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The Order - A Chapter 11 Trustee is to be Appointed; SCO's Sale Motion Denied - Updated

Wednesday, August 05 2009 @ 02:51 PM EDT

The judge in the SCO bankruptcy has ruled at last. SCO's motion to let it sell to unXis is denied. There could be an auction later. The motions to convert to Chapter 7 by IBM, Novell and the US Trustee's Office are also denied, but alternative relief is granted, and there will be a Chapter 11 trustee appointed. IBM and Novell agreed that a Chapter 11 Trustee was appropriate if he did not convert to Chapter 7, and that is what he has done. That means presumably that SCO management no longer run this show. Here they are, the Order and Memorandum in the bankruptcy:

890 - Filed & Entered: 08/05/2009
Opinion
Docket Text: OPINION re Motions to Convert and Sale Motion(related document(s)[750], [751], [815], [881]) (LJS)
891 - Filed & Entered: 08/05/2009
Order
Docket Text: ORDER DENYING Motions to Convert and Sale Motion(related document(s)[750], [751], [815], [881], [890]) Order Signed on 8/5/2009. (LJS)

The judge leaned as far as he could to help SCO, denying the three motions to convert. But the U.S. Trustee's Office will now appoint a Chapter 11 trustee. SCO has "abandoned rehabilitation", the judge says, and bet the company on its litigation, so the Chapter 11 trustee will evaluate whether the litigation is realistic or not. The judge doesn't trust anyone not to have an agenda, so he wants a trustee, but he is clearly trying to help SCO survive. And footnote 6 of the memorandum says this about the sale:

After the Hearing, Debtors wrote to the Court to report that Debtors were now prepared to subject the Sale to an auction, under the auspices of an examiner. The Court's ruling means a trustee will review the Sale Motion and take independent action as a fiduciary.

Sigh. The memorandum misspells the proposed buyer, mischaracterizes the Novell litigation, incorrectly states that the AutoZone case is stayed, etc. The judge agreed with IBM that it would be inappropriate to base anything on the litigation, since the judge would have to have a trial first, but even then, the judge writes, he could only guess as to the outcome. But here, despite writing that, he bases his entire decision on the outcome of the litigation. My logical brain is having trouble processing that.

But there is now going to be an independent fiduciary to run the show. At least. But if the judge says even if he had a trial on the litigation, he could only guess as to the outcome, how can an independent fiduciary do any better without even a trial? You tell me.

The judge says he is relying on 11 U.S.C. § 1104, which is what SCO mentioned in its first letter to the judge post-trial, and on him finding "unusual circumstances" even though he acknowledges that there is ample justification for cause to convert. He worries about whether the litigation might be a big payoff for creditors, and he says he's considering other creditors, not just IBM and Novell. Here's the case he also says he is relying on, In re Marvel Entertainment Group, Inc.. Significantly, he says he is relying on 1104(a)(3), though. Here's 1104(a), and notice the distinctions:

§ 1104. Appointment of trustee or examiner
(a) At any time after the commencement of the case but before confirmation of a plan, on request of a party in interest or the United States trustee, and after notice and a hearing, the court shall order the appointment of a trustee—
(1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or similar cause, but not including the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor;
(2) if such appointment is in the interests of creditors, any equity security holders, and other interests of the estate, without regard to the number of holders of securities of the debtor or the amount of assets or liabilities of the debtor; or
(3) if grounds exist to convert or dismiss the case under section 1112, but the court determines that the appointment of a trustee or an examiner is in the best interests of creditors and the estate.

So despite all the evidence, and even the judge ruling that he finds cause to convert, he says he is relying on (a)(3). Why? To avoid conversion, of course, but on what basis can he find cause and still say he isn't criticizing SCO's conduct? I find it hard to explain, so I'll just leave it at that.

