1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 DOCS_LA:304539.1 35793/001 Stuart Komrower (pro hac vice) Ryan T. Jareck (pro hac vice) COLE SCHOTZ P.C. 25 Main Street Hackensack, NJ 07601 Tel: (201) 489-3000 Fax: (201) 678.6331 Email: [email protected][email protected]Jeffrey N. Pomerantz (CA Bar No. 143717) Jeffrey W. Dulberg (CA Bar No. 181200) PACHULSKI STANG ZIEHL & JONES LLP 10100 Santa Monica Blvd., 13th Floor Los Angeles, Ca 90067 Tel: 310.277.6910 Fax: 310.201.0760 Email: [email protected][email protected]Attorneys for Hercules Capital, Inc. UNITED STATES BANKRUPTCY COURT CENTRAL DISTRICT OF CALIFORNIA LOS ANGELES DIVISION In re: NASTY GAL INC., Debtor. Case No.: 2:16-bk-24862-BB Chapter 11 Adv. Pro. No. 2:17-ap-01120-BB DEFENDANTS’ MOTION TO DISMISS FIRST AMENDED COMPLAINT PURSUANT TO RULE 7012 OF THE FEDERAL RULES OF BANKRUPTCY PROCEDURE, INCORPORATING BY REFERENCE, RULE 12(b)(6) OF THE FEDERAL RULES OF CIVIL PROCEDURE Hearing Date: May 2, 2017 Time: 2:00 p.m. Place: Courtroom 1539 255 E. Temple St. Los Angeles, CA Judge: Honorable Sheri Bluebond OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF NASTY GAL, INC., Plaintiff, v. HERCULES CAPITAL, INC. f/k/a Hercules Technology Growth Capital, Inc.; HERCULES TECHNOLOGY III, L.P., Defendants. Case 2:17-ap-01120-BB Doc 25 Filed 03/30/17 Entered 03/30/17 15:00:02 Desc Main Document Page 1 of 75
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DOCS_LA:304539.1 35793/001
Stuart Komrower (pro hac vice) Ryan T. Jareck (pro hac vice) COLE SCHOTZ P.C. 25 Main Street Hackensack, NJ 07601 Tel: (201) 489-3000 Fax: (201) 678.6331 Email: [email protected][email protected] Jeffrey N. Pomerantz (CA Bar No. 143717) Jeffrey W. Dulberg (CA Bar No. 181200) PACHULSKI STANG ZIEHL & JONES LLP 10100 Santa Monica Blvd., 13th Floor Los Angeles, Ca 90067 Tel: 310.277.6910 Fax: 310.201.0760 Email: [email protected][email protected] Attorneys for Hercules Capital, Inc.
UNITED STATES BANKRUPTCY COURT CENTRAL DISTRICT OF CALIFORNIA
LOS ANGELES DIVISION
In re: NASTY GAL INC., Debtor.
Case No.: 2:16-bk-24862-BB Chapter 11 Adv. Pro. No. 2:17-ap-01120-BB DEFENDANTS’ MOTION TO DISMISS FIRST AMENDED COMPLAINT PURSUANT TO RULE 7012 OF THE FEDERAL RULES OF BANKRUPTCY PROCEDURE, INCORPORATING BY REFERENCE, RULE 12(b)(6) OF THE FEDERAL RULES OF CIVIL PROCEDURE Hearing Date: May 2, 2017 Time: 2:00 p.m. Place: Courtroom 1539 255 E. Temple St. Los Angeles, CA Judge: Honorable Sheri Bluebond
OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF NASTY GAL, INC., Plaintiff, v. HERCULES CAPITAL, INC. f/k/a Hercules Technology Growth Capital, Inc.; HERCULES TECHNOLOGY III, L.P., Defendants.
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DOCS_LA:304539.1 35793/001 i
TABLE OF CONTENTS
PAGE
I. INTRODUCTION ............................................................................................................. 1
II. FACTS ............................................................................................................................... 2
A. The Loan and Security Agreement ........................................................................ 2 B. The Amended Complaint ....................................................................................... 5
III. RELIEF REQUESTED AND BASIS THEREFOR .......................................................... 6
IV. CONCLUSION ................................................................................................................ 41
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TABLE OF AUTHORITIES
PAGE
CASES
18 Unnamed John Smith Prisoners v. Meese, 871 F.2d 883 ......................................................................................................................... 28
ABF Capital Mgmt. v. Kidder Peabody & Co., Inc. (In re Granite Partners, L.P.), 210 B.R. 508 (Bkrtcy. S.D.N.Y. 1997) ................................................................................. 37
American Bankers Mortg. Corp. v. Federal Home Loan Mortg. Corp., 75 F.3d 1401 (9th Cir. 1996) ........................................................................................... 20, 28
Ashcroft v. Iqbal, 556 U.S. 662 (2009) .................................................................................................... 7, 21, 27
Barkis v. Scott, 208 P.2d 367 (1949) ........................................................................................................ 20, 27
Beechum v. Navient Sols., Inc., 2016 WL 5340454, at *4 ....................................................................................................... 12
Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) ................................................................................................................ 7
Benjamin v. Diamond (In re Mobile Steel Co.), 563 F.2d 692 (5th Cir. 1977) ................................................................................................. 37
Butner v. U.S., 440 U.S. 48 (1979) ................................................................................................................ 34
Casa Blanca Project Lenders, L.P. v. City Commerce Bank (In re Casa Blanca Project Lenders, L.P.), 196 B.R. 140 (9th Cir. BAP 1996) ........................................................................................ 24
Contra Alphatec Spine, Inc. v. Tillett, No. 15CV1066 DMS (KSC), 2015 WL 12699858, at *3 (S.D. Cal. July 31, 2015) ............ 26
Countrywide Home Loans, Inc. v. Hoopai (In re Hoopai), 581 F.3d 1090 (9th Cir. 2009) ......................................................................................... 22, 23
Deputy v. du Pont, 308 U.S. 488 (1940) .............................................................................................................. 14
Feder v. Lazar (In re Lazar), 83 F.3d 306 (9th Cir. 1996) ................................................................................................... 37
Gen. Elec. Capital Corp. v. Future Media Prods., Inc., 536 F.3d 969 (9th Cir. 2008) ............................................................................... 22, 23, 24, 27
Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (In re Entz-White Lumber and Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988) ......................................................................................... 24, 25
Greenbriar, Ltd. v. City of Alabaster, 881 F.2d 1570 (11th Cir.1989) .............................................................................................. 30
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Hassen Imps. P'ship v. KWP Fin. VI (In re Hassen Imps. P’ship), 256 B.R. 916 (9th Cir. BAP 2000) ........................................................................................ 23
In re 400 Walnut Assoc, Inc., 473 B.R. 603 (E.D. Pa. 2012) ............................................................................................... 15
In re Badger Freightways, Inc., 106 B.R. 971 (Bankr. N.D. Ill. 1989) .............................................................................. 37, 38
In re Campbell (Balyeat Law Offices v. Campbell), 14 B.R. 132 (9th Cir. BAP 1995) .......................................................................................... 33
In re Castillo, 488 B.R. 441 (2013) .............................................................................................................. 15
In re Catholic Bishop of N. Alaska, No. F08-00110-DMD, 2009 WL 8412174, at *6 (Bankr. D. Alaska Sept. 11, 2009) ..................................................................................................................................... 10
In re Catwil Corp., 175 B.R. 362 (Bankr. E.D. Cal. 1994) .................................................................................... 9
In re Center, 282 B.R. 561 (Bankr. D.N.H. 2002) ..................................................................................... 16
In re Churchill Properties III, Ltd. P'ship, 197 B.R. 283 (Bankr. N.D. Ill. 1996) .................................................................................... 17
In re Clark Pipe & Supply Co., 893 F.2d 693 (5th Cir. 1990) ................................................................................................. 38
In re CP Holdings, Inc., 332 B.R. 380 (W.D. Mo. 2005) ............................................................................................ 17
In re Curry & Sorensen, 57 B.R. 824 (B.A.P. 9th Cir. 1986) ................................................................................ 8, 9, 10
In re Daugherty Coal Co., Inc., 144 B.R. 320 (N.D. W. Va. 1992) .................................................................................. 37, 40
In re First Alliance Mortg. Co., 471 F.3d 977 (9th Cir. 2006) ........................................................................................... 37, 39
In re First Capital Holdings Corp., 146 B.R. 7 (Bankr. C.D. Cal. 1992) ........................................................................................ 9
In re Gledhill, 164 F.3d 1338 (10th Cir. 1999) ....................................................................................... 15, 16
In re Guy F. Atkinson Co. of California, 242 B.R. 497 (B.A.P. 9th Cir. 1999) ....................................................................................... 9
In re Hashim, 379 B.R. 912 (B.A.P. 9th Cir. 2007) ....................................................................................... 9
In re Jacks, 642 F.3d 1323 (11th Cir. 2011) ............................................................................................. 29
In re Landmark W., LLC, No. 11-44240 CN, 2015 WL 7889041, at *4 (Bankr. N.D. Cal. Dec. 2, 2015) .............. 26, 27
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In re Leatherland Corp., 302 B.R. 250 (Bankr. N.D.Ohio 2003) ........................................................................... 16, 17
In re Louisiana World Exposition, Inc., 832 F.2d 1391 (5th Cir. 1987) ................................................................................................. 9
In re Moore, 307 B.R. 394 (Bankr. S.D.N.Y. 2004) .................................................................................. 14
In re Ludwig Honold Mfg. Co., Inc., 46 B.R. 125 (Bankr. E.D. Pa. 1985) ...................................................................................... 38
In re Morse Tool, Inc., 87 B.R. 745 (Bankr. D. Mass. 1988) ..................................................................................... 18
In re Murphy, 279 B.R. 163 (Bankr. M.D. Pa. 2002) .................................................................................. 17
In re New Investments, Inc., Case No. 13-36194, 2016 WL 6543520 (9th Cir. Nov. 4, 2016) .............................. 22, 24, 25
In re Nunez, 317 B.R. 666 (Bankr. E.D. Pa. 2004) ........................................................................ 16, 17, 18
In re Osborne, 42 B.R. 988 (W.D. Wisc. 1984) ............................................................................................ 38
In re Pacific Express, Inc. 69 B.R. 112 (B.A.P. 9th Cir. 1986) ....................................................................................... 37
In re Paradigm Int'l, Inc., 635 F. App'x 355 (9th Cir. 2015) .......................................................................................... 37
In re Parmetex, Inc., 199 F.3d 1029 (9th Cir. 1999) ................................................................................................. 9
In re Parreira, 464 B.R. 410 (Bankr. E.D. Ca. 2012) ................................................................................... 30
In re Price, No. 07-01905-TOM, 2010 WL 1416706, at *6 (Bankr. N.D. Ala. Apr. 8, 2010) ................ 28
In re Sanders, No. 01-13577, 2004 WL 5865044, at *4-5 (Bankr. E.D. Pa. Mar. 22, 2004) ....................... 29
In re Schwarcz, No. BAP CC-06-1386-PAMAB, 2007 WL 7540970, at *7, n. 11 (B.A.P. 9th Cir. Aug. 29, 2007) .............................................................................................. 9
In re Shoen, 176 F.3d 1150 (9th Cir. 1999) ............................................................................................... 14
In re Skyler Ridge, 80 B.R. 500 (Bankr. C.D. Cal. 1987) .............................................................................. 18, 19
In re Spaulding Composites Co., Inc., 207 B.R. 899 (B.A.P. 9th Cir. 1997) ................................................................................. 9, 10
In re Teltronics Services, Inc., 29 B.R. 139 (Bankr. E.D.N.Y. 1983) .............................................................................. 37, 38
In re UC Lofts on 4th, LLC, No. AP 07-90139-CL, 2015 WL 5209252, at *20 (B.A.P. 9th Cir. Sept. 4, 2015) .............. 37
In re WCC Holding Corp., 171 B.R. 972 (Bankr. N.D. Tex. 1994) ................................................................................. 38
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In re Wesley, 455 B.R. 383 (Bankr. D.N.J. 2011) ....................................................................................... 15
Langan v. United Servs. Auto. Ass'n, 69 F. Supp. 3d 965 (N.D. Cal. 2014) .................................................................................... 26
Lee v. City of Los Angeles, 250 F.3d 668 (9th Cir. 2001) ................................................................................................. 13
Lloyd v. Comm’r of Internal Revenue, 154 F.2d 643 (3d Cir. 1946) .................................................................................................. 14
Mann v. Chase Manhattan Mortg. Corp., 316 F.3d 1 (1st Cir. 2003) ..................................................................................................... 29
McCarthy, Johnson & Miller v. N. Bay Plumbing, Inc. (In re Pettit), 217 F.3d 1072 (9th Cir. 2000) ............................................................................................... 34
Owen v. Owen, 500 U.S. 305 (1991) .............................................................................................................. 34
Powe v. Chrysler Fin. Corp. (In re Powe), 278 B.R. 539 (Bankr. S.D. Ala. 2002) .................................................................................. 16
Rake v. Wade, 508 U.S. 464 (1993) .............................................................................................................. 22
Syva Co. v. United States, 681 F. Supp. 885 (Ct. Int’l Trade 1988) ................................................................................ 14
Travelers Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 549 U.S. 443 (2007) ........................................................................................................ 24, 34
United States v. Ron Pair Enters., Inc., 489 U.S. 235 (1989) ........................................................................................................ 17, 22
United States v. Whiting Pools, Inc., 462 U.S. 198 (1983) .................................................................................................. 33, 34, 35
Vanston Bondholders Prot. Comm. v. Green, 329 U.S. 156 (1946) ........................................................................................................ 14, 21
Wells Fargo Bank, N.A. v. Beltway One Development Group, LLC (In re Beltway One Development Group, LLC), 547 B.R. 819 (9th Cir. BAP 2016) .................................................................................. 22, 23
BLACK’S LAW DICTIONARY 935 (10th ed. 2014) ........................................................................ 14
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DOCS_LA:304539.1 35793/001 1
Defendants Hercules Capital, Inc. f/k/a Hercules Technology Growth Capital, Inc., in its
capacity as administrative agent for itself and certain lenders and Hercules Technology III, L.P.
