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In Re Einstein/Noah Bagel Corp.

Citations: 257 B.R. 499; 2000 WL 33125920Docket: 00-04447 ECF-CGC, 00-04448 ECF-CGC

Court: United States Bankruptcy Court, D. Arizona; August 7, 2000; Us Bankruptcy; United States Bankruptcy Court

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Einstein/Noah Bagel Corp. (ENBC) and Einstein/Noah Bagel Partners, L.P. (Bagel Partners), referred to as "Debtors," filed a "Motion for Order Pursuant to Bankruptcy Rule 3013" to classify Bagel Store Development Funding's (Bagel Funding) Unit Rights, including a "Put Right," in an equity class under their Chapter 11 plan. Bagel Funding filed a Proof of Claim/Interest against the Debtors, contested by the Debtors and the Official Committee of Unsecured Creditors, raising questions about whether the Put Right constitutes a claim or an equity interest.

The court ruled that the Put Right does not create a claim against Bagel Partners and, if construed as a claim against ENBC, it would be subordinated to unsecured creditors under 11 U.S.C. § 510(b). Consequently, the court granted the Rule 3013 Motion and upheld the objections to the Proofs of Claim/Interest.

The factual background reveals that Boston Chicken, Inc. owns 51% of ENBC, while ENBC holds 77% of the limited partnership units in Bagel Partners, primarily owned by Bagel Funding. Bagel Funding was an investor in ENBC's area developer franchisees, which merged into Bagel Partners in 1997. ENBC had significant loans to these developers, which were convertible into equity. The merger resulted in Bagel Funding and former management receiving 21.5% of the Units, with ENBC retaining the majority stake in exchange for substantial financial contributions.

The December 5, 1997, Limited Partnership Agreement outlines the partners' rights, particularly focusing on the "Put Right." This provision allows Bagel Funding to demand a purchase of its interest at a price determined by a specified formula under certain conditions. The purchase price can be paid in cash, ENBC common stock, or a combination of both. The formula for the Put Price is 6.5 times the annual post-royalty store level cash flow, adjusted for outstanding debts and cash. Debtors estimate the Put Price to be around $54.4 million. If ENBC or Bagel Partners cannot provide the required cash due to loan restrictions, the only option left is to satisfy the Put Price with ENBC Common Stock. If neither cash nor sufficient stock is available, the Put Right remains unexercised for that amount, and Bagel Funding retains its partnership interests.

The Debtors filed a Rule 3013 Motion to classify Bagel Funding's rights, including the Put Right, as an equity security interest rather than a claim, aiming to place all such interests in one equity class within the Bagel Partners case. Bagel Funding contests this classification, asserting that its Put Right is distinct and adds value to its interests. Under the proposed Joint Plan of Reorganization, general unsecured creditors of ENBC are set to receive approximately 89% of the new equity, with Bagel Partners' limited partners, primarily Bagel Funding, receiving about 11%. Both the Committee representing debenture holders and Bagel Funding oppose the proposal, seeking a greater share of the reorganized entity's value. Existing ENBC Common Stock will be canceled, with current equity holders receiving warrants for 2% of the New Common Stock, contingent on the fulfillment of debenture holders' claims.

Bagel Funding has filed a "Proof of Interest and/or Claim" against Bagel Partners for its 89,450,000 Limited Partner Units and the $54.4 million due under the Put Right. Additionally, it filed a Proof of Claim against ENBC for breach of contract related to the Put Right and acknowledged it will not seek double recovery. A third Proof of Claim alleges breach of fiduciary duty against ENBC for actions by its general partner, to which the Debtors and the Committee have raised objections.

Bagel Funding unilaterally withdrew its Proof of Claim while reserving the right to assert it again based on the resolution of the Put Right issues and to make similar claims against non-debtor third parties. The Debtors and the Official Unsecured Creditors Committee objected to this withdrawal, citing Bankruptcy Rule 3006, which requires court approval for such actions after objections have been filed and significant creditor participation in the case. The Court deferred its ruling on the withdrawal, to be addressed in subsequent proceedings.

The central issue in this case involves whether Bagel Funding's Put Right constitutes a claim or an equity interest in Bagel Partners and ENBC. Bagel Funding contends that the Put Right enhances the value of its minority interest in the partnership. However, determining the nature of the Put Right is critical to understanding its impact on the proposed Plan of Reorganization, which involves a merger of ENBC and Bagel Partners.

Both Bagel Partners and Bagel Funding are governed by Delaware law, as stipulated in their Partnership Agreement. The case emphasizes that understanding contractual terms relies on how a reasonable person would interpret them, rather than the parties' intentions. Bagel Funding has attempted to introduce extrinsic evidence to clarify the Agreement's provisions concerning the Put Right. The division of equity in the reorganized Debtor post-merger, especially regarding the $125 million public subordinated debentures, remains unresolved until the status of Bagel Funding's rights is clarified.

