in jeopardy because Salus wants to be paid back its DIP Loan in short
order. Meanwhile, the minority interest holder in MDG, Ray Bojanowski, wants to buy out the
Debtors interest from Salus. Unless there is a fair auction process for the MDG interests, the
estate may not recover fair value for those interests. If a trustee is not appointed to negotiate an
appropriate wind-down budget with Salus, Salus may look for a quick sale of the interests to Mr.
Bojanowski, which will harm unsecured creditors. Having a chapter 11 trustee at the table may
help achieve a fair sale process.
9. The Committee has recently learned that the unwillingness of Salus to agree tofund the Debtors wind-down derives from, upon information and belief, the mismanagement of
the Debtors finances and misdirecting of funds.
10. For example, the Debtor collected sales taxes from its customers, or received salestaxes from the purchaser of the Debtors Dallas store assets, and then paid those amounts to
Salus as payments on the DIP loan. When Salus subsequently funded amounts under the budget
for the sales taxes, the Debtor used such amounts to pay other expenses, resulting in the accrual
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of up to $2 million in back sales taxes. By using these amounts for other purposes, the Debtor is
out of trust.
11. The Debtors refusal to recognize (or competently anticipate) its liquidity issuesalso caused the Debtor to miss making payroll on time for the wage period ending on June 29,
2012. The Debtor also failed to timely pay rent at a number of its stores despite receiving funds
earmarked for rent from the purchaser of the Debtors Dallas store assets. While Salus later
agreed to fund the payroll under the DIP Loan on an emergency basis, as well as rent, Salus has
not accepted the Debtors latest proposed budget.
12.
In addition, the Debtor received deposits and, in certain cases, full payment from
customers for merchandise ordered as long ago as May 2012, but is now unable to fulfill those
orders or provide refunds to customers. Indeed, the Debtor currently is directing customers to its
website, www.roomstore.com, which has been replaced with two links -- one to a short letter
stating that the company is out of business, and the other to a proof of administrative expense
claim form. It appears that the Debtor has collected and used these deposits to fund other
expenses and must have known, at some point in this process, that collecting deposits from
consumers was no longer consistent with operating in good faith.
13. After the Final Store Closing, as a result of these revelations, the Debtor failed tosecure wind-down funding and operated on an individual expenditure approval basis with Salus,
which has resulted in gross inefficiencies during the wind-down process and squabbling over
receipts submitted for as little as thirteen dollars. This manner of operating proved
unsustainable.
The Debtors Hastily Filed Plan and Disclosure Statement
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14. On February 16, 2012, the Debtor filed itsMotion for Entry of an Order Pursuantto 11 U.S.C. 1121(d) Extending Debtors Exclusive Periods in Which to File a Chapter 11 Plan
and Solicit Votes Thereon (the Exclusivity Motion) [Doc. No. 353], requesting an extension of
the exclusive periods for filing and soliciting votes on a chapter 11 plan. In support of that
motion, the Debtor stated, among other things, that it had timely paid its post-petition debts,
which the Committee has subsequently learned was inaccurate. The Committee objected to the
Exclusivity Motion, see Doc. No. 427, citing as its principal concerns the failure of the Debtor to
demonstrate any reasonable prospect for a viable plan and the operational cash burn that was
occurring during the pursuit of a turnaround without adequate consideration of a sale of the
business.
15. On April 3, 2012, at the hearing on the Exclusivity Motion, the Court overruledthe Committees objection, but limited the Debtors extension to 60 days for the filing of a plan.
16. On June 6, 2012, on the eve of the expiration of the Debtors exclusive filingperiod, the Debtor filed its chapter 11 plan (the Plan) and disclosure statement (the Disclosure
Statement). [Doc. Nos. 633 and 634, respectively]. The Debtor failed to negotiate with the
Committee any of the terms of the Plan or the contents of the Disclosure Statement prior to
filing.1 The Plan and Disclosure Statement were filed after the Debtor had run out of cash, had
stopped paying many vendors, landlords, and professionals, and had accepted deposits, and, in
1 On the eve of filing the Plan, Debtors counsel discussed with Committee counsel the fact that certain provisions of
the proposed Plan might not be acceptable to the Committee, but might be negotiated later. After the Plan was filed,the Committee first learned, for example, that control of the estate is proposed under the Plan to remain with a Board
to be controlled by persons selected by the existing Board, and the Plan contemplates a distribution to equity after
unsecured creditors achieve an 80% distribution on their claims. The Debtor has said the Board is unwilling to cede
control absent a release of threatened fiduciary duty claims. And, while the proposed Plan directly violated the
absolute priority rule, it is abundantly clear now that unsecured creditors will never obtain 80% and equity,
therefore, will receive nothing under the proposed Plan. Thus, while certain of the provisions might have been
subject to negotiation after the Plan was filed, the Plan reveals what the Board was trying to achieve in this case,
control over the assets to try to obtain a recovery for equity, irrespective of its fiduciary duties to unsecured
creditors.
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some cases, full payment, from customers for merchandise that it knew it could not deliver. See
www.roomstore.com, Notice of Store Closing and Proof of Administrative Claim (to which the
Debtor asked Committee professionals to direct all customers who requested refunds or to pick-
up furniture that they had ordered).
17. Incredibly, despite the Debtor running out of cash and accruing significantadministrative claims, the Disclosure Statement projects a payout to unsecured creditors of
100% (less 20% depending on the Debtors realization of certain tax credits, which would then
be paid over to current equity holders). How the Debtor could achieve this result when
scheduled claims total more than $26.5 million and filed claims total approximately $38.5
million is beyond the understanding of the Committee. SeeDisclosure Statement, at 16.
18. The Disclosure Statement also provides that the Debtor expects from the sale ofits Operating Assets to obtain more than sufficient funds to pay in full the Allowed Secured
Claim of Salus. Disclosure Statement, at 18.
19. Notwithstanding that the Debtor actually may be administratively insolvent, theDisclosure Statement provides that under the terms of the Plan, the Debtors current Board of
Directors will retain control over the disposition of the Debtors remaining assets. Under the
terms of the Plan, a new Board will be created with majority control held by current Board
members. See Plan 6.04. This will permit the current Board to control all causes of action of
the Debtors estate, including potential claims against the very same Board members that
oversaw the collapse of the company. The current Board is aware of these potential claims as a
result of the General Liability Notice of Occurrence/Claim that the Debtor filed with its D&O
insurance carrier on March 23, 2012, after receipt of notice from the Committee that claims may
exist against the Board.
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Substantial Operating Losses and Missed Forecasts During the Case
20. The Debtor has suffered an extraordinary operational cash burn since the PetitionDate. The Debtor has missed its forecasted sales nearly 80% of the time and typically by
between 20% and 55% to the downside.2
21. In order to manage its cash over the course of the bankruptcy, the Debtorimplemented a plan to avoid paying parties who did not demand cash before providing services
or delivering goods, such as bankruptcy professionals and certain vendors. For example, on
April 16 and 17, 2012, in a series of emails, the Board made a premeditated decision to object to
all professional fees above a threshold amount, as follows:
No Professional bills will be paid until I [the CEO] approve them andnotify [the Chairman].