(collectively, “Hercules”), by and through their undersigned co-counsel, file this motion to dismiss
(the “Motion”) the first amended complaint [Docket No. 15] (the “Amended Complaint”) of
plaintiff Official Committee of Unsecured Creditors (the “Committee”) of Nasty Gal, Inc. (the
“Debtor”) for failure to state a claim upon which relief can be granted pursuant to Rule 7012 of the
Federal Rules of Bankruptcy Procedure (the “Bankruptcy Rules”), incorporating by reference, Rule
12(b)(6) of the Federal Rules of Civil Procedure (“FRCP”). In support of this Motion, Hercules
further submits the Declaration of Scott Bluestein (the “Bluestein Declaration”), which is attached
hereto as Exhibit A. Hercules respectfully states as follows:
I. INTRODUCTION
1. The Committee’s original complaint was premised upon numerous examples of
patently false allegations of fact and flawed claims for legal relief. In its Motion to Dismiss,
Hercules pointed this out in detail, and begged the Court to appreciate that the Committee
previously received thousands of pages of informal, organized, discovery responses which ought to
have led the Committee to the same conclusion. Rather, despite having three additional weeks since
the filing of its original Complaint to continue its inquiry into the facts and relevant law, the
Committee elected to file an amended complaint that is equally defective as the original.
2. Indeed, even if one were to accept the Committee’s allegations as given, the
Amended Complaint should be dismissed because, among the other reasons set forth in more detail
herein, (i) various statutes cited by the Committee in support of its claims for relief simply do not
apply (or are misapplied), (ii) damages to the estate arising from Hercules’ alleged breach of a
deposit account control agreement (“DACA”) resulting in $300,000 of checks not being honored
cannot exist where Hercules would be owed the same $300,000 had the bank honored the checks,
(iii) even a cursory reading of the unambiguous DACA shows the Committee’s allegations to be
misleading and untrue, (iv) damages to the estate arising from Hercules’ allegedly improper sweep
of funds cannot exist where the Debtor had more than sufficiently liquidity to conduct a successful
sale and made substantial adequate protection payments to Hercules along the way, (v) the post-
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petition application of the swept funds, assuming the sweeps occurred prepetition, is not a stay
violation under the Bankruptcy Code, and (vi) the draconian remedy of equitable subordination
cannot exist where Hercules’ alleged conduct was, at all times, completely within its contractual
rights.
3. If the Committee does not prevail on its claim to disallow interest at the current rate
of 14.2% on Hercules’ remaining claim of approximately $2.4 million, creditor recoveries would
diminish by nearly $1000 per day. Likewise, if the Committee is not the prevailing party, litigation
fees and costs incurred by Hercules for attorneys, experts, a trial and potential appeals, together
with those incurred by the Committee’s professionals, will eclipse any recovery it can achieve on its
weak claims. The Committee has much at stake and nothing to gain in its apparent attempt to
extort a settlement from an oversecured creditor. If the Committee cannot or will not make a
rational cost-benefit decision to discontinue this litigation, there is more than ample authority for the
Court to do so by granting this Motion.
II. FACTS
4. On November 9, 2016 (the “Petition Date”), the Debtor filed a voluntary petition for
relief under Chapter 11 of the Bankruptcy Code. Pursuant to Sections 1107 and 1108 of the
Bankruptcy Code, the Debtor has retained possession of its assets and is authorized, as debtor-in-
possession, to continue the operation and management of its business.
A. The Loan and Security Agreement
5. Prior to the Petition Date, the Debtor executed and entered into that certain Loan and
Security Agreement dated as of November 6, 2015 (the “LSA”) with Hercules. A copy of the LSA
is annexed to the Amended Complaint as Exhibit A. Section 2.4 of the LSA concerning “Default
Interest” provides:
“[i]n the event any payment is not paid on the scheduled payment date, an amount equal to five percent (5%) of the past due amount shall be payable on demand. In addition, upon the occurrence and during the continuation of an Event of Default hereunder, all Secured Obligations, including principal, interest, compounded interest, and professional fees, shall bear interest at a rate per annum equal to the rate set forth in Section 2.2(c), plus five percent (5%) per annum. In
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the event any interest is not paid when due hereunder, delinquent interest shall be added to principal and shall bear interest on interest, compounded at the rate set forth in Section 2.2(c) or Section 2.4, as applicable.”
Complaint, Exhibit A, LSA, p. 12.
6. Section 2.5 of the LSA concerning the “Prepayment Charge” provides:
“[a]t its option upon at least seven (7) Business Days prior notice to Agent, Borrower may prepay all, but not less than all, of the outstanding Advances by paying the entire principal balance, all accrued and unpaid interest thereon, together with a prepayment charge equal to the following percentage of the Advance amount being prepaid: if such Advance amounts are prepaid in any of the first twelve (12) months following the Closing Date, 2.0%; after twelve (12) months but prior to twenty four (24) months, 1.0%; and thereafter, 0% (each, a “Prepayment Charge”). Borrower agrees that the Prepayment Charge is a reasonable calculation of Lender’s lost profits in view of the difficulties and impracticality of determining actual damages resulting from an early repayment of the Advances. Borrower shall prepay the outstanding amount of all principal and accrued interest through the prepayment date and the Prepayment Charge upon the occurrence of a Change in Control. Notwithstanding the foregoing, Agent and Lender agree to waive the Prepayment Charge if Agent and Lender (in its sole and absolute discretion) agree in writing to refinance the Advances prior to the Maturity Date.”
Id.
7. Section 2.6 of the LSA concerning the “End of Term Charge” provides:
“[o]n the earliest to occur of (i) the Term Loan Maturity Date, (ii) the date that Borrower prepays the outstanding Secured Obligations (other than any inchoate indemnity obligations and any other obligations which, by their terms, are to survive the termination of this Agreement) in full, or (iii) the date that the Secured Obligations become due and payable, Borrower shall pay Lender a charge equal to 6.95% of the aggregate amount of the Term Loan Advances. Notwithstanding the required payment date of such charge, it shall be deemed earned by Lender as of the Closing Date” (the “End of Term Charge”).1
Id.
8. Section 7 of the LSA details various covenants of the Debtor. Under Section 7.1 of
the LSA, the Debtor is required to furnish Hercules with the financial statements and reports listed
1 Section 1.1 of the LSA defines “Term Loan Maturity Date” to mean May 1, 2019. A
“Term Loan Advance” means any Term Loan funds advanced under the LSA.
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therein, including, but not limited to, unaudited interim and year-to-date financial statements and a
Compliance Certificate, in the form of Exhibit F to the LSA, on a monthly basis. Id. at pp. 19-21.
9. Under Section 7.17 of the LSA, the Debtor is required, on a trailing three-month
basis, tested as of the end of the Debtor’s fiscal quarters, to maintain not less than 70% of the
forecasted EBITDA for the applicable trailing three month period in accordance with the Plan (as
defined in the LSA) (the “EBITDA Covenant”). Id. at p. 24. Under Section 7.18 of the LSA, the
Debtor is required to maintain minimum unrestricted cash and short term investments of at least
$1,500,000, at all times (the “Minimum Cash Covenant”). Id. at p. 24 (emphasis added).
10. Under Section 9.2 of the LSA, the breach or default in the performance of any
covenant under the LSA, including, for example, Sections 7.1 (financial reporting), 7.17 (EBITDA
Covenant) and 7.18 (Minimum Cash Covenant), is an Event of Default. Id. at p. 25. The Debtor
has ten (10) days to cure any covenant default under Section 7.1 of the LSA, which cure period
commences after the earlier of the date on which (i) Hercules has given notice of such default to
the Debtor, and (ii) the borrower has actual knowledge of such default. Id. (emphasis added).
Accordingly, as to the Debtor’s failure to provide required financial reporting and any covenant
breach as to which the Debtor is aware for ten days, no notice of default is necessary. Events of
Default from a breach the EBITDA and Minimum Cash covenants of Sections 7.17 and 7.18 of the
LSA arise automatically upon their occurrence do not require any notice from Hercules or
knowledge by the Debtor. Id.
11. Section 10.1 of the LSA provides:
Upon and during the continuance of any one or more Events of Default, (i) Agent may, at its option, accelerate and demand payment of all or any part of the Secured Obligations together with a Prepayment Charge and declare them to be immediately due and payable (provided, that upon the occurrence of an Event of Default of the type described in Section 9.5, all of the Secured Obligations shall automatically be accelerated and made due and payable, in each case without any further notice or act) ….
Id. at p. 26 (emphasis added).
12. Section 9.5 of the LSA provides that the filing of a voluntary petition in bankruptcy
shall be an Event of Default. Id. at p. 25-26.
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13. On June 30, 2016, Hercules provided notice to the Debtor that it was in default under
Sections 7.17, 7.18 and 9.2 of the LSA for failure to maintain (a) a minimum EBITDA of not less
than 70% of the forecasted EBITDA for the quarter ending April 30, 2016 and (b) minimum cash of
$1,500,000 at all times as of April 30, 2016 (the “Notice of Default”). A copy of the Notice of
Default is annexed to the Amended Complaint as Exhibit B. The Notice of Default advised that all
amounts due and owing shall bear interest at the default rate as authorized in Section 2.4 of the
LSA. Id.
B. The Amended Complaint
14. On January 31, 2017, the Committee filed its original complaint [Docket No. 1] (the
“Original Complaint”). On February 6, 2017, Hercules filed its motion to dismiss the Original
Complaint pursuant to Bankruptcy Rule 7012, incorporating by reference, FRCP 12(b)(6) [Docket
No. 10].
15. On February 24, 2017, the Committee filed the Amended Complaint, which asserts
eight claims for relief, as follows:
a. Count I – Disallowance of the End of Term Charge under Sections 502(b)(1),
502(b)(2) and/or 506(b) of the Bankruptcy Code;
b. Count II – Disallowance of the Prepayment Charge under Sections 502(b)(1),
502(b)(2) and 506(b) of the Bankruptcy Code and Cal. Civ. Code §§ 1671 and
3275;
c. Count III – Disallowance of Default Interest under Section 502(b)(1) and 506(b)
and Cal. Civ. Code §§ 1671 and 3275;
d. Count IV – Disallowance of Unreasonable Professional Fees under Section
506(b);
e. Count V – Damages for Breach of Contract;
f. Count VI – Damages for Violation of the Automatic Stay under Section 362 of
the Bankruptcy Code;
g. Count VII – Turnover and Disgorgement and/or Avoidance of Post-petition
Transfer under Sections 542, 549, 550 and 551 of the Bankruptcy Code; and
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h. Count VIII – Subordination of Claims under Section 510(c) of the Bankruptcy
Code.
16. The Amended Complaint is noteworthy for its exclusion of certain outlandish
allegations that were in the Original Complaint. For example, the Amended Complaint removes
allegations that (i) breaches of the EBITDA and Minimum Cash Covenants “did not occur or were
cured” [Original Complaint, ¶¶ 29(a), 33(a), 35] and (ii) and by refusing to recognize a cure by the
Debtor or waive an Event of Default, Hercules “breached the covenant of good faith and fair
dealing” [Original Complaint, ¶ 45]. In response to Hercules’ motion to dismiss the Original
Complaint, the Committee now acknowledges that the significant Events of Default reflected in the
Notice of Default annexed as Exhibit B to the Amended Complaint occurred and were never cured.
That is because the Amended Complaint, unlike the original one, does not allege that defaults did
not occur or were cured. Accordingly, the holdover allegations from the Original Complaint that
Hercules is somehow not entitled to its bargained for interest and charges under the LSA even if
Hercules did assert that the defaults “can never be cured” or that “the Debtor had no right to cure
them” are irrelevant to any claim for relief since no cure ever occurred. See Amended Complaint,
¶¶21, 42, 43.
17. The Amended Complaint also deleted the legal claim in Count V of the Original
Complaint, which unintelligibly sought disallowance of a portion of Hercules’ claim for the value of
the warrants issued to Hercules, as “original issue discount”, pursuant to Section 502(b)(2) of the
Bankruptcy Code. Lastly, the Amended Complaint contains three (3) new claims - - Breach of
Contract, Violation of the Automatic Stay and Turnover and Disgorgement - - as it relates to
Hercules’ exercise of its contractual rights to direct the Debtor’s Bank (as defined below) to remit
funds to Hercules prior to the Petition Date under the DACA, and application of such funds to the
End of Term Charge after the Petition Date.
III. RELIEF REQUESTED AND BASIS THEREFOR
18. Hercules hereby moves to dismiss each of the claims for relief in the Amended
Complaint for failure to state a claim upon which relief may be granted pursuant to Bankruptcy
Rule 7012, incorporating by reference, FRCP 12(b)(6). A complaint must allege sufficient factual
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matter, which if accepted as true would “state a claim to relief that is plausible on its face.”
Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atlantic Corp. v. Twombly, 550 U.S. 544,
570 (2007)). “Where a complaint pleads facts that are merely consistent with a defendant’s
liability, it stops short of the line between possibility and plausibility of entitlement to relief.”
Iqbal, 556 U.S. at 678 (citation and internal quotation marks omitted). Plausibility “is not akin to a
probability requirement,” but rather requires “more than a sheer possibility that a defendant has
acted unlawfully.” Id. (citation and internal quotation marks omitted).
19. Courts use a two-prong approach when considering a motion to dismiss. Iqbal, 556
U.S. at 678–79 (stating that motion to dismiss standard “creates a ‘two-pronged approach’ . . . based
on ‘[t]wo working principles’”). First, the court must accept all factual allegations in the complaint
as true, discounting legal conclusions clothed in factual garb. See Iqbal, 556 U.S. at 677–78.
Second, the court must determine if these well-pleaded factual allegations state a “plausible claim
for relief.” Iqbal, 556 U.S. at 679 (citation omitted).
20. Courts do not make plausibility determinations in a vacuum; it is a “context-specific
task that requires the reviewing court to draw on its judicial experience and common sense.” Id.
(citation omitted). A claim is plausible when the factual allegations permit “the court to draw the
reasonable inference that the defendant is liable for the misconduct alleged.” Id. (citation omitted).
