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Rejecting challenges to the bankruptcy reorganization of Zenith Electronics Corp., a federal appeals court Thursday held that the objectors’ claims are now “equitably moot” because the restructuring plan “has already been substantially consummated” and “would be very difficult to retract.” But one of the three judges said he joined the opinion reluctantly and that he fears the 3rd U.S. Circuit Court of Appeals has already expanded the equitable mootness doctrine too far. “As this case shows, our court’s equitable mootness doctrine can easily be used as a weapon to prevent any appellate review of bankruptcy court orders confirming reorganization plans. It thus places far too much power in the hands of bankruptcy judges,” U.S. Circuit Judge Samuel A. Alito wrote. But Alito said he was forced to join the opinion because the lower courts had properly applied the equitable mootness test established by the 3rd Circuit’s en banc 1996 opinion in In Re: Continental Airlines — in which Alito himself had dissented — and because the Zenith objectors never asked lower courts for a stay. In the appeal, a group of unsecured creditors led by Nordhoff Investments Inc. argued that the bankruptcy judge erred by relying on a biased valuation that Lincolnshire, Ill.-based Zenith was worth just $300 million. In fact, the appeal said, the company was worth $1.05 billion and the plan should have been converted into a Chapter 7 liquidation. Zenith has suffered huge financial losses over the past 12 years. During that time, LG Electronics invested $360 million in Zenith — increasing its holdings from 5 percent to 58 percent — and now holds six of the 11 seats on Zenith’s board of directors. At one point, Zenith put itself on the selling block and held talks with Microsoft, Intel, General Instruments and other leaders in the electronics industry, but no buyers came forward. As the financial hemorrhaging continued, LGE proposed a major restructuring of Zenith’s debt and equity in April 1998. Ultimately, LGE, Zenith’s board and the bondholders agreed to a plan that called for exchanging $103 million in bonds bearing interest at 6.25 percent for $50 million in new bonds bearing interest at 8.19 percent; canceling Zenith’s stock for no consideration; issuing new Zenith stock to LGE in exchange for forgiveness of $200 million of Zenith’s debt to LGE. The plan also required LGE to extend a new $60 million credit to Zenith; canceled $175 million in debt owed to LGE in exchange for $135 million of new debt and ownership of a Zenith television plant; refinancing of debt owed to a consortium of banks led by Citicorp. And while the plan did not alter the debt owed to Zenith’s trade creditors, it released LGE, Zenith directors and officers and the bondholder’s committee from any liability to Zenith or certain creditors. Zenith submitted the plan to the Securities and Exchange Commission which declared it effective one year later. The bondholders also voted overwhelmingly in favor of the plan. BANKRUPTCY COURT But when the plan was submitted to the Bankruptcy Court in Delaware, objections were lodged by Nordhoff and a committee representing the interests of the other minority shareholders. The primary dispute at the hearings centered on competing valuations of Zenith. Debtor’s counsel presented a report from Peter J. Solomon Co. that valued Zenith at $300 million — a figured corroborated by the fact that Zenith had been unable to sell for more. But Ernst & Young, appearing on behalf of the unsecured creditors’ committee, valued Zenith at $1.05 billion, saying it based the figure on a discount rate the “same as Microsoft’s” and a higher royalty rate than calculated by Solomon. Nordhoff and the unsecured committee tried to discredit Solomon by presenting evidence that it had a conflict of interest due to its previous relations with Zenith and because it would receive a $1 million award if Zenith’s plan was successful. In the end, the bankruptcy court accepted Solomon’s valuation and decided that Zenith’s plan was fair and had been proposed in good faith. Although the bankruptcy court found that the reorganization “is exactly what Chapter 11 of the Bankruptcy Code was designed to accomplish,” it insisted that Zenith modify the release order to allow claims by creditors who did not vote in favor of the plan. Zenith quickly made the charges and won final approval. But at the time, it failed to serve Nordhoff with the amended plan. Immediately putting the plan into effect, Zenith accomplished many of its goals before Nordhoff had the chance to file an appeal to the U.S. District Court. By Nov. 9, 1999, Zenith had replaced its debtor-in-possession credit facility with a new $150 million facility syndicated by Citicorp; entered into a new $60 million credit facility with LGE; canceled old stock and issued new stock to LGE; and Zenith canceled certain debt owed to LGE, issued new debt to LGE, and canceled some of the new debt in exchange for the transfer of the Reynosa plant at a later date. Zenith’s bondholders, however, did not begin to tender their $103.5 million in old bonds for $50 million in new publicly traded instruments until Nov. 19, 1999. Nearly all of the bonds were exchanged by Jan. 3, 2000, and they have been subject to public trading ever since. In the first round of appeals before U.S. District Judge Gregory M. Sleet of the District of Delaware, the unsecured creditors challenged the valuation of their shares and the reliance on Solomon’s valuation. They also complained of unfairness in the expedition of the proceedings, the lack of evidentiary record, and the plan provisions releasing LGE and Zenith’s directors from potential liability. But Sleet dismissed the appeal as equitably moot. 3RD CIRCUIT RULING Now the 3rd Circuit has ruled that Sleet properly applied the doctrine and that the unsecured creditors lost their chance to wage further attacks on the plan when they failed