We will object to all unreasonable invoices (FTI, Lowenstein, HuntonWilliams [sic], A&M and Kaplan (Lowensteins local counsel --TroySavenko) which will take (according to Brian) 15 days to dispute andpossibly another 15 days to reconcile after 30 days (or so) dating to bebilled.
Greenberg Traurig is a bit more challenging. Since they are counsel toSalus, they do not bill us, they bill Salus, who pays them and sweeps ouraccount.
2 The Debtor was able to avoid breaching its financial covenants with Salus for several months because the budget
test imposed under the DIP Loan did not test compliance with sales or liquidity. SeeThird Amendment to Loan and
Security Agreement 1.2(o) [Doc. No. 339]. Not until the Debtor and Salus entered into the Fifth Amendment to
Loan and Security Agreement, dated as of April 19, 2012 (the Fifth Amendment), did Salus impose a budget test
on sales (and liquidity), which substantive change the Debtor omitted in its description of the terms of the FifthAmendment in its motion filed with Court. See Motion to Approve Fifth Amendment 12 [Doc. No. 514] (The
majority of the amended terms are not material.); Fifth Amendment 1.6. Instead, the Debtor touted the benefit
of the removal of line item expense testing -- the very testing that allowed the Debtor to perpetuate its substantial
operating losses without defaulting under the terms of the DIP Loan. SeeMotion to Approve Fifth Amendment
13.
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Email from S.Giordano (Apr. 17, 2012 12:04 PM) [Exhibit A]3.
22. Upon information and belief, the Debtor also withheld payment for over fivemonths from certain of its vendors who were willing to provide the Debtor credit post-petition,
despite personal assurance of payment from the Debtors CEO. See Motion for Allowance of
Administrative Claim for Post-Petition Goods Provided [Doc. No. 778] (On post-petition debt of
$654,204.50, [t]he Debtor has failed to make a single payment on any invoice since the Petition
Date, despite multiple promises from its President and Chief Executive Officer, Steve
Giordano.); Email from J.Bookner (June 11, 2012 12:31PM) [Exhibit B] (failure to pay
$178,705.93 for post-petition deliveries).
23. By April 17, 2012, a mere two weeks after the hearing on the DebtorsExclusivity Motion, the Debtors CEO informed the Board that the Debtor had entered into a
cyclical process whereby growing back-orders of merchandise meant that even if we do well
in sales, we will hit the demand of $7M per month and be in a worse position in June. Email
from S.Giordano (Apr. 17, 2012 6:06 PM). In other words, by April 2012, the Board knew that
the Debtors retail store operations were in a death spiral without an infusion of millions of
dollars for additional inventory, but declined to act to save any value for unsecured creditors.
Incredibly, the Debtors CEOs email makes reference to the fact that at least one of the Board
members had always maintained [this] would happen. Id.
3 Certain Exhibits referenced in this Motion have been provided by the Debtor to the Committee and have been
marked confidential. The Committee entered into a Confidentiality Agreement, dated December 23, 2011,
pursuant to which the Committee agreed not to publicly disclose certain information received from the Debtor. The
Committee is seeking consent from the Debtor to file with the Court those Exhibits to which the Committee believes
the Confidentiality Agreement may apply. In the event the Debtor does not consent, the Committee will seek to file
those Exhibits under seal.
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The Liquidation of the Debtors Retail Stores and Remaining Secured Obligations
24. Despite implementing desperate measures to stretch its finances, including failingto pay bankruptcy professionals, failing to pay vendors, failing to return customer deposits, using
funds provided by Salus under the budget for rent and sales taxes to pay other expenses, and
stonewalling attempts by the Committee to commence a marketing process of the Debtor to
potential strategic and financial buyers, the Debtor finally succumbed. On June 7, 2012, with
essentially all liquidity exhausted, the Debtor filed a motion to approve the auction of its
remaining retail store assets (the Final Store Closing). See Doc. No. 637. This final step
concluded what was over the course of the case essentially a long, drawn-out liquidation of the
Debtors retail store assets while burning through over $9 million of operating cash that could
have been paid to creditors on their unsecured claims.
25. In total contradiction of the statement in the Disclosure Statement, despiteconducting the Final Store Closing, and having received all but a small percentage of payments
from the purchasers of the assets, there remains an outstanding secured obligation owed to Salus
of approximately $1.5 million with significant accrued, but unpaid post-petition liabilities,
including up to $2 million in sales taxes.
Control of the Debtors Remaining Assets
26. Apart from the assets associated with the Debtors retail stores, the Debtor alsoowns a 65% equity interest in MDG, a Virginia limited liability company that operates
approximately eighty-one retail bedding stores in Delaware, District of Columbia, Maryland and
Virginia. MDG is not a debtor in these proceedings. MDG is profitable. The Debtor has valued
its 65% interest in MDG at between $7.8 million and $19.5 million, see Disclosure Statement at
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19, although the Committee has never seen an independent valuation supporting the Debtors
valuation range.
27. Recently, the Committee learned that the Chairman, who owns an equity stake inthe Debtor through a hedge fund he founded, approached Mr. Bojanowski, the minority
stakeholder in MDG, and offered him $2,000,000 for his interest in MDG after the filing of the
bankruptcy case. This fact was not disclosed by the Debtor to the Committee, and only become
known to the Committee through a pleading recently filed by Mr. Bojanowski. See Declaration
of Raymond T. Bojanowski, Exhibit A [Doc. No. 747]. The Chairman was, at the time of the
offer, both a director on the Debtors Board and one of the Debtors representatives on MDGs
board of managers.
28. In connection with the Stipulation and Agreed Order Between Debtor and OfficialCommittee of Unsecured Creditors Relating to Fifth Amendment to Loan and Security
Agreement[Doc No. 557], the Debtor was required to retain an investment banker to market the
Debtors interest in MDG. Without the Committees consent, the Debtor filed an application to
retain Northeast Securities Inc. (Northeast) to sell its interest in MDG. See Application to
Retain and Employ Northeast Securities, Inc. as Investment Banker for the Debtor and Debtor in
Possession Effective as of May 17, 2012 (the Northeast Application) [Doc. No. 588]. The
Committee expressed concern regarding Northeasts qualification and experience and the
Debtors selection process, and proposed four alternative candidates for the Debtor to consider.
29. The Debtors criteria in selecting Northeast was not immediately clear from theNortheast Application. Rather, in the Debtors Omnibus Reply to Objections to the Application
to Retain and Employ Northeast Securities, Inc. as Investment Banker for the Debtor and Debtor
in Possession Effective as of May 17, 2012 Pursuant to 11 U.S.C. 327, 328(a) and 1107 and
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Bankruptcy Rules 2014 and 2016 (the NE Omnibus Response) [Doc. No. 735], filed in
response to the objection of the Committee and others, the Debtor states that the alternative
investment bankers proposed by the Committee were unsuitable because,
[w]hen asked to provide their estimates of proper valuation multiples for MDG,[three of the four alternatives] gave estimates below segment norms and wellbelow the Boards internal valuation estimates, and [the fourth alternative] did notdirectly respond. Northeast, on the other hand, gave an estimate in line with theBoards internal benchmark, supported by comparable transactions that the Boardviewed as appropriate.