A complaint that pleads only facts that are “merely consistent with a defendant’s liability” does not
meet the plausibility requirement. Id. at 678 (quoting Twombly, 550 U.S. at 557). “A pleading that
offers ‘labels and conclusions’ or ‘a formulaic recitation of the elements of a cause of action will
not do.’” Id. (quoting Twombly, 550 U.S. at 555) (internal quotation marks omitted). “Threadbare
recitals of the elements of a cause of action, supported by mere conclusory statements, do not
suffice.” Id. (citation omitted).
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I. As a threshold matter, and upon consideration of the arguments herein (only if required), this Court must dismiss the Complaint because the Committee lacks standing to assert the claims set forth in the Complaint.2
21. The Committee was never afforded standing to file a Complaint on behalf of the
Debtor. See Fourth Interim Stipulation Authorizing Use of Cash Collateral and Granting Adequate
Protection [Docket No. 226] (“[n]otwithstanding the foregoing stipulations and waivers by the
Debtor, any other estate representative, including the Official Committee of Unsecured Creditors of
the Debtor (the “Committee”), that has or obtains standing to challenge the Prepetition Lender’s
liens, claims and interests…”). See Complaint, ¶ 8 (emphasis added). Unlike a chapter 11 or 7
trustee that has standing, the Committee does not. The need for a Committee to obtain standing is
reinforced by the very tactics of the Committee here - - an ill-advised gambit to extort from
Hercules a settlement of deficient allegations in the hope that Hercules would not wish to undergo
litigation costs. The Committee’s strategy is flawed by the fact that Hercules is oversecured and the
very creditors for whom the Committee’s members serve as fiduciaries will bear every penny of
Hercules’ substantial costs to dispose of the Complaint in addition to those of the Committee’s own
professionals. Thus, the standing requirement serves as the gatekeeper to prevent harm to creditors
that the greatly flawed Amended Complaint will certainly cause.
22. “If an aggrieved creditor believes that the debtor-in-possession has failed to fulfill its
duty to prosecute actions, then the creditor must bring this to the attention of the court by an
appropriate motion… This judicial intervention is crucial….” In re Curry & Sorensen, Inc., 57 B.R.
824, 828 (B.A.P. 9th Cir. 1986) (affirming bankruptcy court’s dismissal of fraudulent transfer
complaint brought by creditors against debtor’s president for failing to seek derivative standing to
bring claim, and noting that judicial review is necessary to “determine if the initiation of such an
2 In paragraph 11 of the Amended Complaint, the Committee alleges that Hercules’ counsel
stipulated in open court that the Committee would have standing to prosecute claims and that Hercules would not challenge such standing. Hercules’ counsel has no notes of such stipulation but has been diligently attempting to obtain and review the relevant court transcripts. As of yet, counsel has either not been able to obtain all cash collateral hearing transcripts nor locate the oral stipulation to which the Amended Complaint refers. Should the Committee prove to be correct regarding such stipulation, Hercules shall immediately withdraw its standing argument.
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action at that time would forward the reorganization effort, or to the contrary, might be a
detriment”). The BAP also noted that “even creditors’ committees organized under 11 U.S.C. §
1102 must also secure prior court approval before instituting such suits.” Curry & Sorensen, 57
B.R. 828, n. 3; see also In re First Capital Holdings Corp., 146 B.R. 7, 11 (Bankr. C.D. Cal. 1992)
(citing to precedent for the requirement that “before a committee may bring an action on behalf of
the estate… the committee must first obtain leave to sue from the bankruptcy court”)
(emphasis added); In re Schwarcz, No. BAP CC-06-1386-PAMAB, 2007 WL 7540970, at *7, n. 11
(B.A.P. 9th Cir. Aug. 29, 2007) (Noting that “[t]he Committee may not act on behalf of, or with
rights derivative of, the debtor-in-possession or estate without permission of the bankruptcy
court.”); In re Guy F. Atkinson Co. of California, 242 B.R. 497, 503 (B.A.P. 9th Cir. 1999)
(reversing bankruptcy court’s grant of authority to bonding companies to settle claims against estate
because bankruptcy court failed to apply correct standard in determining “whether there was
sufficient reason to allow a party other than the trustee or debtor in possession to pursue those
settlements” and remanding to bankruptcy court to apply recognized test for derivative
standing). Cf. In re Parmetex, Inc., 199 F.3d 1029, 1031 (9th Cir. 1999) (stating that creditors in a
Chapter 7 case had standing “where the trustee stipulated that the Creditors could sue on his behalf
and the bankruptcy court approved that stipulation-the Creditors had standing to bring the suit”).
23. Courts in this district have held that the Committee should, but is not required to,
secure approval from the Court before filing the complaint. “While the better practice is for the
plaintiff to secure approval before filing the complaint, we will not foreclose the ability of a court to
make its approval of the representation retroactive to the time of the filing. To hold otherwise would
generate needless dismissals and refilings.” In re Spaulding Composites Co., Inc., 207 B.R. 899,
905 (B.A.P. 9th Cir. 1997) (citing In re Catwil Corp., 175 B.R. 362, 365 (Bankr. E.D. Cal. 1994); In
re Louisiana World Exposition, Inc., 832 F.2d 1391, 1398 (5th Cir. 1987)); see also In re Hashim,
379 B.R. 912, 922 (B.A.P. 9th Cir. 2007) (“Our controlling decision on the temporal question is
Spaulding Composites, in which we clarified that Curry & Sorensen’s reference to prior approval
states what is plainly the better practice but does not preclude requests for court approval that are
made after the complaint is filed.”).
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24. Assuming this Court permits the Committee to file the Amended Complaint nunc
pro tunc, and then move for standing, such standing should be denied. For example, after
examining Ninth Circuit precedent, and the tests used in other Circuits to determine whether
derivative standing should be granted, the Bankruptcy Court for the District of Alaska held that
“[c]learly, a ground for justifiably refusing to pursue a claim exists where the projected cost of
pursuing the litigation would exceed the value of the claim.” In re Catholic Bishop of N. Alaska,
No. F08-00110-DMD, 2009 WL 8412174, at *6 (Bankr. D. Alaska Sept. 11, 2009) (holding that the
requirements of In re Spaulding Composites Co., Inc., 207 B.R. 899, 904 (B.A.P. 9th Cir. 1997) that
a court verify “that the litigation is indeed necessary and beneficial” and Curry & Sorensen, 57 B.R.
at 828, that a court determine whether “the debtor-in-possession’s failure to bring the action
is unjustifiable” support the requirement of a cost-benefit analysis)(emphasis added).
25. In applying such cost-benefit analysis after consideration of this Motion, the Court
can easily conclude that the expenses to litigate the Committee’s novel and weak claims will far
exceed any reasonable estimate of recovery to the estate. As such, the Committee can never meet
its burden to establish that it is entitled to standing to pursue the Complaint. For these reasons, the
Complaint should be dismissed.
II. The First Claim for Relief, Which Seeks Disallowance of the End of Term Charge, Should be Dismissed for Failure to State a Claim
26. When accepting all factual allegations in the Amended Complaint as true, Count I
fails to state a plausible claim for relief for five independent reasons. First, the Secured Obligations
became due and payable as a result of the bankruptcy filing, which triggered Hercules’ entitlement
to the End of Term Charge. Second, the End of Term Charge is enforceable against the Debtor
under applicable non-bankruptcy law and, thus, should not be disallowed under Section 502(b)(1) of
the Bankruptcy Code. Third, the End of Term Charge is not unmatured interest disallowable under
Section 502(b)(2) of the Bankruptcy Code. Fourth, the End of Term Charge is not subject to the
Section 506(b) “reasonableness” standard because it was not earned nor did it arise after Petition
Date. Fifth, assuming, arguendo, that Section 506(b) applies, the End of Term Charge is a
“reasonable” fee and it is enforceable under California law.
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i. The End of Term Charge Was Triggered by the Bankruptcy Filing
27. The Committee alleges that as of the Petition Date, the “Secured Obligations had not
become due and payable.” See Amended Complaint, ¶ 27. The Committee is incorrect.
28. The voluntary bankruptcy filing by the Debtor was an Event of Default that
automatically accelerated and made due and payable the Secured Obligations under Sections 9.5
and 10.1 of the LSA the same instant the Debtor’s chapter 11 case was filed. See, e.g., LSA, § 10.1
(“[u]pon and during the continuance of any one or more Events of Default, (i) Agent may, at its
option, accelerate and demand payment of all or any part of the Secured Obligations together with a
Prepayment Charge and declare them to be immediately due and payable (provided, that upon the
occurrence of an Event of Default of the type described in Section 9.5, all of the Secured
Obligations shall automatically be accelerated and made due and payable, in each case without
any further notice or act) ….”) (emphasis added); LSA, § 9.5 (provides that the filing of a voluntary
petition in bankruptcy shall be an Event of Default). Accordingly, the bankruptcy filing itself
triggered Hercules’ entitlement to receive payment of the End of Term Charge under Section 2.6(iii)
of the LSA. See LSA, § 2.6 (“[o]n the earliest to occur of … (iii) the date that the Secured
Obligations become due and payable ….”).
29. For these reasons, the Committee fails to state a plausible claim for relief that the
End of Term Charge should not be allowed upon allegations that the Secured Obligations had not
become due and payable.
ii. The End of Term Charge is Enforceable Under California Law
30. The Amended Complaint alleges that the End of Term Charge should be disallowed
under Section 502(b)(1) because it is “inherently unreasonable, inequitable and unconscionable.”
See Amended Complaint, ¶ 37(a).
31. The validity of the End of Term Charge must be viewed under California law, which
governs the LSA. California’s constitution contains a usury provision. Cal. Const. art. XV, § 1.
Specifically, it states that:
in the case of a “loan or forbearance of any money, goods, or things in action, if the money, goods, or things in action“ are not “primarily for personal, family, or household purposes,” interest can accrue “at a
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rate not exceeding the higher of (a) 10 percent per annum, or (b) 5 percent per annum plus the rate prevailing on the 25th day of the month preceding the earlier of (i) the date of execution of the contract to make the loan or forbearance, or (ii) the date of making the loan or forbearance established by the Federal Reserve Bank of San Francisco on advances to member banks under Sections 13 and 13a of the Federal Reserve Act as now in effect or hereafter from time to time amended (or if there is no such single determinable rate of advances, the closest counterpart of such rate as shall be designated by the Superintendent of Banks of the State of California unless some other person or agency is delegated such authority by the Legislature).
Cal. Const. art. XV, § 1.
32. The California Constitution further provides that “[n]o person, association, co-
partnership or corporation shall by charging any fee, bonus, commission, discount or other
compensation receive from a borrower more than the interest authorized by this section upon any
loan or forbearance of any money, goods or things in action.” However, California has declared
certain lenders exempt from its constitutional usury laws. WRI Opportunity Loans II LLC v.
Cooper, 154 Cal. App. 4th 525, 533, 65 Cal. Rptr. 3d 205, 212 (2007) (“The usury law is subject to
numerous exceptions and statutory exemptions”).
33. “The essential elements of a claim for usury are that: (1) the transaction must be a
loan or forbearance; (2) the interest to be paid must exceed the statutory maximum; (3) the loan and
interest must be absolutely repayable by the borrower; and (4) the lender must have a willful intent
to enter into a usurious transaction.” Beechum v. Navient Sols., Inc., 2016 WL 5340454, at *4
(citations omitted) (noting that intent is established by intent to consummate a transaction and does
not require improper motives). Where “a loan meets the requirements for a statutory exemption to
the usury law, courts will not look beyond those requirements to determine whether the underlying
transaction exposes the lender's profits to significant risk or betrays an intent to evade the usury
law.” WRI Opportunity, 154 Cal. App. 4th 536.
34. “The California Constitution exempts from its usury restrictions “persons authorized
by statute—such as finance lenders (§ 22002).” Montgomery v. GCFS, Inc., 237 Cal. App. 4th 724,
732, 188 Cal. Rptr. 3d 446, 452 (2015) (internal marks omitted) (citing Cal. Fin. Code § 22000).
Cal. Fin. Code § 22002 is a provision of the “California Finance Lenders Law.” Cal. Fin. Code §
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22000 et seq. Broadly speaking, finance lenders are required to register with the California
Department of Business Oversight in order to become licensed to make certain loans. See
35. The definition of finance lender “includes any person who is engaged in the business
of making consumer loans or making commercial loans.” Cal. Fin. Code § 22009. In turn, a
“commercial loan” is “ a loan of a principal amount of five thousand dollars ($5,000) or more, or
any loan under an open-end credit program, whether secured by either real or personal property, or
both, or unsecured, the proceeds of which are intended by the borrower for use primarily for other
than personal, family, or household purposes.” Cal. Fin. Code § 22502 (emphasis added). Section
22002 itself “creates a class of exempt persons [for finance lenders] pursuant to Section 1 of Article
XV of the California Constitution.” Cal. Fin. Code § 22002.
36. Because Hercules is a licensed finance lender, it is exempt from the California
Constitution’s usury restrictions. A true copy of Hercules’ license is attached as Exhibit 2 to the
Bluestein Declaration filed in support of this Motion.3
37. Accordingly, the End of Term Charge is “enforceable” under California law and,
thus, the End of Term Charge is not disallowable under Section 502(b)(1) of the Bankruptcy Code.
iii. The End of Term Charge is Not Unmatured Interest
38. The Complaint also alleges that the End of Term Charge should be disallowed to the
extent it constitutes unmatured interest under Section 502(b)(2) of the Bankruptcy Code. See
Amended Complaint, ¶ 37(b).
39. The term “unmatured interest” is unambiguous. “Interest” is:
3 As a general rule, the court may not consider any material beyond the pleadings in
considering a motion to dismiss under FRCP 12(b)(6). Lee v. City of Los Angeles, 250 F.3d 668, 688 (9th Cir. 2001). However, the Rule permits the Court to consider matters outside of the Complaint and treat a motion to dismiss as one for summary judgment under FRCP 56. Hercules submits that its license as a commercial lender is a matter that is uncontrovertible and can easily be gleaned from the public record and suitable for consideration on this Motion. Moreover, a court may “take judicial notice of matters of public record without converting a motion to dismiss into a motion for summary judgment . . . but [only when taking] judicial notice of a fact that is [not] subject to reasonable dispute. Lee, 250 F.3d at 689-90.