But he also didn't like SCO's suggestion to leave the Board and management in control either. He wants a really neutral party to report to him. He simply doesn't know if SCO's litigation dreams are based in reality or not. Um. They have lost in every courtroom they've entered, but the judge wants someone to investigate just for him. Remember this judge's ruling at the hearing that he wouldn't allow the Hans Bayer emails into the record, in which Bayer wrote that even inside the company, employees including Bayer himself think the litigation is hopeless? See now why IBM fought so hard to get them included? Without them, the judge can say he doesn't know if the litigation is realistic or not. Puh lease. I think that is one clear area where there could be an appeal, frankly, based on the reasons the emails were not allowed in. Or they can just show some new materials to the new trustee. The picture is clear enough.

Oddly, the judge seems to have ignored the recommendation and the arguments of the US Trustee, who wrote this:

11. The purpose of 11 U.S.C. § 1112(b)(4)(A) is to "preserve estate assets by preventing the debtor in possession from gambling on the enterprise at the creditors' expense when there is no hope of rehabilitation." In re Lizeric Realty Corp., 188 B.R. 499, 503 (Bankr. S.D.N.Y. 1995) (quoted in Loop Corp. v. United States Trustee (In re Loop Corp.), 379 F.3d 511, 516 (8th Cir. 2004)).

It doesn't say you can gamble if the odds are evaluated and it seems a good gamble. Here's Section 1112(b)(4):

(4) For purposes of this subsection, the term “cause” includes—
(A) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation;

Just above it, it says when a judge can avoid conversion or dismissal, one of which is required upon establishing cause:

1) Except as provided in paragraph (2) of this subsection, subsection (c) of this section, and section 1104 (a)(3), on request of a party in interest, and after notice and a hearing, absent unusual circumstances specifically identified by the court that establish that the requested conversion or dismissal is not in the best interests of creditors and the estate, the court shall convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, if the movant establishes cause.
(2) The relief provided in paragraph (1) shall not be granted absent unusual circumstances specifically identified by the court that establish that such relief is not in the best interests of creditors and the estate, if the debtor or another party in interest objects and establishes that—
(A) there is a reasonable likelihood that a plan will be confirmed within the timeframes established in sections 1121 (e) and 1129 (e) of this title, or if such sections do not apply, within a reasonable period of time; and
(B) the grounds for granting such relief include an act or omission of the debtor other than under paragraph (4)(A)—
(i) for which there exists a reasonable justification for the act or omission; and
(ii) that will be cured within a reasonable period of time fixed by the court.

The US Trustee concluded:

16. Under these circumstances, and consistent with 11 U.S.C. § 1112(b)(1), this Court is required to convert the above-captioned cases to cases under chapter 7 or dismiss the cases. In light of the facts and circumstances of these cases, the U.S. Trustee submits that conversion of the cases to cases under chapter 7 is the appropriate course of action.

If that's true, then can the order be right, since there is an obvious conflict? Unusual circumstances indeed. However, our reporters at the hearing said that all three, IBM, Novell and the US Trustee said either a 7 or an 11 trustee would be acceptable. When we get the transcript, we'll be able to figure out that part.

So. Bottom line? SCO has lost control of the bankruptcy. That assumes the Chapter 11 person appointed isn't Darl's cousin, if you catch my drift. But it's the US Trustee's Office that gets to choose, and it asked for Chapter 7 conversion, if you recall, so that's boding well for a true neutral fiduciary. However, delay is also achieved, as SCO awaits the appeal. Guess what could happen if the appeal is in any significant part successful? Or there might be an appeal of this order. Oddly, the judge writes that preserving the litigation is the reason for the bankruptcy:

These bankruptcy cases arose from and primarily seek to preserve litigation between Debtors and parties over rights to computer operating systems.