The Court excluded extrinsic evidence in the case, adhering to Delaware's parol evidence rule, which mandates that contracts be interpreted in their entirety, reconciling all provisions to ascertain their intended meaning. The analysis focuses on Section 4.7 of the Agreement, which grants the Fund the right to require the Partnership or ENBC to purchase all Units at a specified Put Price, contingent upon giving notice and certain conditions not occurring. This Put Right is personal to the Fund and cannot be assigned. The Put Price, calculated as approximately $54.4 million, is defined as 6.5 times the income from store operations. 

Upon exercising the Put Right, the selected purchaser (either the Partnership or ENBC) must complete the purchase within 60 days, with payment options including cash, ENBC common stock, or a combination. Although the Fund can initiate the purchase, the Agreement clarifies that the choice of purchaser lies with the Partnership, and the purchaser determines the payment method. The Court rejected Bagel Funding's claim that designating ENBC as the purchaser would not relieve the Partnership of its obligations, concluding that the Agreement does not support any continued obligations from the Partnership once ENBC is designated. Additionally, if payment is made in ENBC stock, the number of shares is calculated based on an average recent closing price, and while ENBC will use reasonable efforts to register the shares for resale, there is no absolute obligation to do so.

Section 4.7(e) outlines the protocol if ENBC cannot pay the Put Price in cash due to loan document restrictions and is unable to issue enough shares without prior shareholder approval. In this case, ENBC must issue the maximum allowable shares and exert reasonable efforts to obtain the necessary shareholder approval for additional shares. The Put Right is considered exercised for the shares that can be issued, and Bagel Partners will remain intact for the unpaid portion of the Put Price. If shareholder approval is not obtained, Bagel Funding retains its pro rata Units until approval is secured, with neither ENBC nor Bagel Partners liable for cash payment of the unpaid Put Price.

Section 4.7(f) indicates that exercising the Put Right and the payment of the Put Price fully releases the Fund’s claims against ENBC, Bagel Partners, and related entities, contingent upon full payment of the Put Price. However, this must be read alongside Section 4.7(c), which allows Bagel Partners to select the purchaser. If ENBC is chosen but cannot issue sufficient shares, the only obligation left for Bagel Partners or ENBC is to continue seeking shareholder consent or, optionally, to pay any remaining amount in cash.

The Bankruptcy Code's Section 101 defines a "claim" broadly, encompassing any right to payment or equitable remedy for breach leading to a right to payment, emphasizing that claims take precedence over equity security interests. The definition of "equity security" includes limited partnership interests, which is acknowledged as applicable to Bagel Funding’s Units.

The Put Right in question pertains to Bagel Funding's status as an equity security holder in Bagel Partners, granting it the right to require the purchase of its equity interest by either Bagel Partners or ENBC, as chosen by Bagel Partners. This right is explicitly nontransferable and non-assignable under the Partnership Agreement, which also restricts the sale of Units without ENBC's consent. The Put Right is characterized as a liquidity mechanism for Bagel Funding to liquidate its investment but does not constitute a "right to payment" in cash, as defined by 11 U.S.C. section 101(5). Instead, it allows Bagel Funding to sell its Units at a specified price without guaranteeing cash payment, placing it within the framework of section 101(16). 

Bagel Funding argues that the distinction between its right to require the purchase and its right to sell its Units excludes it from section 101(16), but this argument is deemed inconsequential since the limited nature of the purchasers does not alter the transaction's classification. Even if the Put Right suggested a cash payment component, that right would not mature at the time of the case filing, thereby not converting the equity security into a claim. 

Regarding the Put Right with respect to ENBC, Bagel Funding's claim rests on the assumption that ENBC is contractually bound to deliver value equivalent to the Put Price upon exercising the Put Right. However, the Agreement specifies that ENBC's obligation is to provide stock to satisfy the Put Price, with no cash payment obligation. Consequently, if ENBC fails to deliver sufficient stock, Bagel Funding retains its Units and a continuing right to request stock from ENBC, which does not equate to a "right to payment." Thus, the Court concludes that Bagel Funding lacks an enforceable claim against ENBC under 11 U.S.C. section 101(5), classifying the Put Right instead as a right to purchase ENBC stock, reinforcing the application of section 101(16). Further analysis under section 510(b) supports this conclusion.

Section 510(b) mandates that claims related to the purchase or sale of a debtor's security be subordinated to all senior or equal claims. Bagel Funding contends that its claim against ENBC is not subject to this statute, arguing that (1) its claim does not fit the defined types eligible for subordination, and (2) ENBC's creditors do not belong to the classes entitled to benefit from subordination. Despite the initial appeal of these arguments, they do not hold upon deeper examination. The "Put Right" can be viewed as either Bagel Funding's right to compel ENBC to purchase its Units with ENBC stock or ENBC's obligation to issue stock in exchange for those Units. For section 510(b) to apply, two criteria must be satisfied: the claim must fit within the statute's scope, and the underlying equity security must be junior to the claims benefitting from subordination. The securities in question—either the Units from Bagel Partners (an ENBC affiliate) or shares of ENBC—are clearly within the statute's purview. If Bagel Funding's claim is seen as a breach of ENBC's obligation to sell shares, it relates to an interest junior to ENBC's creditors. Even if the claim is interpreted as tied to Bagel Partners' Units, case law supports a broad interpretation of section 510(b), aligning with Congressional intent. The obligation to purchase the Units is limited to stock issuance, meaning that failing to subordinate Bagel Funding's claim would undermine the statute's purpose, aligning it with junior claims rather than subordinating them. Ultimately, Bagel Funding lacks an enforceable claim against ENBC; even if a claim existed, it would be classified under section 510(b) as an equity security interest in both Debtors' cases.