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[t]he compensation fixed by agreement or allowed by law for the use or detention of money, or for the loss of money by one who is entitled to its use; [especially], the amount owed to a lender in return for the use of borrowed money.
BLACK’S LAW DICTIONARY 935 (10th ed. 2014); accord Lloyd v. Comm’r of Internal Revenue, 154
F.2d 643, 646 (3d Cir. 1946) (quoting Deputy v. du Pont, 308 U.S. 488, 498 (1940)).
40. In other words, “interest” is “the basic cost . . . for borrowing money,” Syva Co. v.
United States, 681 F. Supp. 885, 888 (Ct. Int’l Trade 1988). Further, “interest” is “unmatured” if it
is: (a) postpetition interest that is not yet due and payable or (b) “prepaid interest that represents an
original discounting of the claim” and “would not have been earned” prepetition. H.R. Rep. No. 95-
595, at 352 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6308. Therefore, “unmatured interest” is
the cost of borrowing that was either (a) not due and payable prepetition, or (b) paid but not earned
prepetition. In re Moore, 307 B.R. 394, 397 (Bankr. S.D.N.Y. 2004). Here, the End of Term
Charge was earned as of the Closing Date and due and fully payable when the petition was filed
and, thus, cannot be characterized as unmatured interest. The unclear allegation in paragraph 37 a.
of the Amended Complaint that the End of Term Charge “did not become due until after the Petition
Date and must be disallowed to the extent to which it constitutes embedded OID or unmatured
interest” is belied by the very terms of the LSA attached to the Amended Complaint.
41. Further, Section 502(b)(2) does not apply to the End of Term Charge because
Hercules is an oversecured creditor. As a general rule, post-petition interest and expenses are not an
allowed component of a creditor’s claim under § 502(b)(2). Vanston Bondholders Prot. Comm. v.
Green, 329 U.S. 156 (1946). The Court in Vanston noted that the reasons for this rule are as
follows: “‘(1) post-petition interest is a penalty imposed for a delay of payment required by law to
allow the preservation and protection of the estate for the benefit of all interests, (2) the rule avoids
the administrative inconvenience of continuously recomputing claims, and (3) it avoids the gain or
loss as between creditors whose obligations bear different interest rates or who receive payment at
different times.’ Id. at 163-64. The rule does not, however, apply to an over-secured creditor who
is entitled to post-petition interest up to the value of its collateral. See Vanston, 329 U.S. at 164; see
also In re Shoen, 176 F.3d 1150, 1153, n.2 (9th Cir. 1999) (there are two exceptions to 11 U.S.C. §
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502(b)(2): first, where the debtor is actually solvent, 11 U.S.C. § 726(a)(5); and second, where the
creditor is oversecured, 11 U.S.C. § 506(b)); In re Castillo, 488 B.R. 441, 448 (2013) (when a
creditor is oversecured, entitlement to interest is governed by Section 506(b); if a creditor is
unsecured, it is left with Section 502(b), which expressly disallows a claim for interest that is
unmatured as of the petition date).
iv. The End of Term Charge was not Earned Post-Petition and Therefore Not Subject to Section 506(b) Review
42. The Committee alleges that the End of Term Charge is an unreasonable charge under
Section 506(b) of the Bankruptcy Code. See Amended Complaint, ¶ 37(c).
43. Section 506(b) deals exclusively with the claims of oversecured creditors. It
provides that “[t]o the extent that an allowed secured claim is secured by property the value of
which ... is greater than the amount of such claim, there shall be allowed to the holder of such claim,
interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement
or State statute under which such claim arose.” 11 U.S.C. § 506(b) (emphasis added). Under
Section 506(b), therefore, if an oversecured creditor’s right to a payment under the loan is
characterized as “interest” or as a reasonable “fee” or “charge,” that right to payment will be
respected.
44. As an initial matter, the majority view is that Section 506(b) applies only to post-
petition fees, costs or charges. See In re 400 Walnut Assoc, Inc., 473 B.R. 603, 610 (E.D. Pa. 2012)
(“The majority view is that § 506(b) does not apply to interest and other charges that accrue before
the filing of the bankruptcy petition.”) (emphasis in original) citing inter alia Collier on Bankruptcy
¶ 506.04[1] (16th ed. 2012) (“The allowability of ... prepetition amounts as part of the secured
creditor's ‘claim’ is not determined by section 506, but is governed by section 502 in conjunction
with other provisions of the Code.”); In re Gledhill, 164 F.3d 1338, 1340 (10th Cir.
1999) (“[H]olders of an oversecured ... claim are entitled to interest [and other costs] that
accrue before the debtor’s bankruptcy petition is filed. Interest [and other costs] that accrue after the
petition has been filed ... are permitted only if authorized under 11 U.S.C. § 506(b).”); In re
Wesley, 455 B.R. 383, 387 (Bankr. D.N.J. 2011) (“[P]re-petition claims ... are governed by section
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502 and not prohibited under section 506(b)....”); In re Nunez, 317 B.R. 666, 670 (Bankr. E.D. Pa.
2004); (“[S]ection 506(b) applies only to post-petition interest, fees and costs sought in a secured
creditor's proof of claim. The ‘allowability’ of pre-petition claims is governed by section 502 and
not by section 506(b).”); In re Leatherland Corp., 302 B.R. 250, 257–58 (Bankr. N.D.Ohio 2003)
(Section 506(b) applies only to post-petition secured amounts); Collier on Bankruptcy ¶ 506.04
(16th ed. 2012) (“The allowability of ... prepetition amounts as part of the secured creditor's ‘claim’
is not determined by section 506, but is governed by section 502 in conjunction with other
provisions of the Code.”); but see Wetzel v. Advocate Realty Inv., LLC, 275 F.3d 1308, 1318 (11th
Cir. 2001) (applying the reasonableness standard of § 506(b) to unpaid attorney fees that the
creditor incurred both prepetition and postpetition, deciding that § 502 and § 506 “should be read in
tandem with one another,” as § 502 deals with the threshold question of whether a claim should be
allowed or disallowed, then § 506 deals with the narrow issue of whether certain types of claims
should be considered secured or unsecured); In re Center, 282 B.R. 561, 565 (Bankr. D.N.H. 2002)
(same); Powe v. Chrysler Fin. Corp. (In re Powe), 278 B.R. 539, 554 (Bankr. S.D. Ala. 2002)
(same).
45. The majority view is buttressed by the fact that interest and fees that accrue before
the filing of the bankruptcy petition are already part of the underlying bankruptcy claim. In re
Nunez, 317 B.R. at 670. “The amount of a creditor's bankruptcy claim is measured as of the date of
the filing of the petition.” In re Gledhill, 164 F.3d at 1340 (quoting 11 U.S.C. § 502(b)).
46. As the Nunez court noted,
[t]he starting point in the application of [section 506(b) ] is the existence of “an allowed secured claim,” which is determined by looking to applicable law. A “claim” includes “any right to payment....” The plain language of § 506(b) does not limit the definition of an “allowed secured claim” to include only the principal amount due. Rather, the “allowed secured claim” referred to in that section necessarily includes the principal as well as any interest and fees for which the creditor has a right to payment as of the time the bankruptcy petition is filed. Section 506(b) then provides that a creditor may collect certain postpetition additions to the extent that its “allowed secured claim” is oversecured.
In re Nunez, 317 B.R. at 670 (quoting In re Leatherland Corp., 302 B.R. at 258).
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47. Further, the majority interpretation comports with the Supreme Court’s explanation,
albeit in a different context, that “[s]ection 506(b) allows a holder of an oversecured claim to
recover, in addition to the prepetition amount of the claim, ‘interest on such claim, and any
reasonable fees, costs, or charges provided for under the agreement under which such claim arose.’”
United States v. Ron Pair Enters., Inc., 489 U.S. 235, 239–40 (1989) (emphasis added) (quoting 11
U.S.C. § 506(b)); see also In re Murphy, 279 B.R. 163, 165 (Bankr. M.D. Pa. 2002) (“pre-petition
penalty amounts included in nonconsensual, secured claims are not prohibited by § 506(b)” and
therefore, the IRS properly included prepetition penalties in its secured proof of claim).
48. This Court should adopt the reasoning in Nunez and Leatherland Corp. The
Bankruptcy Code “is not intended to be read in a vacuum.” In re Churchill Properties III, Ltd.
P'ship, 197 B.R. 283, 288 (Bankr. N.D. Ill. 1996). Section 506(b) must be read in conjunction with
section 502, which provides that “[a] claim or interest, proof of which is filed under section 501 of
this title, is deemed allowed, unless a party in interest, including a creditor of a general partner in a
partnership that is a debtor in a case under chapter 7 of this title, objects.” Accordingly, it is
apparent that “since an ‘allowed secured claim’ under section 502 includes amounts that have
accrued pre-petition, section 506(b) applies only to post-petition interest, fees and costs sought in a
secured creditor's proof of claim.” See In re Nunez, 317 B.R. at 670
49. Here, Section 2.6 of the LSA provides that, “[n]otwithstanding the required payment
date of such charge, it shall be deemed earned by Lender as of the Closing Date,” which was pre-
petition. Accordingly, the reasonableness standard under Section 506(b) of the Bankruptcy Code
does not apply because the End of Term Charge was earned and accrued on the Closing Date, which
is prior to the commencement of this Chapter 11 case. Also, the End of Term Charge became
automatically payable as of the acceleration of the debt, concurrent with the bankruptcy filing itself,
not after the filing. The End of Term Charge is “already a part of [Hercules’] secured … proof of
claim in the first instance rendering section 506(b) inapplicable.” See In re Nunez, 317 B.R. at 670.
50. As a result, Hercules need only satisfy Section 502(b)(1) of the Bankruptcy Code,
which contains no “reasonableness” requirement. See In re CP Holdings, Inc., 332 B.R. 380 (W.D.
Mo. 2005), aff'd 2006 WL 3203751 (8th Cir. 2006); In re Leatherland Corp., 302 B.R. at 257-58; In
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re Nunez, 317 B.R. at 670. Here, Hercules satisfies Section 502(b)(1) because, as set forth above,
the End of Term Charge is enforceable against the Debtor under California law.
v. The End of Term Charge is Reasonable
51. Assuming, arguendo, that the Court determines that Section 506(b) applies, the End
of Term Charge is “reasonable” under Section 506(b). A review of Ninth Circuit cases
demonstrates that there are varying tests for “reasonableness” under Section 506(b). One view is
that prepayment fees have to satisfy both state and federal law before they can be enforced against a
debtor. See In re Skyler Ridge, 80 B.R. 500 (Bankr. C.D. Cal. 1987). The rationale for these
decisions is straightforward: Section 502(b)(1) of the Bankruptcy Code “requires that the validity of
claims be determined according to non-bankruptcy law,” and Section 506(b), rather than overriding
that requirement, “creates a supplemental requirement that the charge be reasonable.” See In re
Morse Tool, Inc., 87 B.R. 745, 748-50 (Bankr. D. Mass. 1988). Another view – which appears to
be the minority – is that Section 506(b) is only a question of federal law. See Imperial Coronado
Partners, Ltd., 96 B.R. 997, 1000-01 (B.A.P. 9th Cir. 1989) (where en route to remanding to the
bankruptcy court so that lenders could present evidence of actual damages, the Bankruptcy
Appellate Panel for the Ninth Circuit stated without further explanation that “[w]hat constitutes a
‘reasonable’ charge under section 506(b) is a question of federal, not state law”).
52. Assuming Skyler is the correct view, the validity of the End of Term Charge must be
viewed under California law, which governs the LSA. As set forth above, because Hercules is a
licensed finance lender, it is exempt from the California Constitution’s usury restrictions.
Accordingly, the End of Term Charge is “enforceable” under California law and, thus, the End of
Term Charge is “reasonable” under Section 506(b).
53. For all these reasons, the First Claim for Relief fails to state a claim for which relief
can be granted and must be dismissed.
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III. The Second Claim for Relief, Which Seeks Disallowance of the Prepayment Charge, Should be Partially Dismissed Because no Relief is Available Under Sections 502(b)(1) and 502(b)(2) of the Bankruptcy Code
54. When accepting all factual allegations in the Amended Complaint as true, this Court
should dismiss Count II because it fails to state a plausible claim for relief.
55. The Committee seeks to challenge the Prepayment Charge on three independent
bases: (i) the charge is unenforceable under California law (Cal. Civ. Code §§ 1671 and 3275) and,
therefore, must be disallowed under Section 502(b)(1) of the Bankruptcy Code; (ii) the charge is
unmatured interest disallowable under Section 502(b)(2) of the Bankruptcy Code; and (iii) the
charge, when coupled with the End of Term Charge, is “inherently unreasonable, inequitable and
unconscionable. See Amended Complaint, ¶ 39.4 Each of these challenges to the Prepayment
Charge is without merit as a matter of law.
i. The Prepayment Charge is Enforceable Under California Law
56. Section 502(b)(1) provides that a court should disallow a claim to the extent it is
unenforceable against the debtor under applicable non-bankruptcy law. 11 U.S.C. § 502(b)(1). The
Committee argues the charge is unenforceable under Cal. Civ. Code §§ 1671 and 3275. That
argument is misplaced.
57. Cal. Civ. Code § 1671 provides that “a provision in a contract liquidating the
damages for the breach of the contract is valid unless the party seeking to invalidate the provision
establishes that the provision was unreasonable under the circumstances existing at the time the
contract was made.” Cal. Civ. Code § 1671 is not applicable because the Prepayment Charge is not
a liquidated damages provision payable upon a breach of the LSA. Section 2.5 of the LSA provides
4 The Committee also asserts the Prepayment Charge is an unreasonable fee under Section 506(b) of
the Bankruptcy Code. That allegation is a fact issue that is inappropriate for Hercules to address in the context of this Motion under FRCP 12(b)(6). Moreover, the Committee makes passing reference to the acceleration of the debt under the LSA. See Amended Complaint, ¶ 39(b). In In re Skyler Ridge, 80 B.R. 500 (Bankr. C.D. Cal. 1987), the bankruptcy court held “[t]he automatic acceleration of a debt upon the filing of a bankruptcy case is not the kind of acceleration that eliminates the right to a prepayment premium.” Id. at 507.
