Case 2:13-bk NB Doc 113 Filed 03/11/13 Entered 03/11/13 17:59:18 Desc Main Document Page 1 of 11

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1 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 RICHARD L. WYNNE (SBN 0) rlwynne@jonesday.com JOSHUA MESTER (SBN ) jmester@jonesday.com LORI SINANYAN (SBN 0) lsinanyan@jonesday.com JONES DAY South Flower, 0 th Floor Los Angeles, California 00 Telephone: () - Facsimile: () - Counsel for Twentieth Century Fox and Universal City Studios LLC UNITED STATES BANKRUPTCY COURT CENTRAL DISTRICT OF CALIFORNIA LOS ANGELES DIVISION 0 In re: RHYTHM AND HUES, INC., Debtor and Debtor in Possession. CASE NO. :--NB Chapter REPLY IN SUPPORT OF EMERGENCY MOTION FOR INTERIM AND FINAL ORDERS APPROVING POST-PETITION FINANCING AGREEMENT Hearing Date: March, 0 Time: :00 p.m. Place: Courtroom E. Temple Street Los Angeles, CA 00 Twentieth Century Fox, a Division of Twentieth Century Fox Film Corporation ( Fox ) and Universal City Studios LLC ( Universal and together with Fox, the DIP Lenders ) hereby submit this reply in support of the Debtor s Emergency Motion For Interim And Final Orders Approving Post-Petition Financing Agreement and respond as follows: LAI-v --

2 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 I. INTRODUCTION It is unfortunate that in the first pleading the Creditors Committee filed it decided that not only was it appropriate to suggest that the precipitous shut down of the Debtor, termination of all of the Debtor s employees, and breach of all of its contracts might be the desirable outcome in this case, but that it also would include baseless and gratuitous attacks on the DIP Lenders. The DIP Lenders will address the somewhat limited and technical specific objections raised with respect to the DIP financing. However, the blunderbuss attack on the DIP Lenders for having done everything possible to preserve the Debtor as a going concern is puzzling and troublesome. It appears to have been a cynical attempt to threaten that the Creditors Committee would seek the immediate shutdown and liquidation of R&H unless their demands were met. Thus, statements like If the Debtor cannot continue operating its business and must close its doors, so be it and false attacks on the DIP Lenders as parties whose sole interest was and is the completion of their projects and that the entire case appears to have been designed primarily as a mechanism to benefit Fox and Universal cannot be countenanced. As shown below, the DIP Loan provided by the DIP Lenders gave the Debtor the life line that it so desperately needed to keep the team together and preserve the prospect of a going concern sale for the benefit of stakeholders. Moreover, the terms of the DIP Loan are consistent with those routinely granted to lenders that put fresh money into a debtor s enterprise. The mere fact that the DIP Lenders are studios with projects in production with the Debtor does not mean that they are not entitled to these standard protections for their new money investment. Accordingly, the Creditors Committee s objection should be overruled and the Court should approve the DIP Loan on a final basis as requested. II. RESPONSE A. The Debtor Has Demonstrated A Sound Business Judgment For The DIP Loan. The Creditors Committee expressly criticizes the Debtor s business judgment for choosing to seek and obtain the DIP Loan, and implicitly, the DIP Lenders for having provided it, instead of letting the Debtor shut down its operations. The Creditors Committee first questions the LAI-v --