Bagel Funding contests the classification of its Put Right, arguing that it would undermine the parties' intentions to allow satisfaction with "worthless stock." However, the analysis should focus on the rights established in the Agreement, independent of stock value. The Put Right is classified as an equity security under the Bankruptcy Code, regardless of the stock's market price at the time of the bankruptcy petition. Bagel Funding further asserts that the Put Right holds substantial future value due to anticipated improvements in ENBC's financial situation post-confirmation. This claim contradicts bankruptcy principles, as rights are fixed at the petition date, and the Put Right was unexercised at that time, making it subject to potential cancellation upon plan confirmation.

Bagel Funding also argues that the Put Right lacks equity characteristics since its value is tied solely to store operations rather than ENBC’s overall financial health. This claim is deemed disingenuous since Bagel Funding acknowledged that the Put Price could be settled with ENBC stock, thus linking its fortunes to ENBC's performance. Moreover, it overlooks the interdependence of store operations and ENBC's resources. Ultimately, the Put Right is recognized as an equity security, and even if treated as a claim, it would be subordinated under section 510(b) of the Bankruptcy Code. Finally, Bagel Funding posits that the Put Right must yield a claim if there is insufficient or worthless stock available for issuance, a conclusion not supported by the Limited Partnership Agreement.

An agreement could have included a provision requiring one or both Debtors to financially compensate for any unexercised portion of the Put Right, which is notably missing. The Agreement outlines ENBC's obligations if there is insufficient stock to satisfy the Put Price, but does not imply a monetary payment obligation. Bagel Funding contends that the Debtors cannot depend on issuing stock as an alternative due to potential violations of section 365(c)(2); however, this argument is deemed irrelevant because the Debtors are not attempting to assume the contract, and Bagel Funding can refuse stock in exercising the Put Right. The Put Right is classified as an equity security interest within the partnership agreement's framework, and while it is determined to be an equity security in the Bagel Partners case, its incremental value relative to Bagel Funding's 21.5% equity interest remains unresolved. Although the classification relief sought under Rule 3013 does not require addressing the Put Right's value, objections indicate a desire to deem it "worthless," which Bagel Funding disputes. The value issue may influence confirmation proceedings, as it could entitle Bagel Funding to a larger share if the Put Right is deemed valuable. Certain provisions in the Agreement suggest no incremental value exists, such as the absence of additional consideration, non-transferability, and lack of monetary remedies. The Court determines that resolving the value issue is unnecessary at this stage and will defer any related evidence or arguments until confirmation unless a party requests a different order.

Bagel Funding initially filed a breach of fiduciary duty claim against ENBC but later unilaterally withdrew it. The Committee and Debtors objected, citing Bankruptcy Rule 3006, which requires court approval for claim withdrawal under certain conditions. Both conditions are satisfied in this case, leading to a court order that Bagel Funding cannot assert future fiduciary duty claims against the Debtors. Additionally, the Committee and Debtors request the court to prohibit Bagel Funding from making fiduciary duty claims related to the Put Right against non-debtor entities like ENBPI.

Claims against the Debtors could potentially result in indemnity or reimbursement obligations for them, which the Court seeks to prevent, rejecting Bagel Funding's approach that aims to circumvent restrictions. The Court supports the notion that the Debtors and the Committee should not be disadvantaged by the claim's filing, but notes that the matter had not been litigated and was withdrawn for specificity. No discovery or findings have taken place, and future claims against non-debtors should be assessed in a concrete context. Consequently, the Court denies Bagel Funding's request for additional conditions. 

The Rule 3013 Motion is granted, sustaining objections to Bagel Funding's Proofs of Claim, while further consideration of its Proof of Interest in the Bagel Partners case is postponed until confirmation. The Court ruled that the Limited Partnership Agreement is unambiguous under Delaware law, allowing no extrinsic evidence to interpret its terms, although some historical context documents were admitted. 

Bagel Funding claims to hold 89,450,000 limited partnership units in Bagel Partners and has filed additional breach claims against both Bagel Partners and ENBC. Trade creditors of ENBC and Bagel Partners will be fully compensated during and after the reorganization. Bagel Funding also acknowledges unresolved issues regarding its Put Right, which may be limited by the secured loan agreement, indicating all parties were aware of such restrictions. The agreement stipulates no liquidation preference for Bagel Funding concerning its Put Right, and distributions will align with capital accounts unaffected by the Put Right. The Court recognizes the Committee's stance that Bagel Funding may not be entitled to any benefits from the reorganization regardless of its equity position.