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that such payment is due upon the prepayment of advances within a specified time period having
nothing to do with a breach of the LSA. See LSA, § 2.5.
58. Cal. Civ. Code § 3275 provides: “[w]henever, by the terms of an obligation, a party
thereto incurs a forfeiture, or a loss in the nature of a forfeiture, by reason of his failure to comply
with its provisions, he may be relieved therefrom, upon making full compensation to the other
party, except in the case of a grossly negligent, willful, or fraudulent breach of duty.” The party in
default must plead and prove facts entitling it to relief under the section. Barkis v. Scott, 208 P.2d
367, 370 (1949).
59. Cal. Civ. Code § 3275, which was intended to “to relieve a defaulting purchaser from
the odious burden of losing previous installment payments by virtue of a default on a single,
subsequent payment,” does not apply to this case because the Debtor has not been deprived of the
benefit of any previous payments. See American Bankers Mortg. Corp. v. Federal Home Loan
Mortg. Corp., 75 F.3d 1401, 1414 (9th Cir. 1996). The Committee has failed to include the
required allegation that the Debtor made full compensation for its failure to comply with the
provisions of the LSA. Instead, the Committee alleges that “[I]f Defendants assert that the
Prepayment Charge was triggered by provisions of the LSA causing acceleration of the loan based
on the filing of the Debtor’s Chapter 11 Case as an ‘Event of Default’, then the Prepayment Charge
constitutes a penalty and/or forfeiture by reason of the Debtor’s filing of a bankruptcy case…”. See
Amended Complaint, ¶ 39 b.
60. That is a very big “if”. Hercules does not assert that the Prepayment Charge has
anything to do with the Debtor’s chapter 11 filing. It is payable during certain timeframes and in
certain amounts, or not at all, depending on when the payment is made and not upon whether an
acceleration from the bankruptcy filing occurred.
61. As a result, § 3275 is not applicable to this case and even if it were, the Committee
has failed to properly plead any right to relief thereunder.
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62. Lastly, as noted above, the Prepayment Charge is enforceable because Hercules is a
licensed finance lender, exempt from the California Constitution’s usury restrictions. Accordingly,
the Prepayment Charge is not disallowable under Section 502(b)(1).
ii. The Prepayment Charge is Not Unmatured Interest
63. Section 502(b)(2) provides that a court should disallow a claim for unmatured
interest. 11 U.S.C. § 502(b)(2). For the same reasons set forth above as it relates to the End of
Term Charge, Section 502(b)(2) does not apply to the Prepayment Charge because Hercules is an
oversecured creditor. See, e.g., Vanston, 329 U.S. at 164 (1946); Thrifty Oil Co., 322 F.3d at 1046 .
64. Because Section 502(b)(2) does not apply to Hercules, as an oversecured creditor,
the Prepayment Charge is not subject to challenge under that Code Section.
iii. The Prepayment Charge, When Coupled with the End of Term Charge, is Legitimate and Reasonable
65. Under the clear terms of the LSA, Hercules is entitled to both the End of Term
Charge and the Prepayment Charge. As a matter of law, the Prepayment Charge neither duplicates
the End of Term Charge nor results in a double recovery to Hercules. Under Iqbal, the Committee’s
conclusory and factually implausible allegations - - such as the “Prepayment Charge, when coupled
with the End of Term Charge and default interest, has no legitimate financial or economic basis and
is inherently unreasonable, inequitable and unconscionable.” See Amended Complaint, ¶ 39 f. - -
are insufficient and cannot withstand the pleading stage.
66. For all of these reasons, even if this Court accepts all factual allegations in the
Complaint as true, the Committee has failed to state a claim under Code Sections 502(b)(1) and
502(b)(2) or under Cal Civ. Code §§ 1671 and 3275. Therefore, all clams under the Second Claim
for Relief should be dismissed, except only for the Committee’s claim under Section 506(b) of the
Bankruptcy Code.
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IV. The Third Claim for Relief, Which Seeks Disallowance of Default Interest, Should be Dismissed for Failure to State a Claim
67. When accepting all factual allegations in the Amended Complaint as true, the Court
should dismiss Count III because it fails to state a plausible claim for relief.5
68. Given there was an Event of Default, Hercules is entitled to default interest as part of
its allowed claim under the governing cases in the Ninth Circuit, which are: (i) Wells Fargo Bank,
N.A. v. Beltway One Development Group, LLC (In re Beltway One Development Group, LLC), 547
B.R. 819 (9th Cir. BAP 2016) (“Beltway”); (ii) Gen. Elec. Capital Corp. v. Future Media Prods.,
69. The Bankruptcy Code does not specifically deal with pendency interest - - interest
accrued after the filing of a petition but prior to the effective date of a reorganization plan - -
because the filing of the petition usually stops interest from accruing. See Beltway, 547 B.R. at 826.
Section 506(b), however, provides an exception for oversecured creditors. Id. Section 506(b)
provides:
(b) To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.
11 U.S.C. § 506(b).
70. Thus, an oversecured creditor can recover pendency interest as part of its allowed
claim, at least to the extent it is oversecured. Beltway, 547 B.R. at 826 (citing Rake v. Wade, 508
U.S. 464, 471 (1993); U.S. v. Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989); and Countrywide
5 As discussed in detail above, the “reasonableness” standard under Section 506(b) is only
applicable to post-Petition Date default interest. The pre-Petition Date default interest is governed by and authorized by Section 502(b)(1), which contains an “enforceability” requirement but not a reasonableness requirement.
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Home Loans, Inc. v. Hoopai (In re Hoopai), 581 F.3d 1090, 1101 (9th Cir. 2009) (pendency period
includes from the petition date to the date of plan confirmation as opposed to the “effective date,”
unless the plan specifically provides an effective date)).
71. In Beltway, the Ninth Circuit BAP held in the context of plan confirmation that the
bankruptcy court erred when it utilized the “fair and equitable” test under Section 1129(b) to deny
default interest under Code Section 506(b). Id. at 828. The Ninth Circuit BAP held that pendency
interest to be included as part of “an allowed secured claim as of the date of confirmation under
Section 506(b) is an issue separate and distinct from the fair and equitable test for plan confirmation
under Section 1129(b). Essentially, application of the default rate to pendency interest is a claim
issue. The ‘fair and equitable’ test under Section 1129(b) is a plan issue and concerns only the
treatment of the allowed claim after confirmation.” Therefore, the circuit court ruled that
bankruptcy court erred in conflating the fair and equitable standard of Section 1129(b) with the
elimination of pendency default interest under Section 506(b). Id.
72. In coming to that conclusion, the Ninth Circuit BAP relied on Hassen Imps. P'ship v.
KWP Fin. VI (In re Hassen Imps. P’ship), 256 B.R. 916, 924–25 (9th Cir. BAP 2000), superseded
by § 506(b) (2005), which held that an oversecured creditor is entitled to default interest that
reasonably compensates it for losses arising from the default. Id. at 828. In other words,
entitlement to contractual default interest is not automatic but may be allowed upon demonstrating
that it meets certain requirements. Id. (citing In re Hassen Imps. P’ship, 256 B.R. at 924–25)). The
Ninth Circuit BAP then held that the debtor in Beltway had sufficiently shifted the burden to the
lender when the lender's officer testified that one purpose of the default rate is to encourage timely
payment—i.e., it was a penalty as opposed to compensating the lender for any demonstrated losses
due to the default. Id. at 828-29. Consequently, the Ninth Circuit BAP remanded for a
determination of whether the default rate reasonably compensated the lender for actual loss. If so,
then the bankruptcy court was free to award such interest. Id. (citing In re Hassen Imps. P’ship,
256 B.R. at 925).
73. In Future Media, the Ninth Circuit reversed and remanded the bankruptcy court’s
denial of default interest to lender GECC. Because the only dispute was what type of interest was
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due to GECC under Section 506(b), the court determined that the two relevant issues on appeal
were: (1) whether Great Western Bank & Trust v. Entz-White Lumber and Supply, Inc. (In re Entz-
White Lumber and Supply, Inc.), 850 F.2d 1338 (9th Cir. 1988), superseded by § 1123(d), applied;
and (2) if it did not, how the bankruptcy court should evaluate the viability of the contractual default
interest rate on remand. Id. at 959–60. Distinguishing Entz–White on its facts, the court determined
that the bankruptcy court had erred in extending the per se rule from Entz–White to the case at bar.
Id. at 960. The court found that “‘[c]reditors’ entitlements in bankruptcy arise in the first instance
from the underlying substantive law creating the debtor's obligation, subject to any qualifying or
contrary provisions of the Bankruptcy Code.’” Id. (quoting Travelers Cas. & Sur. Co. of Am. v.
Pac. Gas & Elec. Co., 549 U.S. 443, 450, 127 S.Ct. 1199, 167 L.Ed.2d 178 (2007)). Moreover,
such a “qualifying or contrary” provision of the Code was present in Entz–White—the ability to
cure a default in a chapter 11 plan under § 1124(2)(A)—but was not present in Future Media —
paying the oversecured creditor’s claim in full through a Section 363 asset sale. Id.
74. In reviewing the Ninth Circuit BAP’s decision in Casa Blanca Project Lenders, L.P.
v. City Commerce Bank (In re Casa Blanca Project Lenders, L.P.), 196 B.R. 140 (9th Cir. BAP
1996), abrogated by Future Media, 536 F.3d at 973, a similar asset sale case, the Ninth Circuit
found that the Ninth Circuit BAP had improperly extended Entz–White by “transposing” the
concept of “cure” from § 1124 and § 365 into § 363. Id. at 961. The court reasoned that in the
context of an asset sale, there is no “cure” of events of default. Id
75. Because Entz–White did not apply, the Future Media court instructed the bankruptcy
court on remand to apply the “rule adopted by the majority of federal courts. That rule simply stated
is: The bankruptcy court should apply a presumption of allowability for the contracted for default
rate, ‘provided that the rate is not unenforceable under applicable nonbankruptcy law.’” Id. Future
Media made clear that the burden is on the debtor to demonstrate the rate’s unreasonableness, or
that it is not enforceable under nonbankruptcy law. Id.
76. Most recently, the Ninth Circuit held that a creditor is entitled to collect default
interest at the rate provided in the loan documents where the debtor’s chapter 11 plan proposes to
cure the pre-bankruptcy default. New Investment, 2016 WL 6543520, at *2-4. In so holding, the
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Ninth Circuit overruled Entz-White and joined the majority of other circuits limiting a debtor’s
ability to avoid paying default interest.
77. In In re New Investments, Inc., the debtor obtained a roughly $3 million loan from
Pacifica L 51, LLC to purchase a hotel. Id. at *2. The loan documents provided for an interest rate
of 8 percent and in the event of default, the interest rate would increase by 5 percent. Id. Under the
authority of the Ninth Circuit precedent Entz-White, the debtors proposed a plan to sell the hotel
property and use the resulting proceeds to pay the outstanding amount of the loan at the pre-default
interest rate. Id. The lender objected, arguing the 1994 amendments to the Bankruptcy Code
required the debtor to comply with all default cure provisions of the loan documents. Id.
78. In In re Entz-White Lumber, the Ninth Circuit established that when a debtor cures a
default under a plan of reorganization, the debtor is entitled to avoid all consequences of default that
are provided in the loan documents, “including avoidance of default penalties such as higher
interest.” 850 F.2d at 1340. Essentially, this allowed the debtor to return to pre-default conditions
at the expense of the creditor’s contracted for default remedies. Id. After the Entz-White decision,
the Bankruptcy Code was amended in 1994 with the addition of Section 1123(d), providing that “if
it is proposed in a plan to cure a default the amount necessary to cure the default shall be
determined in accordance with the underlying agreement and applicable nonbankruptcy law.” Id. at
*3.
79. In light of the 1994 amendment, the Ninth Circuit in In re New Investments, Inc. held
that the creditor was entitled to receive the benefit of its bargain and obtain interest at the default
rate based on the plain language of Section 1123(d) and the legislative history. Id. at *3. Thus, the
court held that “Subsection § 1123(d) renders void Entz-White’s rule that a debtor who proposes to
cure a default may avoid a higher, post-default interest rate in a loan agreement.” Id. Instead where,
as in In re New Investments, Inc., the underlying agreement and “applicable nonbankruptcy law”
“respectively require and permit repayment at a higher, post default interest rate,” the Bankruptcy
Code requires that the parties are limited to “the benefit of their bargain.” Id. at *4.
80. While In re New Investments, Inc. was a plan confirmation case, the authority that
post-default interest rate is required under a Section 1123(d) plan case should be no different in a
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363 sale context. Certainly, since Hercules did not receive all of the proceeds of its collateral at
closing of the sale to Boohoo, and the Debtor has now indicated that it intends to pay Hercules
through a plan, Hercules would be entitled to default rate interest. Accordingly, this Court can find
on this Motion that Hercules is entitled to the default rate for its pendency interest, since that rate is
not unenforceable under California law. Id.
81. Moreover, “California Civil Code § 1671(b) creates a presumption of validity for a
liquidated damages clause.” In re Landmark W., LLC, No. 11-44240 CN, 2015 WL 7889041, at *4
(Bankr. N.D. Cal. Dec. 2, 2015). Therefore, “the burden of proof on the issue of reasonableness is
on the party seeking to invalidate the liquidated damages provision.” Cal. Civ. Code § 1671 (1977
Editors’ Notes). Several California Courts have held that a plaintiff must, in its complaint, allege
some facts or explain why a liquidated damages provision is unreasonable in order to survive a
motion to dismiss. Goldenpark, LLC v. Urban Commons, LLC, No. B257597, 2015 WL 5146159,
at *5 (Cal. Ct. App. Sept. 2, 2015) (“The SAC alleges no facts showing that UCS's application of
the default interest provision to the outstanding loan balance… was unreasonable under the
circumstances existing at the time Goldenpark entered into the loan agreements. It accordingly fails
to state a claim to invalidate UCS's actions under Civil Code section 1671, subdivision (b).”);
Langan v. United Servs. Auto. Ass'n, 69 F. Supp. 3d 965, 981 (N.D. Cal. 2014) (to survive motion to
dismiss, plaintiff must “specify the terms of the alleged liquidated damages provision… allege the
events that triggered such provision… [and] explain why application of the provision would be
unreasonable.”). Contra Alphatec Spine, Inc. v. Tillett, No. 15CV1066 DMS (KSC), 2015 WL
12699858, at *3 (S.D. Cal. July 31, 2015) (although plaintiff, by failing to plead any facts regarding
the reasonableness of the contract at the time it was made, would not carry his burden of proof upon
summary judgment, such an inquiry “is inappropriate on a motion to dismiss, and must be resolved
through a motion for summary judgment.”).