3 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 benefit of the DIP Loan (Obj. at :) and then asserts that it is neither beneficial nor reasonable (Obj. at :).. To analyze these important threshold issues requires some factual background, which the Court is already largely familiar with from the pleadings filed by the Debtor, and prior proceedings. Pre-petition, the DIP Lenders were faced with an extremely difficult situation, the precipitous inability of the Debtor to fund an approximate $ million of payroll obligations. R&H had pending projects for the DIP Lenders, as well as for Warner Brothers, Legendary and others. At the time, R&H had over 00 employees in Los Angeles, plus another 0 employed by its subsidiaries and affiliates. Despite running a process over the course of nine months, with Focal Point s assistance, seeking either new financing or an outright sale, and the hiring of a Chief Restructuring Officer, in January, R&H approached its major customers, Warner Brothers, Universal, Fox and Legendary and informed them that it had insufficient funds for payroll, and needed to obtain immediate bridge financing in order to maintain its operations. The DIP Lenders could have simply moved their projects to other vendors, declared a default under their contracts, and effectively let R&H die. In fact, Warner Brothers, a member of the Creditors Committee determined that it did not want to participate in advancing funds either pre-petition, or postpetition, and pulled its projects from R&H. Only the DIP Lenders agreed to provide the liquidity and on January and advanced $ million to R&H on an unsecured basis. That bridge loan directly benefited the Creditors Committee s largest constituency, the employees of R&H, who were thus able to be paid for their work. Upon the Chapter filing, the DIP Lenders agreed to fund an additional $. million DIP Loan, which upon interim approval, paid the employees first their pre-petition payroll of approximately $. million directly, and It appears that the Committee may have gotten past many of the issues relating to keeping the Debtor operating and promoting a sales process during the March, 0 lengthy hearing on bid procedures when it ultimately acknowledged that the sales process was necessary and beneficial for all parties, and supported the reduction in break-up fee and other changes to the bid procedures that were negotiated with the prospective purchaser. However, because the Committee s omnibus objection to both the bid procedures and the DIP financing raised these general issues, and also objected to certain portions of the DIP financing, the DIP Lenders will correct the record, refute the Creditors Committee s incorrect assertions, as well as respond to the specific objections raised to the DIP loan provisions themselves. LAI-v --

4 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 indirectly allowed the Debtor s affiliates and subsidiaries to receive funds to make their payrolls as well. So far, the DIP Lenders have advanced $ million, largely for employee payroll, and the Debtor now seeks final approval for the remaining advances and the terms of the DIP loan. The DIP Lenders did not make an ordinary commercial loan. In fact, no other lender offered to make this loan on such generous terms or on any other terms. Given the very substantial risks of repayment faced by the DIP Lenders when they agreed to advance the loans, and even today, the economic benefits provided to the DIP Lenders are very modest, as the DIP Loan is atypically generous to the Estate. The Court has to look at the DIP loan provisions taken as a whole, which includes the following significant benefits:. The DIP Loan and the Approved Budget provides funding for approximately $ million of overhead to keep the Debtor operating in order to attract a buyer or additional source of capital. That $ million is in excess of the funds the Debtor projected was needed to complete its existing projects for the DIP Lenders.. The DIP Loan is convertible into exit financing for a buyer approved by the DIP Lenders, with the 0 maturity date.. The DIP Loan is a % interest only loan, and is not payable until 0, as opposed to the double digit interest rates, short maturity, and mandatory prepayment provisions found in most typical DIP loans.. The DIP Loan allows the Debtor to use the proceeds from the sale of the affiliated real estate (now estimated to generate $ million through the associated shareholder notes payable to R&H) for operational working capital needs, provided no default exists.. The DIP Lenders do not receive a lien on the Estate s avoidance actions.. The DIP Lenders do not receive a lien on other projects for other studios.. The Loan documents provided for the possible addition of other studios as New Lenders if they chose to provide funding to the Debtor.. The DIP Lenders attorneys fees are capped at $00,000, and are accrued, not paid currently, making them payable at maturity in 0. As an alternative to the DIP Loan, the Creditors Committee asserts that the Debtor might have been better off shutting its doors, and liquidating, collecting the estimated $ million in net proceeds from the sale of the building, and some $ million in accounts receivable. Obj. at :- :. While acknowledging that in that scenario, Fox and Universal would perhaps have had unliquidated and disputed unsecured damages claims against the estate, (CC Opp at :0) the LAI-v --