What do I know? I thought that was a bankruptcy no no. And here's the part about guesswork:

The Movants insist that only a neutral party should control the process and make the necessary decisions. The Court fully agrees. Where the Court differs from the Movants is that the Movants seek appointment of a Chapter 7 trustee. The Court is convinced that a Chapter 11 trustee better serves the interests of creditors and the estate. At the request of IBM, the Court ruled that it would not consider evidence concerning the merits of the Litigation. IBM was correct that the Court could not decide the merits of the Litigation without conducting a mini-trial and even then, the Court's conclusions would not be more than guesswork of the outcome. Accordingly, the Court is unable to opine on whether the Debtors should continue to pursue the Litigation, but cannot ignore the significance and potential benefit to SCO of the Litigation. The "potential" of the Litigation must, however, be weighed against the reality of the cost. A trustee will be in a better position to make that assessment without the personal and emotional investment of SCO's management. Similarly, a Chapter 11 trustee can evaluate an asset sale independent of Debtors' management's pursuit of the Litigation.

And how will a fiduciary be able to do that, if the judge can't, and even more if he already ruled he shouldn't consider such merits? It seems a strange workaround.

Here's the section about the Sale Motion:

D. The Sale Motion
In May 2009, the OUST, Novell and IBM filed the Conversion Motions. The Court scheduled the Conversion Motions to be heard on June 15, 2009, at 2:00 p.m. The Debtors appeared claiming they had just entered into a sale agreement (the "Sale Agreement") and told the Court that were the Court to approve the sale, Debtors would close the sale, dismiss the case, pay creditors in full and proceed with the Novell Litigation and the IBM Litigation. IBM and Novell objected, expressing the view that given Debtors' history during these cases, the Sale Agreement was a ploy to avoid proceeding on the Conversion Motions. The Court overruled the objection and agreed to consider the latest sale proposal in connection with the Conversion Motions. In fact, the Sale Agreement lacked necessary schedules and exhibits. Debtors did not file the Sale Motion until late on June 22. The Sale Motion proposes a sale to Unixis, Inc. ("Unixis"), of all of Debtors' assets except for its "Mobility" business, the Litigation and such assets as are necessary for Debtors to prosecute the Litigation, assets which Debtors would transfer to Unixis when appropriate to do so. The sale price is $5.25 million consisting of a $250,000 cash deposit, a $2.15 million letter of credit to be drawn upon closing and a $2.85 million letter of credit as a payment toward any final judgment which Novell obtains....
A. The Sale Motion
A sale out of the ordinary course of business is governed by Bankruptcy Code 363(b)(1). Such a sale requires proof that:
(1) there is a sound business purpose for the sale; (2) the proposed sale price is fair; (3) the debtor has provided adequate and reasonable notice; and (4) the buyer has acted in good faith.
In re Delaware & Hudson Railway Co., 124 BR. 169, 176 (D. Del. 1991). Here, the Debtors offered no evidence of the fairness of the price and, indeed, the price is highly suspect as the sale was clearly a rushed, last ditch effort to avoid the Conversion Motions. There is no evidence that the sale price is fair because it is just enough for Debtors to dismiss their cases.
The terms are equally, if not more, troublesome. Debtors are retaining the Mobility business that is virtually worthless, the letter of credit to pay a Novell judgment terminates on December 31, 2009, with no guarantee that the Novell Litigation will be concluded. Further, the Court is unable to find based on this record, the Debtors' history of unsuccessful sale efforts and this sale's peculiar and questionable timing that Unixis has acted in good faith.
The Court is also very disturbed that the Sale Agreement contains a provision (which Movants refer to as a "poison pill") requiring the transfer of assets to Unixis upon conversion or appointment of a trustee. Here, again, the Sale Motion calls into question whether the sale has a sound business purpose and raises doubts of the parties' good faith. There is simply no record upon which the Court can find that the Sale is in the best interests of the creditors and the estate. The Sale Motion is denied as falling short of the required standards.