82. As set forth above, the Amended Complaint fails to address liquidated damages or
facts which support the argument that the Default Interest should be disallowed. Indeed, the
Amended Complaint fails to mention Cal. Civ. Code § 1671 other than in a conclusory fashion
without alleging any facts at all as to why default interest in the LSA was “was unreasonable under
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the circumstances existing at the time the contract was made.” Cal. Civ. Code § 1671(b). Under
Iqbal, these “labels and conclusions” are not sufficient. See 556 U.S. at 678. The Amended
Complaint merely and improperly asserts, for example, that default interest constitutes an
“unenforceable and unreasonable penalty” and is not allowable for a “non-monetary” default
“where no payment defaults existed”. See Amended Complaint, ¶ 43. Each of these hollow and
conclusory allegations woefully fails on its face under the terms of the LSA and well-settled Ninth
Circuit law.
83. Under Future Media and Landmark W., Hercules understands that the presumptive
rule for default interest is subject to rebuttal based on equitable considerations. In other words, with
this presumption of allowability intact, the Committee has the burden to demonstrate that the rate is
unreasonable. The Committee, again, however, asserts only deficient, conclusory allegations in its
Amended Complaint, which even if taken as true, would not satisfy the Committee’s burden. For
example, to demonstrate the rate’s unreasonableness, the Committee relies on the following single
sentence in the Amended Complaint: the default interest “charged by Defendants based on ‘non-
curable’ Events of Default, where no payment defaults existed, was unrelated to, and not intended
to compensate Defendants for, any economic loss, economic harm, economic damages, or increased
costs arising from such Events of Default.” See Amended Complaint, ¶ 43.
84. Based on this empty “legal” type allegation, in the absence of any pled facts in
support, the Court can easily conclude the Committee cannot meet its burden to overcome the
presumption of allowability for an interest rate bargained for in the LSA by two sophisticated,
arms-length, represented parties.
85. Furthermore, for the first time in the Amended Complaint, the Committee asserts the
Default Interest was an unreasonable forfeiture under Cal. Civ. Code § 3275. That statute provides:
“[w]henever, by the terms of an obligation, a party thereto incurs a forfeiture, or a loss in the nature
of a forfeiture, by reason of his failure to comply with its provisions, he may be relieved therefrom,
upon making full compensation to the other party, except in the case of a grossly negligent, willful,
or fraudulent breach of duty.” The party in default must plead and prove facts entitling it to relief
under the section. Barkis v. Scott, 208 P.2d 367, 370 (1949).
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86. Cal. Civ. Code § 3275, which was intended to “to relieve a defaulting purchaser from
the odious burden of losing previous installment payments by virtue of a default on a single,
subsequent payment,” does not apply to this case because the Debtor has not been deprived of the
benefit of any previous payments. See American Bankers Mortg. Corp. v. Federal Home Loan
Mortg. Corp., 75 F.3d 1401, 1414 (9th Cir. 1996). However, again, the Committee has failed to
plead the Debtor made full compensation for its failure to comply with the provisions of the LSA.
As a result, even if § 3275 applies to this situation, the Committee has failed to demonstrate its right
to relief under that section.
87. Accordingly, the Third Claim for Relief should be dismissed in its entirety for failure
to state a claim for relief.
V. The Fourth Claim for Relief, Which Seeks Disallowance of Professional Fees, Should be Dismissed Because it is not Ripe and Fails to State a Claim
88. In its Fourth Claim for Relief, the Committee seeks disallowance of unreasonable
professional fees incurred by Hercules under Section 506(b) of the Bankruptcy Code. Because
Hercules has not yet submitted any claims for professional fees under Section 506(b) and, by
agreement, the Debtor has not yet paid Hercules for its accrued professional fees and expenses
incurred in this proceeding to date, the Committee’s fourth claim for relief is simply not ripe for
adjudication and must be dismissed.
89. The Ninth Circuit and California courts have explained, “[t]he ripeness doctrine
prevents courts, through avoidance of premature adjudication, from entanglement [sic] in theoretical
or abstract disagreements that do not yet have a concrete impact on the parties.” 18 Unnamed John
Smith Prisoners v. Meese, 871 F.2d at 883 (citing cases). Furthermore, a number of courts have
held that challenges to a creditor’s right to seek reimbursement for professionals fees and expenses
under Section 506(b) is not ripe until the creditor actually submits such claims for
reimbursement. E.g. In re: Price, No. 07-01905-TOM, 2010 WL 1416706, at *6 (Bankr. N.D. Ala.
Apr. 8, 2010) (holding that Chapter 13 Debtor’s claims that mortgage lender “is ‘attempting to
collect,’ ‘scheming to collect’ or ‘will collect’ fees which were allegedly wrongfully assessed” were
by their nature “hypothetical and conjectural” and “[t]hus, Plaintiff does not have standing to assert
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these claims” for lack of ripeness.); In re Jacks, 642 F.3d 1323, 1332 (11th Cir. 2011) (holding that
Chapter 13 debtors’ argument that mortgage lender’s “failure to disclose the fees renders them
uncollectible at any point” was not ripe for adjudication and, “[t]herefore, to the extent the
[debtors’] claims are based on events that may take place in the future, these claims are dismissed
for lack of jurisdiction.”); In re Sanders, No. 01-13577, 2004 WL 5865044, at *4-5 (Bankr. E.D. Pa.
Mar. 22, 2004) (ordering Chapter 13 debtors and mortgage lender to submit supplemental briefs on
whether challenge to mortgage lender’s right to seek reimbursement of professional fees and
expenses under § 506(b) was ripe for adjudication); Mann v. Chase Manhattan Mortg. Corp., 316
F.3d 1, 6, n. 8 (1st Cir. 2003) (noting that there was a “serious question” of ripeness where “Chase
has never billed the [debtors] for these fees, nor communicated to any third party its putative
entitlement to the fees.”).
90. To the extent the Committee seeks a ruling from this Court stating that Hercules’
professional fees must be reasonable in order to be reimbursed under Section 506(b), such a ruling
would be both an advisory opinion in violation of the case or controversy requirement of Article III
of the United States Constitution and wholly unnecessary. Similarly, the Committee’s allegation
that Hercules’ professional fees should be disallowed on the grounds of unreasonableness - - claims
that Hercules has not yet even submitted to the Court - - is so blatantly absurd that the Court need
not entertain it further.
91. It should be noted that, at the very least, the plaintiffs in Jacks, Sanders and Mann
may have theoretically presented a ripe claim for declaratory judgment that the defendant-creditor
had no right to reimbursement whatsoever. In contrast, the Committee does not argue that Hercules
has no right to seek reimbursement under § 506 at all—the Committee only seeks the disallowance
of unreasonable fees and expenses. See Amended Complaint, ¶ 48. The Committee is no different
than the plaintiff in Price, and its claim is similarly “hypothetical and conjectural” in that it seeks
the disallowance of allegedly unreasonable fees and expenses that Hercules might submit in the
future.
92. Moreover, the Bankruptcy Rules distinguish “contested matters” from “adversary
proceedings”. The latter, governed by Part VII of the Bankruptcy Rules, are “commenced by filing
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a complaint with the court.” Fed. R. Bankr. P. 7003. Bankruptcy Rule 7001 provides an exhaustive
list of those proceedings deemed “adversary proceedings.” Fed. R. Bankr. P. 7001. Significantly,
an objection to legal fees under Section 506(b) of the Bankruptcy Code is not one of them. Rather,
an objection to fees recoverable under Section 506(b) is a contested matter. See In re Parreira, 464
B.R. 410, 412 (Bankr. E.D. Ca. 2012).
93. The Committee’s attempt to force a Section 506(b) determination for Hercules’ fees
before it is ripe will run up Hercules’ expenses in order to redact privileged information from its
professionals’ bills and to undergo multiple contested hearings as the fees continue to accrue.
Although Hercules has received no reimbursement for the fees it has paid to date, it believes it far
more appropriate to await the outcome of this adversary proceeding before unnecessarily incurring
fees to fight for its fees.
94. As a result, the Fourth Claim for Relief must be dismissed because it is not only
fatally flawed as a matter of procedure, it fails to state a claim upon which relief can be granted
because it is not yet ripe and the Court therefore lacks subject matter jurisdiction over
it. Greenbriar, Ltd. v. City of Alabaster, 881 F.2d 1570, 1574, n. 7 (11th Cir.1989) (“[R]ipeness
goes to whether the district court had subject matter jurisdiction to hear the case.”).
VI. The Fifth Claim for Relief, Which Seeks Damages For Breach of Contract, Should be Dismissed for Failure to State a Claim
95. The Committee asserts Hercules breached the loan documents, including the deposit
account control agreement dated February 2, 2016 (the “DACA”) with Pacific Western Bank (the
“Bank”), a copy of which is attached to the Bluestein Declaration as Exhibit 1, by (a) directing the
Debtor’s bank to stop payment on over $300,000 in check payments, (b) initiating instructions to
the Bank resulting in $796,833 being swept, and (c) allocating and applying $769,333 of the swept
funds to prepay a portion of the End of Term Charge. See Amended Complaint, ¶ 51. When
accepting those factual allegations as true, the Court should dismiss Count V because it fails to state
a plausible claim for relief.
96. Under Section 10.1 of the LSA, upon and during the continuance of an Event of
Default, Hercules may, at its option, exercise its rights under control agreements. See LSA, § 10.1.
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Moreover, under Section 10.4 of the LSA, the “exercise of any one or more of the rights, powers
and remedies provided [under the LSA] shall not be construed as a waiver of or election of remedies
with respect to any other rights, powers and remedies of [Hercules].” See LSA, § 10.4.
97. Under Section 3 of the DACA, the Bank “agrees that it will comply with instructions
originated by Lender directing disposition of the funds in the Account without further consent by
[the Debtor].” Further, under Section 3 of the DACA, the Bank:
may (at its discretion and without any obligation to do so) (x) cease honoring [Debtor’s] instructions and/or commence honoring solely Lender’s instructions concerning the Account at any time or from time to time after it becomes aware that Lender has sent it a Shifting Control Notice but prior to the Effective Time therefor (including, without limitation halting, reversing or redirecting any transaction ….”
DACA, § 3 (emphasis added).
98. The “Effective Time” is defined under the DACA to mean the second business day
next succeeding the business day on which a notice signed by Lender (the “Shifting Control
Notice”) is received by the Bank.
99. As of November 9, 2016, it is undisputed that there was and remained continuing
Events of Default under the LSA. As set forth in paragraph 7 of the Bluestein Declaration, on
November 9, 2016, at 12:21 p.m. (Eastern Standard Time), Hercules sent to the Bank a Shifting
Control Notice and a copy of the DACA, requesting that the Bank cease complying with
instructions from the Debtor and immediately withdraw and remit all funds in two accounts in the
name of the Debtor to Hercules. See Bluestein Declaration, ¶ 6. The Bank, in its discretion,
honored Hercules’ instruction “after it bec[ame] aware that [Hercules] … sent it a Shifting Control
Notice but prior to the Effective Time therefor,” which it was authorized to do under Section 3 of
the DACA. Id. A copy of the Shifting Control Notice is annexed to the Bluestein Declaration as
Exhibit 3.
100. Accordingly, Hercules did not breach the Loan Documents, including the DACA,
because it was allowed under the DACA: (i) to give the bank instructions which the Bank was
obligated to follow, (b) to initiate the sweeps in light of the now undisputed continuing Events of
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Default under the LSA, and (c) allocate and apply the Swept Funds to the Debtor’s obligations
under the LSA “in such order and priority as [Hercules] may choose in its sole discretion”. See
LSA, §10.2.
101. The Committee’s allegation that Hercules did not allow for two business days to pass
between the sending of the Shifting Control Notice and the sweep is completely wrong based on
even a cursory reading of the DACA referenced in the Amended Complaint. Bluestein Declaration,
Exhibit 1. The Bank, in its discretion, pursuant to Section 3 of the DACA, was authorized to honor
Hercules’ instructions after it became aware that Hercules sent a Shifting Control Notice but prior
to the Effective Time.
102. Accordingly, each and every factual allegation in the Committee’s Fifth Claim for
Relief is simply incorrect under any reading of the DACA and LSA. Uncontroverted Events of
Default continued to exist at the time of the sweeps, including a Material Adverse Effect under
Section 9.3 of the LSA based on the Debtor’s announced intention to file a petition under chapter
11.6 The allegation of “no new events of default” in paragraph 50 a. of the Amended Complaint is
not only irrelevant, but blatantly wrong. Hercules was not required to “allow two business days to
pass”, as alleged in paragraph 51 b. of the Amended Complaint, before providing instructions to the
Bank. Hercules was also fully within its rights under the LSA to “prepay a portion of the End of
Term Charge”.
103. Moreover, even if Hercules did breach the terms of the LSA and the DACA the
allegations that the estate incurred damages are wrong and do not require a trial. The “increased
creditor claims” allegedly arising from the Bank’s stoppage of checks alleged in paragraph 52 of the
Amended Complaint are in the exact same amount of the additional claim that Hercules would have
had the checks not been stopped. Likewise, there was no “impairment of the Debtor’s business
operations and its ability to obtain credit during the Chapter 11 case”, Id., since the Court can take
judicial notice that the Debtor never applied for credit in its bankruptcy proceeding and it had
6 The Amended Complaint even concedes this by alleging that Hercules acted under the
DACA “with knowledge that the Debtor’s Chapter 11 Case would be filed shortly.” See Amended Complaint, ¶¶ 60 b. and c.