5 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 Creditors Committee s cynical advocacy of a shutdown and liquidation cannot withstand even the slightest scrutiny. First, if the Debtor was not operating, many of the assets the Creditors Committee would hope to receive would be ephemeral at best. The receivables, which are for projects not yet completed, would disappear, as the Debtor would not deliver the associated projects and would be in breach of the agreements. Second, there is no assurance that the estate would receive any proceeds from the sale of the building the Debtor occupies. The DIP Lenders have also been informed that the purchaser of the real estate where the Debtor operates has required that the Debtor enter into a new short term lease: in a shutdown, that would not be possible and would likely jeopardize the proposed sale itself. Finally, the shareholder loans that exist from the Debtor s principals relating to the real estate purchase are non-recourse and supported only by the real estate value. Even if those loans were fully recourse, whether the Debtor s principals have the ability to repay significant loans to the Estate is highly questionable, and collection would involve both litigation risk and a significant time delay. More fundamentally, the DIP loan only provides that the shareholder notes, as assets of the company, are collateral for the loan. If claims or causes of action exist against principals, or any other party, the DIP Loan does not provide for the release of such claims by the Estate. Thus, the DIP Loan only augments the asset side of the Estate s balance sheet. Completely ignored by the Creditors Committee is that a shutdown, pre-petition, would have caused the Debtor s liabilities to dramatically increase. The Debtor would have breached all of its agreements with all its employees, customers, suppliers, and landlord, causing significant damage claims to be asserted, far in excess of what is now asserted. The DIP Lenders have been informed by the Debtor that they believe that approximately $ million in unsecured claims is being asserted against the Debtor. These include $ million from the DIP Lenders, $ million from Warner Brothers, $00,000 from Focal Point, $ million in trade payables, $ million for the terminated employees WARN act priority and unsecured claims, $00,000 in Medical claims, LAI-v --

6 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 and $. million for the remaining employees priority and unsecured claims. Had there not been a DIP loan but instead a shutdown, the Debtor s liabilities would have grown substantially, including liabilities entitled to priority over unsecured creditors. The Creditors Committee s seeming preference for liquidation is all the more puzzling when considering its membership, all of whom should understand the dramatic negative consequences of a shut-down and liquidation. While the Creditors Committee has a duty to represent all unsecured creditors, it has only members, Warner Brothers, the terminated employees WARN act claimants, and Focal Point, the Debtor s former investment banker. The DIP Lenders understand that Warner Brothers, whose projects were not as far along in production as the DIP Lenders, has asserted a $. million damage claim for the Debtor s failure to complete its projects. Suffice it to say, the DIP Lenders would assert very significant damage claims if the Debtor failed to complete their projects on a timely basis, and that whatever the ultimately proven and allowed amount, the DIP Lenders damage claims would greatly exceed any claim made by Warner Brothers. Thus, the DIP Lenders prepetition claims and contract claims constitute a substantial portion of the unsecured claims in this case and share the same risks as the other unsecured creditors. The Debtor s current remaining employees would also have asserted significant damage claims, particularly if their pre-petition wages had not been paid, and they had been unceremoniously fired as the Creditors Committee seems to be advocating. The current employees WARN act claims alone would have been roughly double what the terminated employees have so far asserted, since there are roughly twice as many current employees as terminated ones. The approximately terminated employees assert claims for unpaid wages and future WARN act claims in the amount of approximately $ million. The remaining Los Angeles based employees claims, if they had all been terminated instead of paid pre-petition, would have asserted claims that would dramatically increase the existing claims pool. Moreover, those employees would not have been paid the $ million that the DIP Lenders advanced pre-petition on an unsecured basis and would not have been paid their $. million in pre-petition priority wage claims. They would not have been paid their estimated $. million in LAI-v --