NE Omnibus Response 17. In other words, the three alternative investment bankers that gave
independent indications of value different from the Boards opinion (i.e., the Chairmans) were
rejected out of hand by the Debtor. The Board thus sought to retain the only investment banker
that held out hope for a return to equity.
30. The Debtor also owns a 31% equity interest in Creative Distribution Services,LLC (CDS). CDS is a Virginia limited liability company that was formed for the purpose of
buying and holding real estate. CDS owns a former retail store operated by the Debtor in
Lanham, Maryland, and a distribution center in Orangeburg, South Carolina, which is currently
leased to Husqvarna. The Debtor has valued its interest in CDS at between $2.7 million and $3.7
million. Disclosure Statement, at 19. The Committee is not aware of any agreement by other
members of CDS to this valuation, or to their consent for the Debtors planned disposition of
these assets.
31. In addition, the Debtor owns a distribution center in Rocky Mount, NorthCarolina that served as the Debtors main distribution center for its furniture business. Upon
information and belief, the Rocky Mount distribution center is unencumbered. The Debtor has
valued this asset at between $4 million and $5.5 million. Disclosure Statement, at 19. Again, the
Committee has never seen an independent valuation of this asset.
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32. Pursuant to the Disclosure Statement and Plan, the Debtor proposes that a newBoard be formed for the reorganized entity, the majority of which would be comprised of
members of the current Board, see Disclosure Statement, at 32, which presumably would include
the Chairman, to manage and sell the Debtors remaining assets. That new Board would have
unfettered discretion to make decisions about the liquidation of the remaining assets without any
timeframe, parameters or oversight by unsecured creditors (other than a minority position on the
new Board), which have the most at stake in the liquidation process.
33. Upon information and belief, these uncertain timelines have contributed to therefusal of Salus to fund the Debtors wind-down. Absent the appointment of a chapter 11
trustee, the Debtor likely will not have the opportunity to pursue any meaningful marketing
process to sell its remaining assets. A chapter 11 trustee will have the opportunity to negotiate
with Salus and the other major constituents for an expeditious, but appropriate, marketing and
sale process for MDG to pay the balance owed to Salus in full and permit the orderly sale of the
Debtors remaining assets.
Relief Requested
34. By this Motion, the Committee respectfully requests entry of an order directingthe immediate appointment of a chapter 11 trustee to replace the Board pursuant to sections
105(a), 1104(a)(1) and/or 1104(a)(2) of the Bankruptcy Code.
Basis for Relief Requested
A. Standard for Appointment of Chapter 11 Trustee
35. Section 1104(a) of the Bankruptcy Code provides that at any time after thecommencement of a chapter 11 case but prior to confirmation of a plan, a bankruptcy court shall
order the appointment of a trustee:
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(1) for cause, including fraud, dishonesty, incompetence, or grossmismanagement of the affairs of the debtor by current management, either beforeor after the commencement of the case, or similar cause, but not including thenumber of holders of securities of the debtor or amount of assets or liabilities ofthe debtor; or
(2) if such appointment is in the interests of creditors, any equity security holders,and other interests of the estate, without regard to the number of holders ofsecurities of the debtor or the amount of assets of liabilities of the debtor.
11 U.S.C. 1104(a). The two subsections of 1104(a) are written in the disjunctive, requiring
that a movant meet one of the two standards for appointment of a chapter 11 trustee.
36. Even though appointment of a chapter 11 trustee is generally considered anextraordinary remedy, if cause is found under 1104(a)(1), appointment of a chapter 11 trustee
is mandatory. In re Funge Systems, Inc., 2002 Bankr. LEXIS 1937 (Bankr. E.D. Va. October 17,
2002) (citing Marvel Entertainment, 140 F.3d at 471).
37. Further, if cause exists, a motion for appointment of a trustee should be filed evenprior to expiration of the debtors exclusive periods in order to avoid unnecessary cost and delay
in a chapter 11 case. See e.g., In re Colorado-Ute Elec. Assn., Inc., 120 B.R. 164, 175 (Bankr.
D. Colo. 1990) ([I]f facts and circumstances warrant the appointment of a trustee, it is not
appropriate to wait to file [a trustee motion] until the termination of the exclusive period. Such a
deferral will only further delay the progress toward the effective rehabilitation and reorganization
of the debtor.).
38. Even in the absence of cause, the Court may still appoint a trustee pursuant tosection 1104(a)(2) if it is in the interest of creditors, any equity security holders, and other
interests of the estate. 11 U.S.C. 1104(a)(2); see also, In re Sharon Steel Corp., 871 F.2d
1217, 1226 (3d Cir. 1989) (Subsection (a)(2) allows appointment of a trustee even if no cause
exists.); In re Euro-American Lodging Corp., 365 B.R. 421, 428 (Bankr. S.D.N.Y. 2007)
(same); and In re Ionosphere Clubs, Inc., 113 B.R. 164, 168 (Bankr. S.D.N.Y. 1990) (same).
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39. A moving party has the burden of showing by clear and convincing evidencethat the appointment of a trustee is warranted. In re Tanglewood Farms, Inc., Case No. 10-
06719-8-JRL, 2011 WL 606820 at *2 (Bankr. E.D.N.C. Feb. 10, 2011); see also, Adams v.
Marwil (In re Bayou Group, LLC), 564 F.3d 541, 546 (2d Cir. 2009).
40. There are many factual scenarios that have been held to support the appointmentof a trustee under section 1104(a), many of which are relevant here, including:
material conflicts of interest preventing the debtor from discharging itsfiduciary duties to creditors;4
a lack of confidence in the debtors abilities to manage its business anddischarge its fiduciary duties;
5
and
acrimony between the debtor and its creditors;641. The Committee submits that the circumstances of this case warrant appointment
of a chapter 11 trustee under each of the two bases provided in section 1104(a). As a result of
the Boards conduct in this case, cause exists under section 1104(a)(1) to replace the Board
4See, e.g., Marvel, 140 F.3d at 471; Cajun Elec., 69 F.3d at 751;In re Eurospark Indus., Inc., 424 B.R.621 (Bankr. E.D.N.Y. 2010);In re Euro-American Lodging Corp., 365 B.R. 421 (S.D.N.Y. 2007);In reBellevue Place Assocs., 171 B.R. 615 (Bankr. N.D. Ill. 1994);In re Microwave Prods. of Am., Inc., 102B.R. 666 (Bankr. W.D. Tenn. 1989);In re McCorhill Publg Inc., 73 B.R. 1013 (Bankr. S.D.N.Y. 1987);In re Humphreys Pest Control Franchises, Inc., 40 B.R. 174 (Bankr. E.D. Pa. 1984);In re Great Ne.Lumber & Millwork Corp., 20 B.R. 610 (Bankr. E.D. Pa. 1982);In re Philadelphia Athletic Club, Inc., 15B.R. 60 (Bankr. E.D. Pa. 1981); Smith v. Concord Coal Corp. (In re Concord Coal Corp)., 11 B.R. 552(Bankr. S.D. W. Va. 1981);In re L.S. Good & Co., 8 B.R. 312 (Bankr. W. Va. 1980).
5See, e.g., Sharon Steel, 871 F.2d 1217; Petit, 182 B.R. 64;Eurospark Indus., 424 B.R. 621; Colorado-
Ute Elec. Assn., 120 B.R. at 176;Microwave Prods. of Am., 102 B.R. 666; Concord Coal Corp., 11 B.R.552.