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sufficient liquidity to operate until it achieved a successful sale, after making $1,500,000 in
adequate protection payments to Hercules. For all of these reasons, the Fifth Claim for Relief fails
to state a claim for breach of contract and must be dismissed.
VII. The Sixth Claim for Relief, Which Seeks Damages for a Violation of the Automatic Stay, Should be Dismissed for Failure to State a Claim
104. The Committee alleges that Hercules’ receipt of any portion of the Swept Funds after
the Petition Date and/or Hercules’ allocation and application of any portion of the Swept Funds to a
portion of the End of Term Charge after the Petition Date, constitutes a violation of the automatic
stay under Section 362 of the Bankruptcy Code. See Amended Complaint, ¶ 54. Even accepting
those as well as all factual allegations in the Amended Complaint as true, the Court should dismiss a
portion of Count VI because it fails to state a plausible claim for relief.
105. Section 362(a)(3) provides that the filing of a bankruptcy petition operates as a stay
of “any act to obtain possession of property of the [bankruptcy] estate . . . or to exercise control over
property of the estate.” Section 362(b)(24), however, provides that the filing of a petition in
bankruptcy does not operate as a stay “under subsection (a), of any transfer that is not avoidable
under section 544 and that is not avoidable under section 549.”
106. As an initial matter, the automatic stay only applies if the Swept Funds are “property
of the [bankruptcy] estate” as of the commencement of this case. See 11 U.S.C. § 362(a)(3).
Section 541(a) of the Bankruptcy Code defines “[p]roperty of the estate” to include “all the
following property, wherever located and by whomever held:” (1) ... all legal or equitable interests
of the debtor in property as of the commencement of the case. Section 541(a)(1) of the Bankruptcy
Code is intended to include in the estate “all legal or equitable interests of the debtor in property as
of the commencement of the case.” In re Campbell (Balyeat Law Offices v. Campbell), 14 B.R.
132, 140–41 (9th Cir. BAP 1995). In Campbell, the BAP wrote:
The legislative history indicates that the scope of § 541(a)(1) is broad. See United States v. Whiting Pools, Inc., 462 U.S. 198, 205 (1983). Section 541(a)(1) is intended to include in the estate any property made available to the estate by any other provisions of the Bankruptcy Code. Id. (citing H.R.Rep. No. 95–595, p. 367 (1977)). Several provisions in the Code permit the trustee to recover property in which the debtor did not have a possessory interest when the
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bankruptcy petition was filed. See, e.g., 11 U.S.C. §§ 543,544, 547 & 548; Whiting Pools, 462 U.S. at 205. Thus, “[a]n estate in bankruptcy consists of all the interests in property, legal and equitable, possessed by the debtor at the time of filing, as well as those interests recovered or recoverable through transfer and lien avoidance provisions.” Owen v. Owen, 500 U.S. 305, 308 (1991).
107. Whether a debtor’s interest constitutes “‘property of the estate’ is a federal question
to be decided by federal law.” McCarthy, Johnson & Miller v. N. Bay Plumbing, Inc. (In re Pettit),
217 F.3d 1072, 1078 (9th Cir. 2000). However, the nature and extent of the debtor’s interest in
property must be determined by nonbankruptcy law. Travelers Cas. & Sur. Co. of Am. v. Pac. Gas
& Elec. Co., 549 U.S. 443, 451 (2007) (citing Butner v. U.S., 440 U.S. 48, 54–55 (1979)).
108. The Amended Complaint alleges in the alternative that Hercules violated the
automatic stay either (i) by providing instructions to the Bank and obtaining the Swept Funds after
the time of the chapter 11 filing, and/or (ii) by the “allocation and application of any portion of the
Swept Funds” after the Debtor’s Petition was filed. See Amended Complaint, ¶¶ 54-55. Hercules
recognizes that the issue of whether the funds were swept before or after the time of the filing is one
that the Committee should be allowed to prove at trial. 7 However, based on the Committee’s
alternative pleading, there is no stay violation as a matter of law for “allocation and application” of
the Swept Funds if the sweeps occurred before the filing.
109. Section 362(b)(24) of the Code provides that the stay does not apply to transfers that
are not avoidable under sections 544 or 549. If the funds were swept pre-filing, the estate’s “strong
arm” powers under Section 544 would not defeat Hercules’ receipt of the funds. Moreover, the
transfer to Hercules is likewise not avoidable under Section 549 because Section 549(a) only avoids
unauthorized post-petition transfers of “property of the estate” under Section 541. As set forth
above, the Swept Funds ceased to become “property of the estate” under Section 541 when they
7 Although not relevant to this Motion, Hercules will easily prove that its exercise of rights
under the DACA and the sweeps occurred before the chapter 11 Petition was filed. Interestingly, counsel for the Committee indicated in an email that it knew of this with respect to at least a portion of the Swept Funds.
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were paid to Hercules. Therefore, no basis exists for the stay to apply to the post-filing allocation
and/or application of funds which are not property of the estate.
110. In U.S. v. Whiting Pools, the Supreme Court held that certain personal property of
the debtor, seized pre-petition by the IRS to satisfy a tax lien, constituted property of the debtor’s
bankruptcy estate under § 541(a) and, accordingly, was subject to turnover under § 542 of the
Bankruptcy Code. Central to the Supreme Court’s decision was the observation that the seizure did
not operate under applicable law to transfer ownership of the property to the IRS; ownership would
be transferred only when the property was sold to a bona fide purchaser at a tax sale, and until then,
the property remained the debtor’s. Id. at 210.
111. The critical distinction between Whiting Pools and the present case is that in Whiting
Pools, under state law, the debtor retained an interest in the repossessed vehicle until such time as it
was sold. Therefore, because there was merely a change in possession rather than a transfer of
ownership, the repossessed automobile in Whiting Pools remained property of the debtor’s
bankruptcy estate. Because the Swept Funds in the Debtor’s bank account were no longer property
of the estate as of the filing of the Petition - - i.e., there was a transfer of ownership - - Hercules’
retention, application and allocation of the funds was not a violation of the automatic stay. See 11
U.S.C. §§ 362(a)(3), 362(b)(24).
112. Accordingly, Count VI should be dismissed for failure to state a claim for relief with
respect to the Committee’s allegations of a stay violation arising from application and/or application
of the funds. VIII. The Seventh Claim for Relief, Which Seeks Disgorgement and Turnover,
Should be Dismissed for Failure to State a Claim
113. The Committee’s seventh claim for relief seeks a turnover or disgorgement of the
Swept Funds under Sections 542, 549, 550 and 551 of the Bankruptcy Code. For the reasons
described above and herein, if the Court concurs with Hercules’ arguments for dismissal of the First
through Sixth Clams for Relief, the Seventh Claim for Relief must also be dismissed for failure to
state a claim.
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IX. The Eighth Claim for Relief, Which Seeks Subordination of Hercules’ Claims, Should be Dismissed for Failure to State a Claim
114. The Committee’s eighth claim for relief seeks to equitably subordinate Hercules’
entire claim.
115. The Committee’s general or specific allegations in support of its equitable
subordination claim are limited to the following:
a. As set forth in the email attached as Exhibit C to the Amended Complaint,
Hercules allegedly expressed its belief that the End of Term Charge could be unenforceable as a
penalty or otherwise, and directed its finance department to “avoid using the term ‘penalty’ in any
payoff forms being circulated” regarding the amount of Hercules’ claim as of the Petition Date. See
Amended Complaint, ¶ 28.
b. When with knowledge that the Debtor’s Chapter 11 case “would shortly be
filed and in violation of the LSA, DACA and/or state law, including, but not limited to, Cal. Civ.
Code § 1719, [Hercules directed] the Bank to stop payment on over $300,000 in checks that were
already issued, outstanding, and in the clearing process….,” which:
i. Increased the “amount of the Swept Funds swept from the Debtor’s
bank accounts to the direct detriment of the creditors….” See
Amended Complaint, ¶ 60(b); and
ii. Improved Hercules’ collateral at the expense of the vendors who had
provided goods to the Debtor. See Amended Complaint, ¶ 60(c).
116. When accepting all of the aforementioned factual allegations in the Amended
Complaint as true, the claim should be dismissed because the Committee has failed to adequately
plead an equitable subordination claim.
iv. Legal Framework of Equitable Subordination Under Section 510(c)
117. Section 510(c) provides that a court, after notice and a hearing, may, “under
principles of equitable subordination, subordinate for purposes of distribution all or part of an
allowed claim to all or part of another allowed claim or all or part of an allowed interest to all or
part of another allowed interest.” 11 U.S.C. § 510(c).
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118. In In re First Alliance Mortg. Co., the Ninth Circuit stated:
The subordination of claims based on equitable considerations generally requires three findings: “(1) that the claimant engaged in some type of inequitable conduct, (2) that the misconduct injured creditors or conferred unfair advantage on the claimant, and (3) that subordination would not be inconsistent with the Bankruptcy Code.” Feder v. Lazar (In re Lazar), 83 F.3d 306, 309 (9th Cir. 1996) (citing Benjamin v. Diamond (In re Mobile Steel Co.), 563 F.2d 692, 699–700 (5th Cir. 1977)). Where non-insider, non-fiduciary claims are involved, as is the case here, the level of pleading and proof is elevated: gross and egregious conduct will be required before a court will equitably subordinate a claim. See In re Pacific Express, Inc. 69 B.R. 112, 116 (B.A.P. 9th Cir. 1986) (“The primary distinctions between subordinating the claims of insiders versus those of non-insiders lie in the severity of misconduct required to be shown, and the degree to which the court will scrutinize the claimant's actions toward the debtor or its creditors. Where the claimant is a non-insider, egregious conduct must be proven with particularity.”) (citing Matter of Teltronics Servs., Inc., 29 B.R. 139, 169 (Bkrtcy. E.D.N.Y. 1983)). Although equitable subordination can apply to an ordinary creditor, the circumstances are “few and far between.” ABF Capital Mgmt. v. Kidder Peabody & Co., Inc. (In re Granite Partners, L.P.), 210 B.R. 508, 515 (Bkrtcy. S.D.N.Y. 1997) (collecting cases).
In re First Alliance Mortg. Co., 471 F.3d 977, 1006 (9th Cir. 2006); see also In re UC Lofts on 4th,
LLC, No. AP 07-90139-CL, 2015 WL 5209252, at *20 (B.A.P. 9th Cir. Sept. 4, 2015) (finding no
“inequitable conduct” where, inter alia, the creditors in question were not insiders and their
relationship with the Debtors “never extended beyond those of a borrower-lender relationship”); In
re Paradigm Int'l, Inc., 635 F. App'x 355, 358 (9th Cir. 2015) (rejecting a Trustee’s motion to
equitably subordinate a secured creditor’s claim where “BHC had the right to obtain payment under
the Guaranty as a secured creditor, and there was no evidence of fraud or concealment”).
119. Therefore, the severity of the conduct depends on whether the claimant owed a
fiduciary duty to the debtor and the debtor’s creditors. See, e.g., In re Badger Freightways, Inc.,
106 B.R. 971, 972 (Bankr. N.D. Ill. 1989); In re Daugherty Coal Co., Inc., 144 B.R. 320, 324 (N.D.
W. Va. 1992) (the “burden and sufficiency of proof required are not uniform in all cases. Where the
claimant is an insider or a fiduciary, the [plaintiff] bears the burden of presenting material evidence
of unfair conduct. . . . If the claimant is not an insider or fiduciary, however, the [plaintiff] must
prove more egregious conduct . . . .”).
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120. Generally, a lending institution does not owe a fiduciary obligation to its customers.
Badger Freightways, 106 B.R. at 976.
An exception to this general rule exists when the lending institution exerts “dominion and control” over its customer. The rationale behind this exception is significant. If the lending institution usurps the power to make business decisions from the customer’s board of directors and officers, then it must also undertake the fiduciary obligation that the officers and directors owe the corporation (and its creditors). This reasoning also dictates the scope of the term “control.” What is required is operating control of the debtor’s business, because only in that situation does a creditor assume the fiduciary duty owed by the officers and directors.
Id. at 977.
121. Every lending institution, through its loan agreement, exercises some degree of
control over its borrower. In re Clark Pipe & Supply Co., 893 F.2d 693, 701 (5th Cir. 1990).
Therefore, operating control of the borrower’s business is required for a fiduciary obligation to
arise. See Badger Freightways, 106 B.R. at 977. Courts have found operating control when a
lending institution exercised control to direct activities of the debtor. In re Clark Pipe & Supply
Co., 893 F.2d at 701; see also In re WCC Holding Corp., 171 B.R. 972, 987 (Bankr. N.D. Tex.
1994) (stating that the lending institution must have exercised actual managerial control or had
some special affinity that extends beyond an arm’s length business relationship)).
122. In contrast, “[c]ontrol is not indicated by financial leverage or the ability to exercise
contractual rights.” WCC Holding Corp., 171 B.R. at 987. Courts have not found operating control
when a lending institution enforces “standard loan agreement restrictions, closely monitors the
debtor’s finances, or makes business recommendations, even in the context of heated bargaining
negotiations . . . .” See Badger Freightways, 106 B.R. at 977; In re Ludwig Honold Mfg. Co., Inc.,
46 B.R. 125, 129 (Bankr. E.D. Pa. 1985); In re Teltronics Services, Inc., 29 B.R. 139, 172 (Bankr.
E.D.N.Y. 1983); see also In re Osborne, 42 B.R. 988, 997 (W.D. Wisc. 1984) (finding no control
where lender’s status with debtor “approached” a joint venture, lender paid debtor’s other creditors
directly, and use of loan proceeds was subject to lender’s direction).
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v. The Committee Has Failed to Adequately Plead Equitable Subordination
123. As an initial matter, the Committee has failed to plead any facts that a fiduciary
relationship existed or that Hercules exerted “dominion and control” over the Debtor. As a result,
given that non-fiduciary claims are involved, as is the case here, the level of pleading and proof for
the Committee is elevated: gross and egregious conduct will be required before a court will
equitably subordinate a claim. See In re First Alliance Mortg. Co., 471 F.3d at 1006. The
Committee has failed to allege facts sufficient to meet that elevated pleading standard of gross and
egregious conduct. For this reason alone, Count VIII should be dismissed.