7 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 health and medical benefits. If instead of being paid they were all terminated, the 0 Los Angeles employees would also have asserted similar WARN act claims for just under double the terminated employees WARN act claims, perhaps another $ million. The Creditors Committee does not even consider the impact of the Debtor terminating its Medical Plan as the result of a shutdown. In its Wages Motion, the Debtor estimates that the failure to provide 0 days notice of the termination of its Medical Plan could result in claims of more than $ million under the Public Health Service Act, the Patient Protection and Affordable Care Act, and COBRA. See Wages Motion [D.I. ] at -, n.. Thus, a shutdown would have inevitably ballooned the Estate s liabilities, adding claims of almost $ million without even considering the size of the claims to be asserted by the DIP Lenders and other studios like Legendary whose projects would not be completed. There is no conceivable scenario where a shut-down of R&H was or is a better alternative than the Estate obtaining the benefits of the DIP Loan and attempting an orderly sale as a going concern. Finally, the DIP Loan has already had an extremely beneficial effect. It has allowed the Debtor to stabilize its operations and maintain the core of its employees by being able to provide millions of dollars in payments to those very deserving employees. This stabilization has allowed the Estate to attract not only a stalking horse bid to acquire the company, but several potential and interested over-bidders. Accordingly, approval of the DIP Loan and its terms as requested is a sound exercise of the Debtor s business judgment. B. Payment Of The DIP Lender Fees Is Appropriate. Payment of attorneys fees incurred by DIP lenders is customary in DIP financing. Significantly, the attorneys fees requested by the DIP Lenders in this case differ in three respects from fees customarily approved by Bankruptcy Courts, including those in this District, and those differences are materially favorable to the Debtor. First, the DIP Lenders have agreed to cap their attorneys fees at $00,000. Second, the fees accrue, and are only payable on maturity, in 0. If the DIP Lenders had not advanced the $ million, they would not have a claim for that amount, but the employees claims would increase by that same amount because they would not have been paid. LAI-v --

8 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 Thus, the DIP Lenders costs and fees will not be directly payable to the DIP Lenders from Estate s assets if the contemplated sale transaction occurs. Rather, pursuant to Section. of the DIP Loan Agreement, such fees constitute Secured Obligations, meaning that they are added to the outstanding balance of the DIP Loan, and are not payable on a current basis, but solely at maturity. Moreover, payment of the DIP Lenders attorneys fees are particularly appropriate in this context as the DIP Lenders are not engaged in the business of providing DIP Financing and are not seeking payment of their attorneys fees in order to bolster their return on their investment, but to minimize their further losses. The routine payment of DIP Lender s fees has been approved in this District even when the DIP lender is a corporate affiliate of the debtor and not only when the DIP lender was a prepetition lender to the debtor. Bankruptcy Courts in this District have routinely approved the payment of such fees in large chapter cases, without a cap. See, e.g., In re American Suzuki Motor Corporation, Case No. :-bk-0-sc (Bankr. C.D. Cal. December 0, 0) [Final DIP Order, Docket No. at Paragraph ]; In re Pacifica Mesa Studios, LLC, Case :0-bk- -GM (Bankr. C.D. Cal. August, 00) [Final DIP Order, Docket No. at Paragraph (b)]; In re The Walking Company, Case :0-bk--RR (Bankr. C.D. Cal. December, 00) [DIP Motion, Docket No., Exhibit at Section ]. Contrary to the Creditors Committee s apparent assertion, a showing that the proposed DIP lender has a prepetition contractual right to attorneys fees is not a requirement to their allowance and there is no logic or legal precedent for such a requirement. This is particularly true where the DIP Lender is lending fresh money to the Debtor rather than rolling over a prepetition secured loan. C. Waiver Of The Automatic Stay Pursuant to the DIP Loan, the DIP Lenders seek a routine and wholly unremarkable modification of the automatic stay to permit the DIP Lenders to exercise remedies following an Event of Default. The Creditors Committee objects to this relief, apparently based on the The DIP Motion was approved by final order entered January, 00 [Docket No. 0]. LAI-v --