6See, e.g.,Marvel, 140 F.3d at 471-72; Cajun Elec. Power Coop. v. Cent. La. Elec. Co. (In re Cajun
Elec. Power Coop.), 69 F.3d 746, 751 (5th Cir. 1995), majority op. withdrawn and dissenting op.adopted, 74 F.3d 599, 600 (5th Cir. 1996); Petit v. New England Mortg. Servs. Inc., 182 B.R. 64 (D. Me.1995); Colorado-Ute Elec. Assn., 120 B.R. at 176;In re Bible Speaks, 74 B.R. 511 (Bankr. D. Mass.1987).
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with a chapter 11 trustee. In addition, the interests of creditors would be best served by the
appointment of an independent chapter 11 trustee pursuant to section 1104(a)(2).
B. Cause Exists Under Section 1104(a)(1) for Replacement of the Debtors Board of
Directors with an Independent Chapter 11 Trustee
42. Section 1104(a)(1) sets forth a nonexclusive list of factual predicates that supporta finding of cause for the appointment of a chapter 11 trustee, including fraud, dishonesty,
incompetence, or gross mismanagement of the affairs of the debtor by current management.
11 U.S.C. 1104(a)(1); see also In re IPofA West Oaks Mall, LP, Case No. 07-33649-KRH,
2007 WL 3223295, at *3 (Bankr. E.D. Va. Oct. 29, 2007) (the list of bases upon which cause
may be found for the appointment of a chapter 11 trustee under 1104(a) is nonexclusive); In re
Ricco, Inc., 2010 Bankr. LEXIS 1916 (Bankr. N.D. W. Va. June 28, 2010); Gomez v. United
States, 2010 U.S. Dist. LEXIS 14403, 4-5 (W.D. Va. Feb. 18, 2010); and In re Marvel Entmt
Group, Inc., 140 F.3d 463, 472 (3d Cir. 1998).
43. The Fourth Circuit has held that section 1104(a)(1) should be flexibly appliedbecause the concepts of incompetence, dishonesty, gross mismanagement and even fraud all
cover a wide spectrum of conduct. Comm. of Dalkon Shield Claimants v. A.H. Robins Co.,
Inc., 828 F.2d 239, 242 (4th Cir. 1987).
44. A chapter 11 debtor owes fiduciary duties to its estate, including obligations toprotect and conserve property in its possession for the benefit of creditors and [to refrain] from
acting in a manner which could damage the estate, or hinder a successful reorganization.
Ionosphere, 113 B.R. at 169 (citations omitted); see also West Oaks Mall, 2007 WL 3223295 at
*3. Where a debtors management suffers from material conflicts of interest that prevent it from
discharging its fiduciary duties, an independent trustee should be appointed. See West Oaks
Mall, 2007 WL 3223295, at *3; see also,Marvel, 140 F.3d at 473 and Cajun Electric, 74 F.3d at
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600. Indeed, the willingness of courts to leave debtors in possession is premised upon an
assurance that the officers and managing employees can be depended upon to carry out the
fiduciary responsibilities of a trustee. Commodity Futures Trading Commn. v. Weintraub,
471 U.S. 343, 355 (1985). Therefore, the appointment of a trustee is a power which is critical
for the Court to exercise in order to preserve the integrity of the bankruptcy process and to insure
that the interests of creditors are served. Intercat, Inc., 247 B.R at 920.
45. For example, in In re Cardinal Industries, Inc., 109 B.R. 755 (Bankr. S.D. Ohio1990), the Official Committees of Unsecured Creditors of the two debtors moved for the
appointment of a chapter 11 trustee under section 1104(a)(1) by alleging (1) a lack or
responsiveness by the debtor to communications and requests by the committees for financial
and other information; (2) concern regarding the accuracy of the debtors record keeping; (3) an
inability to stem operational losses; (4) unreasonable delay in marketing and selling unneeded
assets; (5) conflicts in interest; and (6) a stalled negotiation process of the debtors chapter 11
plan. The bankruptcy court in Cardinal Industries held that notwithstanding the lack of clear
evidence of dishonesty or fraud, the factors cited by the committees, when taken together,
supported the appointment of a trustee pursuant to 1104(a)(1) because they evidenced a serious
loss of confidence in current management.
46. Similarly, in In re Ionosphere Clubs, Inc., 113 B.R. 164 (Bankr. S.D.N.Y. 1990),the bankruptcy court appointed a chapter 11 trustee upon the Official Committee of Unsecured
Creditors motion pursuant to section 1104(a)(1). The bankruptcy court cited to the Debtors
inability to formulate a business plan and make operating projections which have a longevity of
more than several months, along with the continuing enormous operating losses being sustained
by the estate. Ionosphere, 113 B.R. at 170. In addition, the bankruptcy court noted the
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demonstrated insufficient stability and resolve [of the Debtors] in keeping to its promises and
agreements with the Committee and the risk posed to unsecured creditors funds by keeping
in place current management. Id. The bankruptcy court refused to credit the Debtors arguments
that leaks from the Committee and a general market downturn were to blame. Id. at 171.
47. In this case, there are a number of factors remarkably similar to the ones set forthin Cardinal Industries and Ionosphere that demonstrate a total loss of confidence in current
management by the Committee, Salus, individual creditors, and other parties in interest, and the
need for the immediate appointment of an independent chapter 11 trustee.
Gross Inability to Accurately Forecast Finances, Sustained Operational Losses andMisdirected Funds Have Resulted in the Inability to Secure Wind-Down Funding
48. Substantial operating losses combined with an inability of management to reliablyforecast operating results are sufficient grounds for appointment of a chapter 11 trustee. See In
re Ionosphere Clubs, Inc., 113 B.R. 164, 170 (Bankr. S.D.N.Y. 1990). In this case, the Debtor
incurred substantial operating losses, far in excess of managements forecast. For example,
between the Petition Date and the week ending March 4, 2012, a forecast period of less than four
months, the Debtor incurred operational losses in excess $5.2 million with a projected loss of
only $3.5 million. See DIP Budget (Jan. 18, 2012). Stated differently, the Debtor under-
forecasted its short-term operational cash burn by nearly 50%.
49. The Debtors longer term forecast of its operational cash burn missed actualresults by an even greater degree. The Debtor projected an operational cash burn of $3.6 million
between the Petition Date and the week ending June 17, 2012. During that time period, the
Debtor incurred an actual operational cash burn of $8.5 million, representing a miss of its
forecast by an astonishing $4.9 million, or 136%.
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50. Information provided in the Disclosure Statement also reflects currentmanagements gross inability to value its assets. The Debtor stated that it expected more than
sufficient funds from the auction of its remaining retail store assets to pay its DIP lender in full.
Instead, the Debtor currently owes Salus approximately $1.5 million, and has unpaid sales taxes
of perhaps as much as $2 million that Salus believed already had been paid.