124. Further, the Committee’s claim fails because Hercules’ exercise of its contractual
rights under the LSA and DACA cannot rise to the level of gross and egregious conduct. Said
differently, the Committee’s allegations, even if taken as true, cannot overcome the fact that only
the LSA and DACA govern the parties’ relative duties and obligations. As set forth above and in
Section 3 of the DACA, the Bank:
may (at its discretion and without any obligation to do so) (x) cease honoring [Debtor’s] instructions and/or commence honoring solely Lender’s instructions concerning the Account at any time or from time to time after it becomes aware that Lender has sent it a Shifting Control Notice but prior to the Effective Time therefor (including, without limitation halting, reversing or redirecting any transaction ….”
125. The DACA speaks for itself and Hercules was well within its rights to direct the
Bank to remit funds in the accounts and to stop complying with the Debtor’s instructions given the
continuing, multiple Events of Default under the LSA. Indeed, as noted, above the Committee’s
allegation - - “with knowledge that the Debtor’s Chapter 11 cases would shortly be filed” - - means
there was clearly a Material Adverse Effect (as defined in the LSA) on the business, which would
also have supported Hercules sweeping the funds at issue. See LSA, § 9.4.
126. Moreover, the Committee has failed to demonstrate how the alleged misconduct
injured the estate and creditors. Absent the sweep of the Swept Funds and application thereof to the
End of Term Charge, the Debtor would have been incurring default interest on approximately
$300,000 in Swept Funds (i.e., Hercules’ secured claim would have been approximately $300,000
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higher) to the detriment of the estate and creditors. In essence, the sweeps replaced $300,000 in
secured claims with 300,000 in unsecured claims.
127. Moreover, there are no allegations in the Amended Complaint that the sweeps
harmed the Debtor’s operations or liquidity. Indeed, the budget annexed to the Debtor’s first
interim cash collateral order [Docket No. 47] demonstrated that the Debtor maintained a cash
balance of approximately $3 million during the week ended November 19, 2016. Further, pursuant
to the second and third interim cash collateral orders, the Debtor paid Hercules $1.5 million in
adequate protection payments. Those facts alone demonstrate the “alleged” misconduct did not
harm the estate or creditors.
128. Lastly, the instruction from Hercules’ finance department to use the term “Back End
Fee/Charge” instead of “penalty” neither magically transforms a “charge”, as it is called in the LSA,
into a penalty as a matter of law, nor even remotely rises to the level of gross and egregious conduct
warranting equitable subordination. See Amended Complaint, ¶ 28, Ex. C. ; In re Daugherty Coal
Co., Inc., 144 B.R. at 324.
129. Most significantly, since the Amended Complaint alleges nothing more than that
acted consistent with its rights under the LSA and the DACA, the Committee has failed to state a
plausible claim for relief and, thus, Count VIII should be dismissed.
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IV. CONCLUSION
WHEREFORE, for all of the foregoing reasons, Hercules respectfully requests that this
Court grant the Motion, dismiss every Claim for Relief in the Amended Complaint, with prejudice,
as requested herein, and grant such other and further relief as it deems just and proper.
Signed this 10th day of March, 2017.
/s/ Jeffrey W. Dulberg Jeffrey N. Pomerantz (CA Bar No. 143717) Jeffrey W. Dulberg (CA Bar No. 181200) PACHULSKI STANG ZIEHL & JONES LLP 10100 Santa Monica Blvd., 13th Floor Los Angeles, Ca 90067 Tel: 310.277.6910 Fax: 310.201.0760 Email: [email protected][email protected]
- and - Stuart Komrower (pro hac vice) Ryan T. Jareck (pro hac vice) COLE SCHOTZ P.C. 25 Main Street Hackensack, NJ 07601 Tel: (201) 489-3000 Fax: (201) 678.6331 Email: [email protected]
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EXHIBIT A
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49066/0030-14225038v1
Stuart Komrower (pro hac vice) Ryan T. Jareck (pro hac vice) COLE SCHOTZ P.C. 25 Main Street Hackensack, NJ 07601 Tel: (201) 489-3000 Fax: (201) 678.6331 Email: [email protected][email protected] Jeffrey N. Pomerantz (CA Bar No. 143717) Jeffrey W. Dulberg (CA Bar No. 181200) PACHULSKI STANG ZIEHL & JONES LLP 10100 Santa Monica Blvd., 13th Floor Los Angeles, Ca 90067 Tel: 310.277.6910 Fax: 310.201.0760 Email: [email protected][email protected] Attorneys for Hercules Capital, Inc.
UNITED STATES BANKRUPTCY COURT CENTRAL DISTRICT OF CALIFORNIA
LOS ANGELES DIVISION
In re: NASTY GAL INC., Debtor.
Case No.: 2:16-bk-24862-BB Chapter 11 Adv. Pro. No. DECLARATION OF SCOTT BLUESTEIN IN SUPPORT OF DEFENDANTS’ MOTION TO DISMISS FIRST AMENDED COMPLAINT PURSUANT TO RULE 7012 OF THE FEDERAL RULES OF BANKRUPTCY PROCEDURE, INCORPORATING BY REFERENCE, RULE 12(b)(6) OF THE FEDERAL RULES OF CIVIL PROCEDURE
OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF NASTY GAL, INC., Plaintiff, v. HERCULES CAPITAL, INC. f/k/a Hercules Technology Growth Capital, Inc.; HERCULES TECHNOLOGY III, L.P. Defendants.
I, Scott Bluestein, declare as follows:
1. I am the Chief Investment Officer of Defendant Hercules Capital, Inc. f/k/a Hercules
Technology Growth Capital, Inc. (“Hercules”).
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2 49066/0030-14225038v1
2. I submit this declaration (the “Declaration”) in support of Hercules’ motion (the
“Motion”) to dismiss the first amended complaint (the “Amended Complaint”) of plaintiff Official
Committee of Unsecured Creditors (the “Committee”) of Nasty Gal, Inc. (the “Debtor”) for failure
to state a claim upon which relief can be granted pursuant to Rule 7012 of the Federal Rules of
Bankruptcy Procedure, incorporating by reference, Rule 12(b)(6) of the Federal Rules of Civil
Procedure.
3. I have reviewed the Motion and have personal knowledge about the facts and issues
raised therein, including Hercules’ lending relationship with the Debtor, the Loan and Security
Agreement annexed as Exhibit A to the Amended Complaint (“LSA”), the deposit account control
agreement dated February 2, 2016 (the “DACA”) with Pacific Western Bank (the “Bank”) attached
hereto as Exhibit 1, and the other documents annexed hereto.
4. All matters set forth in this Declaration are based on (a) my personal knowledge, (b)
my review of relevant documents, and/or (c) my opinion, based on my experience and knowledge of
the Debtor’s affairs.
5. Hercules is a finance lender registered with the California Department of Business
Oversight. A true copy of Hercules’ finance lender license is attached hereto as Exhibit 2.
A. The Shifting Control Notice and Sweep of Funds.
6. Based on continued and multiple Events of Default under the LSA, on November 9,
2016, at 12:21 p.m. (Eastern Standard Time), Hercules sent to the Bank a shifting control notice and
a copy of the DACA, requesting that the Bank cease complying with instructions from the Debtor
and immediately withdraw and remit all funds in two accounts in the name of the Debtor to
Hercules. A copy of the Shifting Control Notice is annexed hereto as Exhibit 3.
Pursuant to 28 U.S.C. § 1746, I declare under penalty of perjury that the foregoing is true
and correct to the best of my knowledge and belief.
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3 49066/0030-14225038v1
s/ Scott Bluestein __ SCOTT BLUESTEIN
Chief Investment Officer Hercules Capital, Inc.
Date: March 10, 2017
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EXHIBIT 1
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EXHIBIT 2
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EXHIBIT 3
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This form is mandatory. It has been approved for use by the United States Bankruptcy Court for the Central District of California.
June 2012 F 9013-3.1.PROOF.SERVICE DOCS_LA:304530.1 35793/001
PROOF OF SERVICE OF DOCUMENT I am over the age of 18 and not a party to this bankruptcy case or adversary proceeding. My business address is: 10100 Santa Monica Boulevard, 13th Floor, Los Angeles, California 90067 A true and correct copy of the foregoing document entitled (specify): DECLARATION OF SCOTT BLUESTEIN IN SUPPORT OF DEFENDANTS’ MOTION TO DISMISS FIRST AMENDED COMPLAINT PURSUANT TO RULE 7012 OF THE FEDERAL RULES OF BANKRUPTCY PROCEDURE, INCORPORATING BY REFERENCE RULE 12(b)(6) OF THE FEDERAL RULES OF CIVIL PROCEDURE will be served or was served (a) on the judge in chambers in the form and manner required by LBR 5005-2(d); and (b) in the manner stated below: 1. TO BE SERVED BY THE COURT VIA NOTICE OF ELECTRONIC FILING (NEF): Pursuant to controlling General Orders and LBR, the foregoing document will be served by the court via NEF and hyperlink to the document. On (date) March 10, 2017, I checked the CM/ECF docket for this bankruptcy case or adversary proceeding and determined that the following persons are on the Electronic Mail Notice List to receive NEF transmission at the email addresses stated below: Service information continued on attached page 2. SERVED BY UNITED STATES MAIL: On (date) ___________, I served the following persons and/or entities at the last known addresses in this bankruptcy case or adversary proceeding by placing a true and correct copy thereof in a sealed envelope in the United States mail, first class, postage prepaid, and addressed as follows. Listing the judge here constitutes a declaration that mailing to the judge will be completed no later than 24 hours after the document is filed. Service information continued on attached page 3. SERVED BY PERSONAL DELIVERY, OVERNIGHT MAIL, FACSIMILE TRANSMISSION OR EMAIL (state method for each person or entity served): Pursuant to F.R.Civ.P. 5 and/or controlling LBR, on (date) March 10, 2017, I served the following persons and/or entities by personal delivery, overnight mail service, or (for those who consented in writing to such service method), by facsimile transmission and/or email as follows. Listing the judge here constitutes a declaration that personal delivery on, or overnight mail to, the judge will be completed no later than 24 hours after the document is filed. VIA HAND DELIVERY U.S. Bankruptcy Court Honorable Sheri Bluebond 255 E. Temple Street, Suite 1534/Courtroom 1539 Los Angeles, CA 90067 Service information continued on attached page I declare under penalty of perjury under the laws of the United States that the foregoing is true and correct. March 10, 2017 Sophia Lee /s/ Sophia Lee Date Printed Name Signature
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This form is mandatory. It has been approved for use by the United States Bankruptcy Court for the Central District of California.
June 2012 F 9013-3.1.PROOF.SERVICE DOCS_LA:304530.1 35793/001
1. TO BE SERVED BY THE COURT VIA NOTICE OF ELECTRONIC FILING (NEF):
Case 2:17-ap-01120-BB Doc 25 Filed 03/30/17 Entered 03/30/17 15:00:02 Desc Main Document Page 73 of 75
This form is mandatory. It has been approved for use by the United States Bankruptcy Court for the Central District of California.
June 2012 F 9013-3.1.PROOF.SERVICE DOCS_LA:304530.1 35793/001
PROOF OF SERVICE OF DOCUMENT I am over the age of 18 and not a party to this bankruptcy case or adversary proceeding. My business address is: 10100 Santa Monica Boulevard, 13th Floor, Los Angeles, California 90067 A true and correct copy of the foregoing document entitled (specify): DEFENDANTS’ MOTION TO DISMISS FIRST AMENDED COMPLAINT PURSUANT TO RULE 7012 OF THE FEDERAL RULES OF BANKRUPTCY PROCEDURE, INCORPORATING BY REFERENCE, RULE 12(b)(6) OF THE FEDERAL RULES OF CIVIL PROCEDURE will be served or was served (a) on the judge in chambers in the form and manner required by LBR 5005-2(d); and (b) in the manner stated below: 1. TO BE SERVED BY THE COURT VIA NOTICE OF ELECTRONIC FILING (NEF): Pursuant to controlling General Orders and LBR, the foregoing document will be served by the court via NEF and hyperlink to the document. On (date) March 10, 2017, I checked the CM/ECF docket for this bankruptcy case or adversary proceeding and determined that the following persons are on the Electronic Mail Notice List to receive NEF transmission at the email addresses stated below: Service information continued on attached page 2. SERVED BY UNITED STATES MAIL: On (date) ___________, I served the following persons and/or entities at the last known addresses in this bankruptcy case or adversary proceeding by placing a true and correct copy thereof in a sealed envelope in the United States mail, first class, postage prepaid, and addressed as follows. Listing the judge here constitutes a declaration that mailing to the judge will be completed no later than 24 hours after the document is filed. Service information continued on attached page 3. SERVED BY PERSONAL DELIVERY, OVERNIGHT MAIL, FACSIMILE TRANSMISSION OR EMAIL (state method for each person or entity served): Pursuant to F.R.Civ.P. 5 and/or controlling LBR, on (date) March 10, 2017, I served the following persons and/or entities by personal delivery, overnight mail service, or (for those who consented in writing to such service method), by facsimile transmission and/or email as follows. Listing the judge here constitutes a declaration that personal delivery on, or overnight mail to, the judge will be completed no later than 24 hours after the document is filed. VIA HAND DELIVERY U.S. Bankruptcy Court Honorable Sheri Bluebond 255 E. Temple Street, Suite 1534/Courtroom 1539 Los Angeles, CA 90067 Service information continued on attached page I declare under penalty of perjury under the laws of the United States that the foregoing is true and correct. March 10, 2017 Sophia Lee /s/ Sophia Lee Date Printed Name Signature
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This form is mandatory. It has been approved for use by the United States Bankruptcy Court for the Central District of California.
June 2012 F 9013-3.1.PROOF.SERVICE DOCS_LA:304530.1 35793/001
1. TO BE SERVED BY THE COURT VIA NOTICE OF ELECTRONIC FILING (NEF):