9 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 Creditors Committee s concern that upon the completion of their projects, the DIP Lenders will manufacture a default and call the loan, to the detriment of other creditors. This is an illusory concern, as its logical, if paranoid, conclusion would require that there never be events of default for approved DIP financing. These DIP Lenders have already demonstrated significant support for the Debtor, including the willingness to have a maturity date of 0, providing an interest only loan, and allowing for the loan to be assumed as exit financing. Bankruptcy Courts in this District routinely enter DIP financing orders that provide for the modification of the automatic stay, and for less of a notice period than the current DIP proposal. For instance, in In re Pacifica Mesa Studios, LLC, Case :0-bk--GM (Bankr. C.D. Cal. August, 00) [Final DIP Order, Docket No. at Paragraph ], Judge Mund approved DIP financing that granted automatic relief from stay and provided for one () business day s notice prior to the exercise of remedies. In In re The Walking Company, Case :0-bk--RR (Bankr. C.D. Cal. January, 00) [Final DIP Order, Docket No. 0 at Paragraph ], the Bankruptcy Court approved similar provisions with a five business day notice. The three business day notice requirement in the current DIP Loan is designed to afford the Debtor an opportunity to appear before this Court to seek whatever relief it believes is appropriate to prevent the DIP Lenders from exercising remedies after the occurrence of an Event of Default. The time period is appropriate, and falls within the range approved in other cases, such as Pacifica Mesa Studios (expedited review or one business day with respect to collateral located on leased or licensed premises) and The Walking Store ( business days). Significantly, unlike customary automatic stay modification provisions (such as Pacifica Mesa Studios), the DIP Lenders do not seek to limit the Debtor solely to challenging whether a default has occurred and the Debtor instead is able to assert whatever defenses it may have. Finally, the Creditors Committee complains that the DIP Lenders are only required to provide notice of their intent to exercise remedies to the Debtor. The DIP Lenders are willing to include in the proposed Final Order that the DIP Lenders will provide notice of an Event of Default to the Creditors Committee as well. LAI-v --

10 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page 0 of 0 0 D. The Proposed Carve Out Is Appropriate A carve out from a secured lender s collateral is generally provided so that a creditors committee can fund an investigation into the pre-petition secured creditor s loan and collateral. Here, there is simply no need for such an investigation, as the DIP Lenders only made unsecured loan advances to the Debtor, in the month before the Petition Date. Moreover, the DIP Lenders are not receiving liens in all of the Debtor s assets. The Creditors Committee s fees can be funded by the unencumbered assets available to the Estate, such as avoidance actions and the accounts receivable from any other studios projects. A carve out is not a budget, and since the DIP Lenders do not expect any repayment until 0 from their collateral, it is not appropriate to further burden the DIP Lenders with a larger carve out for counsel to the Creditors Committee who, at least in its objection, does not appear to support the Debtor as a going concern. E. The 0 C Waiver Is Appropriate And Reasonable Finally, the Creditors Committee objects to the waiver of the right to seek a surcharge of the DIP Lenders collateral under section 0(c). Notably, all of the cases cited by the Creditors Committee on this point involve factual circumstances where (a) a prepetition secured loan was rolled up into a DIP loan or was repaid from proceeds of a DIP loan, or (b) the Debtor used an existing secured lender s cash collateral. None of these facts are present here. The DIP Loan funded by the DIP Lenders acted to preserve and enhance the Debtor s going concern enterprise value, and the beneficiaries of the loans made by the DIP Lenders were largely the Debtor s largest group of unsecured creditors-the Debtor s employees. If a liquidation were to occur, notwithstanding the substantial efforts of the Debtor and the DIP Lenders to prevent such a result, it would be inequitable to then charge the DIP Lender s collateral under section 0 (c). III. CONCLUSION Based upon the foregoing, the DIP Lenders respectfully request that the Court overrule the Creditors Committee s objection and approve the DIP Loan on a final basis. LAI-v -0-

11 Case :-bk--nb Doc Filed 0// Entered 0// :: Desc Main Document Page of 0 0 DATED: March, 0 JONES DAY By Richard L. Wynne Joshua M. Mester Lori Sinanyan Attorneys for Twentieth Century Fox and Universal City Studios LLC LAI-v --