51. Incredibly, the Disclosure Statement also provides that unsecured creditors willreceive a 100% payout of the allowed amount of their claims (less 20% carved out for equity
holders). In contrast, the Debtor has scheduled unsecured claims totaling nearly $27 million.7
The Debtor currently owes approximately $1.5 million to Salus, owes up to $2 million in back
sales taxes, has not paid professionals since February, and has accrued substantial other
administrative expense claims, see Motion for Allowance of Administrative Claim for Post-
Petition Goods Provided [Doc. No. 778]. Thus, no calculation, even assuming the very highest
(and unsupportable) valuations in the Disclosure Statement and unprecedented success in claims
reconciliation, could result in a 100% return to unsecured creditors. These facts demonstrate
either the Debtors total incompetence or that the Disclosure Statement reflects the continued
illusion regarding the prospects for the Debtors reorganization created by the Chairman and the
Board.
52. Of significant concern to the Committee was the Boards refusal to recognize andstop the Debtors death spiral after the communication from the Debtors CEO in mid-April
2012. At that point, the Board knew that the Debtors liquidity situation would continue to
deteriorate, regardless of improvement in sales, unless the Debtor received a major cash infusion.
Email from S.Giordano (Apr. 17, 2012 6:06 PM) [Exhibit A]. At least one of the Board
7 Filed proofs of claim total approximately $38.5 million, but this does not include substantial lease rejection
damages that have yet to be filed. Disclosure Statement, at 16.
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members had predicted this outcome. Id. The Chairman, who had taken it upon himself to
handle capital raising, knew that a cash infusion before June would be impossible. Gidumal Tr.
141:3-7 (Mar. 29, 2012) [Exhibit D]; 175:8-24 (Mar. 30, 2012) [Exhibit D]. The Committee
submits that the Boards refusal to shut down operations much earlier than it did significantly
reduced the potential distribution to unsecured creditors.
53. Instead of making a decision in the best interest of creditors to pursue strategicalternatives, including considering the immediate commencement of GOB sales in April 2012,
the Board, led by its Chairman, drove the Debtor off the financial cliff. The lack of funding
caused the Debtor to miss payroll temporarily and created serious confusion and concern among
the Debtors remaining employees at a time when the estate desperately needs their continued
service in order to carryout the retail store liquidations. Moreover, the Debtor collected amounts
from the purchaser of the Debtors Dallas store assets that were earmarked for the payment of
rent and used those amounts to pay other expenses. As the Committee has now learned, the
situation grew so dire that the Board misdirected amounts received from Salus under the budget
for the payment of sales taxes in an amount up to $2 million. As a result, Salus has lost all faith
in the Board, refused to fund the Debtors wind-down operations, and has issued a notice that it
has declared defaults under the DIP loan and intends to exercise its rights under the Final DIP
Order to foreclose or liquidate its collateral, which includes the Debtors remaining assets.
54. The immediate appointment of a chapter 11 trustee may salvage any opportunityto reach an agreement with Salus for wind-down funding, which will permit an orderly
liquidation of the Debtors remaining assets. A chapter 11 trustee, with the assistance from
Committee professionals, should be able to quickly prepare a reasonable budget for the Debtors
wind-down and may instill needed confidence in the continued negotiations for funding.
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The Chairman and the Board Have Demonstrated Allegiance to Equity Holders Over
Unsecured Creditors
55. The Committee believes that the Chairman and the Board have disregardedfiduciary duties to maximize value for unsecured creditors in their pursuit of a return for equity.
The Court need only look to the Plan and Disclosure Statement as evidence. At the hearing on
the Exclusivity Motion, the Court heard evidence regarding the Debtors substantial operational
cash burn and the Debtors failure to utilize its bankruptcy professionals, particularly its financial
advisor. The Court gave the Debtor 60 additional days to file a plan, but the Board squandered
the opportunity by continuing to fail to involve the Debtors financial advisor in the process and
by filing an unconfirmable chapter 11 plan that calls for a distribution to equity holders before
unsecured creditors are paid in full.
56. According to the Debtors proposed Disclosure Statement:[D]epending on the amount received from the Debtors Assets, includingthe MDG Interest and CDS Interest, there is a reasonable likelihood that[current equity holders] may receive a distribution in the future.
The limitation on the payment [of 80%] to Holders of Allowed UnsecuredClaims is, in part, due to the delay in Interest Holders being able to utilizea tax benefit by recognizing a potential loss of the value of their Interestsupon Confirmation of the Plan, which in turn directly benefits UnsecuredCreditors.
Disclosure Statement, at 21. The logic in the consideration supporting the carve out of 20% from
the return of unsecured creditors and payment of that amount to equity could only come from
someone putting the interests of equity first. It is black letter law that, under the absolute priority
rule, any assets of the Debtors estate, including tax benefits, must be received by unsecured
creditors until their claims are paid in full, before equity interests are eligible to receive a
distribution. SeeBank of America Natl Trust & Savings Assn. v. 203 N. LaSalle St., 526 U.S.
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434, 119, S.Ct. 1411, 143 L.Ed. 2d. 607 (1999) (referencing the requirement of Bankruptcy Code
1129(b)(2)(B)(ii)).
57. The Plan also provides for the continued control of the Debtors affairs post-confirmation by the current Board members. The Debtor only offers a token minority seat to a
representative of the unsecured creditors. Plan 6.04. Thus, under the terms of the Plan, the
current Board would control potential claims of the Debtors estate against current Board
members, when the Board is aware that such claims may exist following the General Liability
Notice of Occurrence/Claim sent to the Debtors D&O insurance carrier on March 23, 2012.
This is just another example of the Chairman and the Board serving the wrong master in
violation of its fiduciary duties to unsecured creditors.
58. The Chairman and Boards allegiance to equity is further evidenced by theirblackbox approach to managing the bankruptcy. For example, the Chairman fed only selective
information to the Debtors bankruptcy professionals. On one particular meeting of the Debtors
bankruptcy professionals with representatives of Salus, neither Debtors counsel nor financial
advisor could answer key questions regarding the strategic plans of the Debtor. S.Coulombe Tr.
35:12-25, 36:1-14 (Apr. 3, 2012) [Exhibit E]; S.Coulombe Tr. 49:9-25, 50:1-24 (Mar. 20, 2012)
[Exhibit F].
59. The Chairman also improperly utilized the Debtors real estate professional tonegotiate the sale of the Debtors Dallas store inventory when that professional was only
approved to market the Debtors leases. See Objection to Debtors Application for Order
Supplementing Order Authorizing Employment and Retention of Julius M. Feinblum Real Estate
Consultant Nunc Pro Tunc [Doc. No. 745]. The Chairman insisted on using the real estate
professional because the Chairman knew that he could ultimately exercise unfettered control
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over the negotiation of the sales transaction. S.Giordano Tr. 56:11-25, 57:1-10 (Mar. 22, 2012)
[Exhibit G].
60. In order to conceal his allegiance to equity, the Chairman compartmentalized notonly the Debtors professionals, but members of senior management as well. For example, the
Chairman relieved the Debtors CEO of any involvement with exploring strategic alternatives,
equity raising, or negotiating the sale of assets, and restricted or attempted to restrict the Debtors
CEO from contact with the Committee, Salus, the Debtors real estate professional, and Mr.