to seek a stay of the final confirmation. U.S. Circuit Judge Richard L. Nygaard said the equitable mootness doctrine has been characterized as a “misnomer” by one judge who said: “There is nothing equitable about the equitable mootness doctrine. … The matter is moot out of necessity, not application of equitable principles. In a very real sense the doctrine is more accurately denominated as ‘prudential mootness.’” Nygaard disagreed, saying “one inequity, in particular, that is often at issue is the effect upon innocent third parties. When transactions following court orders are unraveled, third parties not before us who purchased securities in reliance on those orders will likely suffer adverse effects.” The doctrine was developed in the Continental Airlines bankruptcy in which complex Chapter 11 reorganization premised upon a $450 million investment by two outside parties was challenged by trustees of creditors due to the decline in value of the aircraft and jet engines securing their investment. The challenge jeopardized the Continental Airlines plan because the investors had conditioned their involvement upon the absence of such liability. The Bankruptcy Court rejected the trustees’ claim. The trustees sought a stay, were denied and appealed to the District Court. Meanwhile, relying on the Bankruptcy Court’s confirmation, the investors committed their capital and consummated the plan. Continental then moved to dismiss the trustees’ appeal on grounds of equitable mootness. The District Court granted the motion and dismissed the appeal. The 3rd Circuit affirmed, stating that such an appeal should be dismissed as moot “when, even though effective relief could conceivably be fashioned, implementation of that relief would be inequitable.” FIVE FACTORS In that en banc decision, Nygaard said, the 3rd Circuit held that five factors had to be considered when conducting an equitable mootness analysis: � Whether the reorganization plan has been substantially consummated. � Whether a stay has been obtained. � Whether the relief requested would affect the rights of the parties not before the court. � Whether the relief requested would affect the success of the plan. � The public policy of affording finality to bankruptcy judgments. The Zenith unsecured creditors conceded that the plan has been substantially consummated. Nonetheless, they argued that the plan was “remarkable” for how little it actually accomplished and that it could be easily retracted. Since it did not contain intricate transactions, they said, the plan could be reversed in a manner equitable to all parties. Zenith, they said, could have conducted the plan under state law and without the approval of the Bankruptcy Court. The only reason it used bankruptcy law, they said, was to eliminate minority shareholders’ rights and expedite the process. They urged Sleet to reverse the Bankruptcy Court’s valuation findings and order a new trial to determine if LGE paid a fair price. Sleet agreed that several aspects of the plan could be undone, but found that the exchange of the bonds was problematic since they could have changed hands several times. Now the 3rd Circuit has ruled that Sleet did not abuse his discretion in making that finding. “Although the plan here is not as complex as the plan in Continental Airlines, it is hardly simple. The plan required 18 months of negotiation between several parties regarding hundreds of millions of dollars, restructured the debt, assets, and management of a major corporation, and successfully rejuvenated Zenith,” Nygaard wrote. The unsecured creditors, Nygaard said, “have not offered any evidence that the plan could be reversed without great difficulty and inequity, and we have reason to believe that the bond redistribution is unretractable.” The second factor weighed heavily against the unsecured creditors, Nygaard said, since the 3rd Circuit has held that bankruptcy objectors must make every effort to seek a stay or risk creating a situation “rendering it inequitable to reverse the orders appealed from.” ALITO ‘RELUCTANTLY’ CONCURS Judge Alito said he “reluctantly” concurred in the judgment of the court because he agreed that Sleet had properly applied the standard adopted in Continental Airlines — especially since the objectors had failed to seek a stay. “Although the district court’s decision is debatable, it did not commit an abuse of discretion,” Alito wrote. But Alito said he wrote separately because he found the result troubling. “It is disturbing that Zenith, in a seeming attempt to moot any appeal prior to filing, succeeded in implementing most of the plan before the appellants even received notice that the plan had been confirmed,” Alito wrote. If the unsecured creditors had asked for a stay, Alito said, he might have viewed their appeal differently. “But the appellants never applied for a stay and have not provided an adequate explanation for their failure to do so. Under these circumstances, I cannot say that the decision of the district court was an abuse of discretion.” However, in his final comment, Alito said that he continues to disagree with “the expansive version of the equitable mootness doctrine that our court adopted in [ Continental Airlines]” because it can now “ easily be used as a weapon to prevent any appellate review of bankruptcy court orders confirming reorganization plans.” Nordhoff Investments Inc. was represented by attorney Arnold S. Albert of Albert & Schulwolf in Washington, D.C., and Thomas G. Macauley of Zuckerman Spaeder in Wilmington, Del. The Official Committee of Equity Security Holders was represented by attorney Thomas D. Schneider of Philadelphia. Zenith Electronics Corp. was represented by James H.M. Sprayregen, Ilana S. Rubel and David J. Zott of Kirkland & Ellis in Chicago; Laura D. Jones of Pachulski, Stang, Ziehl, Young & Jones in Wilmington, Del.; and Eric S. Kurtzman of Pachulski Stang’s Los Angeles office.

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