Bojanowski. S. Giordano Tr. 52:19-25, 53:1-7 (Mar. 20, 2012) [Exhibit G]; Email from
S.Giordano (Feb. 22, 2012 10:52 AM) [Exhibit H]; Email from S.Gidumal (Mar. 12, 2012 4:15
PM) [Exhibit I] (When Giordano butts in on this as inevitably he will do, please tell him to deal
through me. Steve [Giordano] has been stripped of all negotiating authority on the leases and on
Dallas.); Email from S.Gidumal (Mar. 5, 2012 4:20 PM) [Exhibit J] (expressing annoyance with
the CEOs unilateral Salus meeting and referencing that such meeting would be discussed at
the Board meeting where the CEO was stripped of his authority). The Chairman then
misrepresented to the Debtors CEO that he had gotten us the exit funding. Email from
S.Giordano (Feb. 22, 2012 10:52 AM) [Exhibit H].
61. Even now, with the illusion surrounding the prospects of reorganization of theDebtors retail stores evaporated, the Chairman will not give up control of the Debtor absent a
release for all of his transgressions to date. These claims must be investigated by an independent
party. A trustee likely will conclude, as the Committee has concluded, that the Chairmans goal
throughout the case was a return for equity, which he sought to pursue through control of the
Debtors interest in MDG, irrespective of what the value of that asset may have meant for
restructuring the Debtor. In fact, the Chairmans paramount interest has always been MDG. As
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the Chairman testified during this deposition, he would never sell the Debtors interest in MDG,
even if it meant saving Roomstore. Gidumal Tr. 137:21-25, 138:1 [Exhibit D].
62. The Chairmans post-petition attempt to acquire the minority interest in MDGcomports with his plan. The plan all along was to carefully control, manage, and reap a windfall
from the long-term sale of MDG. Thus, it is not a total surprise that Mr. Bojanowski recently
revealed that he received an undisclosed offer by the Chairman of $2,000,000 for his minority
interest in MDG after the Petition Date. Of course, as the Chairman also sat on the board of
managers of MDG at the time, his failure to disclose his offer is inexcusable.
63.
Evidence of the Chairmans wayward plan also flows from the Debtors attempt
to hire Northeast as its investment banker to market MDG. The Committee, Salus, and Mr.
Bojanowski objected to the proposed retention of Northeast because of doubts concerning the
process employed by the Chairman in selecting Northeast, and in Northeasts experience in the
relevant industry. SeeLimited Response of Raymond T. Bojanowski [Doc No. 629]; Committee
Objection [Doc No. 710]; Salus Response [Doc. No. 748]; and Surreply of Raymond T.
Bojanowski [Doc No. 747]. The Debtor decided to hire Northeast over the alternative
investment bankers proposed by the Committee solely because [w]hen asked to provide their
estimates of proper valuation multiples for MDG, [three of the four alternatives] gave estimates
below segment norms and well below the Boards internal valuation estimates, and [the fourth
alternative] did not directly respond. Omnibus Response 17 [Doc. No. 735]. In other words,
the Chairman dismissed the alternative investment banker candidates because they disagreed
with his unrealistic valuation of MDG, instead providing suggestions of value that would not
realize a return for equity. Only on the day of the hearing, facing objections from each major
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creditor constituency, did the Chairman realize his folly, and the Debtor asked to continue the
matter. But, the damage has been done.
64. Ironically, as a result of the Chairmans approach to this case, the realization ofany meaningful value from MDG is at risk. Unless the Court appoints a chapter 11 trustee to
negotiate a potential expeditious, but appropriate, marketing process for MDG, the estate may
not recover the full value for the Debtors interest in that asset.
Numerous Indiscretions by the Debtor Under the Iron Grip of the Chairman Have
Resulted in the Loss of Confidence in the Debtor
65. In conjunction with the gross inaccuracy of the Debtors financial projections, andits extraordinary cash burn, the numerous indiscretions of the Debtor under the thumb of the
Chairman have caused a total loss of confidence in the Board by the Committee, and upon
information and belief, Salus, individual creditors, and Mr. Bojanowski. A significant loss of
confidence in management by the very parties that the Debtor must deal with in order to
successfully navigate this bankruptcy case is grounds for appointment of a chapter 11 trustee.
See In re Cardinal Industries, Inc., 109 B.R. 755, 765 (Bankr. S.D. Ohio 1990).
66. One such indiscretion was the breach of two agreements with the Committee, oneof which was embodied in a stipulation and agreed order. As the bankruptcy court in Ionosphere
pointed to, breaches of agreements with the Committee support the appointment of a chapter 11
trustee. Ionosphere, 113 B.R. at 170.
67. The first occurred, as the Committee has previously articulated, following entryby the Debtor on February 1, 2012, into a side letter agreement with the Committee. The Debtor
agreed to provide a timeline and outline of a process for marketing the company as a going
concern to potential strategic buyers. The purpose of this request was to preserve value for
unsecured creditors that would be lost if the Debtor was forced to liquidate based on a default on
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the DIP loan or failure to achieve milestones accompanying the DIP Loan. Upon information
and belief, the Chairman directed the Debtor to disregard its obligations under the side letter,
failing to hold even a single Board meeting to discuss the marketing of the Debtor to a strategic
buyer as envisioned in the side letter. As the Committee now believes, had the Debtor marketed
its business as a going concern, the illusion of the prospect for the Debtors reorganization would
have disappeared in time for significant value for unsecured creditors to have been preserved.
68. The second occurred when the Debtor breached its agreement to begin a processfor marketing the Debtors interest in MDG. Pursuant to the Fifth Amendment Stipulation, which
the Committee demanded be embodied in a court order as a result of the Debtors breach of the
side letter, the Debtor agreed to execute a retention agreement with an investment banker on or
before May 18, 2012, and to implement a marketing process for the Debtors interest in MDG as
soon as possible. Fifth Amendment Stipulation 3 [Doc. No. 557]. Rather than jointly seek an
investment banker candidate with the Committee, or ask for a list of candidates acceptable to the
Committee, the Chairman, as has become customary, embarked on his own search and produced
a candidate that neither the Committee, Salus nor Mr. Bojanowski found acceptable.
69. The Committee agreed to the Debtor having more time to select an alternativeinvestment banker premised on the condition that the Debtor contact and consider the alternative
investment bankers offered by the Committee. As discussed above, the Chairman then dismissed
the alternative bankers because they offered a realistic valuation of MDG.
70. If the Chairman was truly interested in acting on behalf of unsecured creditors, hewould not have adopted such an antagonistic position in connection with the retention of an
investment banker to sell a non-operating asset, presumably for the primary if not exclusive
benefit of unsecured creditors, particularly when it was a stipulation with the Committee that
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drove the process. As a result, the Committee and other creditors have no confidence in the
ability of the Board to dispose of the Debtors remaining assets in a way that benefits unsecured
creditors.
71. The Debtor also breached the Final Order Authorizing the Debtor to Obtain Post-Petition Financing (Final DIP Order) [Doc. No. 222] despite repeated requests from the
Committee to comply. Section 2.5.3 of the Final DIP Order provides:
Each Friday, the Debtor will utilize a portion of the proceeds of theRevolving Credit Loans extended by Agent and Lenders to Debtor inaccordance with the terms and conditions set forth in the Loan Agreementand the other Loan Documents to wire into an escrow acccout for the
benefit of the Professionals (the Professional Fee Escrow Account).
This provision in the Final DIP Order was specifically negotiated by the Committee in
connection with the Committees agreement to consent to the DIP Loan. Upon repeated
inquiries, the Debtor finally admitted to never funding the Professional Fee Escrow Account.
Email from L.Brubaker (Apr. 20, 2012 7:36 PM) [Exhibit K] (noting that escrow payments were
not scheduled until June 2012). Further, despite agreement by the Debtor at the request of the
Committee to fund the Professional Fee Escrow Account with catch-up payments, upon
information and belief, the Debtor has not funded the Professional Fee Escrow Account with a
single dime during the pendency of this case. Instead, professionals of the estate have not been
paid since February, which would not have occurred if the Debtor had complied with the Final
DIP Order.
72. Rather than ensure that sufficient funding would be available for professionals toproperly serve the Debtor and the Committee, the Chairman has directed the Debtor to object to
professionals requests for payment. For example, in mid-April, sensing an impending cash
shortage, the Debtor, under the direction of the Chairman, adopted a plan to object to all
professional invoices that exceeded a threshold amount. Email from S.Gidumal (Apr. 16, 2012
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7:09 PM) [Exhibit A] ([I]t may require a bit of flexibility among you, me, Lewis and Brian to
pull this all of timely in a way that helps Roomstores cash levels.). In furtherance of this plan,
the Debtor prepared its objections to professional fees, including those of the Debtors, Saluss
and the Committees professionals, prior to receiving the professionals monthly fee statements.
Email from S.Giordano (Apr. 16, 2012 5:55 PM) [Exhibit A] (The only invoice we have
received so far for March is a big one from Greenburg Traurig [sic]. Brian is waiting until we
get the fourth DIP amendment signed before sending a letter he drafted to Greenburg Traurig
[sic] and others (when we are invoiced) which he will use as a basis for his court objections on
professional fees in general.) (emphasis added). The Debtor has since continued to object to
professional fees without asserting a sound basis in an apparent attempt to manage cash flow,
contributing to the loss of confidence in current management.
73. Confidence in the Chairman and the Board also has been lost as a result of thelack of cooperation with the Committees investigation. As set forth in the Committees Rule
2004 Motion [Doc. No. 450] and the Motion for Show Cause [Doc. No. 567], the Debtor has
been slow and non-responsive to certain of the Committees request for documents necessary for
the Committee to conduct its investigation of the Debtors acts, conduct, assets, liabilities and
financial condition pursuant to section 1103(c). Despite numerous requests from the
Committee, and the Courts entry of an order requiring the Debtor to produce documents, the
Committee still believes that the Debtor has refused to fully respond to the document requests,
particularly as the relate to the Chairman and the Board. Letter to A.Behlmann [Exhibit L].
74. The Debtors failure to disclose key facts in this bankruptcy case also havecontributed to the total loss of confidence in current management. For example, the Debtor
failed to disclose that its Chairman of the Board himself approached [the minority interest
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holder of MDG] post-bankruptcy with an offer of approximately $2 million to purchase [the
minority interest holders] 35% interest in MDG. Declaration of Raymond T. Bojanowski
[Doc. No. 747]. The Debtor also failed to disclose that a member of the Board was a licensed
real estate agent with the Debtors real estate professional for a number of years and as recently
as one month prior to the Petition Date.
75. To inject confidence into the remainder of this case, the Court should appoint achapter 11 trustee. An independent fiduciary may improve negotiations with Salus to secure
funding for the Debtors wind-down, and salvage significant value for the Debtors remaining
assets through an expeditious, but appropriate, marketing process.
B. Appointment of a Trustee Under Section 1104(a)(2) Would be in the Best Interest of
Creditors
76. Section 1104(a)(2) provides a more flexible standard for appointment and givesthe court discretion to appoint a trustee when to do so would serve the parties and estates
interest. Marvel, 140 F.3d at 474. In determining whether a trustee should be appointed under
section 1104(a)(2), courts lookto the practical realities and necessities. Ionoshpere, 113
B.R. at 168 (quoting Hotel Assocs., Inc. v. Trustees of Cent. States Se. & Sw. Areas Pension
Fund (In re Hotel Assocs., Inc.), 3 B.R. 343, 345 (Bankr. E.D. Pa. 1980)). Among the factors
considered by courts are:
(i) the trustworthiness of the debtor; (ii) the debtor in possessions past andpresent performance and prospect for the debtors rehabilitation; (iii) theconfidence - or lack thereof - of the business community and of creditors inpresent management; and (iv) the benefits derived by the appointment of a trustee,
balanced against the cost of the appointment.
Ionosphere, 113 B.R. at 168 (citations omitted).
77. The Committee submits that the reasons cited above support the appointment of achapter 11 trustee under section 1104(a)(1), but also support the appointment of a trustee under
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section 1104(a)(2). In addition, under section 1104(a)(2), the Court should weigh the costs of
appointing a trustee against the benefits.
78. At this juncture of the case, the Debtor has cut its staff down to those essentialemployees required to run the support systems for the liquidators. Most mid-level and some
senior management have been terminated. The Debtor is no longer operating retail stores. The
Committee believes that the cost of installing a trustee would be minimal given the current stage
of the wind-down of the Debtors operations.
79. However, there is substantial value in the Debtors remaining assets that deservesto be under the auspices of an independent bankruptcy professional. With the total loss of
confidence in the Board, and conflicts of interest that drive the Chairmans decision making
(with the Boards acquiescence), the Committee submits that the benefits of a trustee far
outweigh the costs. Moreover, the inability of the Debtor to reach an agreement with Salus
regarding the financing of the wind-down, and the intent of Salus to exercise its rights under the
Final DIP Order to foreclose on its collateral, leaves significant risk and potential harm to the
assets remaining in the estate.
80. Acrimony between a debtor and its creditors is another basis for the appointmentof a trustee under section 1104(a)(2). Marvel, 140 F.3d at 472. See also, In re V. Savino Oil &
Heating Co., 99 B.R. 518, 527 n.11 (Bankr.E.D.N.Y. 1989) (Where, as here, it appears that no
meaningful progress towards reorganization is possible because of deep rooted animosities
between a Debtor and major creditors, an independent reorganization trustee may well be
necessary to insulate the reorganization process from paralytic conflict.).
81. Obstructionist behavior by the Chairman has poisoned the relationship betweenthe Committee, as well as other creditors and interested parties, and the Debtor. As discussed
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above, the Chairman has refused to cooperate fully with the Committees document requests.
His compartmentalization of the Debtors bankruptcy professionals has left the Committee, at
times, with very limited access to important information.
82. So long as the Chairman and the current Board remains, the Committee andindividual creditors of the Debtors estate simply cannot trust the Board to perform in a manner
that will be in the best interests of the Debtors estate or creditors. The Committees
investigation and other facts in this case have revealed the Chairmans true agenda. As a result,
if the Board remains as presently staffed, the balance of this case will surely be unnecessarily
litigious, expensive, and unproductive. Given its severity, this acrimony between the Board and
the Committee, in and of itself, is sufficient reason to appoint a chapter 11 trustee. Moreover, if
Salus exercises its rights against its collateral, a quick sale of the Debtors interest in MDG
without a marketing process may result in the substantial loss of value for the estate. The
appointment of chapter 11 trustee may represent the last hope for unsecured creditors to realize
any value in this case.
Notice
83. Notice of this Motion has been given to the Core Group and the 2002 List asrequired by the Order Establishing Notice, Case Management and Administrative Procedures
[Docket No. 189] and Local Bankruptcy Rule 2004-1.8 In light of the nature of the relief
requested, the Committee submits that no further notice is required.
WHEREFORE, the Committee respectfully request that this Court appoint a chapter 11
trustee to replace the Debtors Board of Directors, and such other and further relief as this Court
deems appropriate.
8 Capitalized terms used in this paragraph 22 but not otherwise defined herein shall have the meanings set
forth in the Order Establishing Notice, Case Management and Administrative Procedures [Docket No. 189].
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Dated: July 19, 2012 HUNTON & WILLIAMS LLP
/s/Justin F. PagetTyler P. Brown (VSB No. 28072)
Justin F. Paget (VSB No. 77949)Eric W. Flynn (VSB No. 78488)HUNTON &WILLIAMS LLPRiverfront Plaza, East Tower951 East Byrd StreetRichmond, Virginia 23219-4074Telephone: (804) 788-8200Telecopier: (804) 788-8218
Counsel for the OfficialCommittee of Unsecured Creditors
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LOCAL BANKRUPTCY RULE 2002-1 CERTIFICATE OF SERVICE
I hereby certify on this 19th day of July, 2012, a copy of the foregoing was delivered byelectronic means to all parties who receive notice in this case pursuant to the Courts CM/ECFsystem and/or by electronic mail pursuant to the Order Establishing Notice, Case Managementand Administrative Procedures [Docket No. 189] docketed in this case.
/s/ Justin F. PagetTyler P. Brown (VSB No. 28072)Justin F. Paget (VSB No. 77949)Eric W. Flynn (VSB No. 78488)HUNTON &WILLIAMS LLPRiverfront Plaza, East Tower951 East Byrd StreetRichmond, Virginia 23219-4074
Telephone: (804) 788-8200Telecopier: (804) 788-8218
Counsel for the Official Committee of Unsecured Creditors
79005.000002 EMF_US 41193613v4
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Exhibit A
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[POTENTIALLY SUBJECT TO CONFIDENTIALITY AGREEMENT - Omitted Pending
Debtors Consent or Motion to File Under Seal]
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Exhibit B
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Lambert, Matthew A.
From: Brookner, Jason [[email protected]]
Sent: Monday, June 11, 2012 12:31 PM
To: [email protected]; [email protected]; Brown, Tyler; Paget, Justin F.
Cc: King, BruceSubject: RoomStore: Post-petition Payables to Steve Silver Company
Attachments: Roomstore post petition AR.pdf
Page 1 of 2
7/3/2012
Gentlemen (and in particular, Ken and Bruce), we represent Steve Silver Company, a prepetition and postpetitioncreditor of The RoomStore, Inc.
The Debtor has failed to pay $178,705.93 in postpetition payables to Steve Silver, for postpetition deliveriesmade. Such amounts are now past due. A schedule showing the invoice amounts, dates due, etc. is attachedhereto for your convenience.
There is also an additional $17,175.08 coming due between June 21 and June 23, as well as another $11,224.73
coming due on August 7, all for deliveries that have already been made.
Please advise whether the Debtor will promptly make payment of the past due amounts and whether the Debtorintends to promptly pay the amounts coming due in June and August (or whether the Debtor is willing to pay theJune and August amounts right now). If the Debtor has any issues/disputes with the attached spreadsheet,please let us know so that we can work through any such issues/disputes in an effort to avoid the time andexpense for both parties in connection with filing a request for payment of administrative claim and having acontested hearing.
Many thanks in advance.
Jason S. Brookner
Partner
Andrews Kurth LLP1717 Main Street, Suite 3700, Dallas, Texas 75201214.659.4457 Phone | 214.659.4829 Fax
450 Lexington Avenue, New York, New York 10017212.850.2835 Phone | 212.850.2929 FaxEmail:[email protected]
vCard | Bio | andrewskurth.com
Confidentiality Notice: The information contained in this e-mail and any attachments to it may belegally privileged and include confidential information intended only for the recipient(s) identifiedabove. If you are not one of those intended recipients, you are hereby notified that any dissemination,distribution or copying of this e-mail or its attachments is strictly prohibited. If you have received this e-mail in error, please notify the sender of that fact by return e-mail and permanently delete the e-mail andany attachments to it immediately. Please do not retain, copy or use this e-mail or its attachments for anypurpose, nor disclose all or any part of its contents to any other person. Thank you
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Treasury Circular 230 Disclosure: Any tax advice in this e-mail (including any attachment) is notintended or written to be used, and cannot be used, by any person, for the purpose of avoiding penaltiesthat may be imposed on the person. If this e-mail is used or referred to in connection with the promotingor marketing of any transaction(s) or matter(s), it should be construed as written to support thepromoting or marketing of the transaction(s) or matter(s), and the taxpayer should seek advice based onthe taxpayer's particular circumstances from an independent tax advisor.
Page 2 of 2
7/3/2012
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Roomstore,Inc.Postpetitionopeninvoices(after12/12/2011bankruptcydate)
SUMMARYASOF6/11/2012:
PastDue 178,705.93
Due6/216/23/2012 17,175.08
Due8/7/2012 11,224.73
TOTAL
at
6/11/2012 207,105.74
DETAILINVOICESAT6/11/2012:
Invoice# InvDate DueDate Terms InvoiceAmt OpenAmt DaysOld
1041361 12/30/2011 1/29/2012 Net30 24.50 24.50 164
1046030 1/19/2012 5/18/2012 Net120 11,084.70 5,454.75 144
1046596 1/23/2012 5/22/2012 Net120 33,471.64 16,394.28 140
1061218 3/22/2012 4/21/2012 Net30 102.90 102.90 81
1064294 4/2/2012 5/2/2012 Net30 20.58 20.58 70
1064419 4/3/2012 5/3/2012 Net30 102.90 102.90 69
1064526 4/3/2012 5/3/2012 Net30 41,946.84 41,946.84 69
1064534 4/3/2012 5/3/2012 Net30 7,472.50
7,472.50
69
1065113 4/5/2012 5/5/2012 Net30 16.66 16.66 67
1065114 4/5/2012 5/5/2012 Net30 20.58 20.58 67
1065829 4/9/2012 8/7/2012 Net120 10,529.73 10,529.73 63
1065830 4/9/2012 8/7/2012 Net120 695.00 695.00 63
1065831 4/9/2012 5/9/2012 Net30 681.10 681.10 63
1065832 4/9/2012 5/9/2012 Net30 17,304.84 17,304.84 63
1065833 4/9/2012 5/9/2012 Net30 611.52 611.52 63
1065834 4/9/2012 5/9/2012 Net30 1,722.84 1,722.84 63
1065835 4/9/2012 5/9/2012 Net30 1,155.42 1,155.42 63
1066077 4/10/2012 5/10/2012 Net30 18,112.00
18,112.00
62
1066078 4/10/2012 5/10/2012 Net30 22,198.00 22,198.00 62
1066235 4/10/2012 5/10/2012 Net30 20,638.27 20,638.27 62
1066291 4/10/2012 5/10/2012 Net30 19.60 19.60 62
106649