And my biggest questions: if SCO has abandoned rehabilitation, on what basis is it allowed to stay in Chapter 11? Isn't that the goal of Chapter 11? If the litigation is SCO's only hope, how long are we talking about remaining in Chapter 11? Until a Supreme Court appeal years down the road? And does IBM have to wait to get its litigation going again? Would that not answer the judge's questions about the viability of the SCO litigation better than a fiduciary's guesswork?

You probably want to know a little bit about what a Chapter 11 Trustee means, and what he can do. Here's one thing he can do, sue and be sued:

§ 323. Role and capacity of trustee
(a) The trustee in a case under this title is the representative of the estate.
(b) The trustee in a case under this title has capacity to sue and be sued.

The legal system in the US is a lot of checks and balances. So even if a trustee went bad or whatever, there is a system in place to address any problems. The trustee can hire lawyers, obviously, with court approval. He doesn't have to keep the current ones, but I guess he can:

§ 327. Employment of professional persons
(a) Except as otherwise provided in this section, the trustee, with the court’s approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee’s duties under this title.
(b) If the trustee is authorized to operate the business of the debtor under section 721, 1202, or 1108 of this title, and if the debtor has regularly employed attorneys, accountants, or other professional persons on salary, the trustee may retain or replace such professional persons if necessary in the operation of such business.
(c) In a case under chapter 7, 12, or 11 of this title, a person is not disqualified for employment under this section solely because of such person’s employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.
(d) The court may authorize the trustee to act as attorney or accountant for the estate if such authorization is in the best interest of the estate.
(e) The trustee, with the court’s approval, may employ, for a specified special purpose, other than to represent the trustee in conducting the case, an attorney that has represented the debtor, if in the best interest of the estate, and if such attorney does not represent or hold any interest adverse to the debtor or to the estate with respect to the matter on which such attorney is to be employed.
(f) The trustee may not employ a person that has served as an examiner in the case.

How do I read that? That the trustee could hire SCO's lawyers. That would, of course, mean that they'd "inform" him that they think SCO has a case. I doubt this worst case scenario would happen, but I'm just showing you how things could be fixed to SCO's advantage, if anyone were trying.

Finally, this part of the memorandum is odd:

The reality is that eliminating Debtors' litigation against them is far more valuable to IBM and Novell than any recovery from Debtors in the bankruptcy cases.

That would be true only if the litigation has value to SCO, which is precisely what the judge said he can't evaluate. But here, he clearly has, albeit wrongly from all I've seen. See what I mean about logic? Either it is appropriate for him to evaluate the litigation or it isn't, but it really ought not to be both at once.

And as for the Marvel case, having now read it, I don't see any application, except contrary to this ruling, because the facts are entirely different. In Marvel Carl Icahn took over the company and ended up wearing two hats, only one of which was debtor in possession, the other being as a creditor, and the other creditors were wondering how fair that was:

Under the Bankruptcy Code, the district court was empowered to appoint a trustee:
(1) for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case, or similar cause, . . . or
(2) if such appointment is in the interests of creditors, any equity security holders, and other interests of the estate . . . .
11 U.S.C. § 1104(a). The party moving for appointment of a trustee, in this case the Lenders, must prove the need for a trustee under either subsection by clear and convincing evidence. See Sharon Steel, 871 F.2d at 1226. "It is settled that appointment of a trustee should be the exception, rather than the rule." Id. at 1225. In the usual chapter 11 proceeding, the debtor remains in possession throughout reorganization because "current management is generally best suited to orchestrate the process of rehabilitation for the benefit of creditors and other interests of the estate." In re V. Savino Oil & Heating Co., 99 B.R. 518, 524 (Bankr. E.D.N.Y. 1989). Thus, the basis for the strong presumption against appointing an outside trustee is that there is often no need for one: "The debtor-in-possession is a fiduciary of the creditors and, as a result, has an obligation to refrain from acting in a manner which could damage the estate, or hinder a successful reorganization." Petit v. New England Mort. Servs., 182 B.R. 64, 69 (D. Me. 1995) (internal quotations omitted). The strong presumption also finds its basis in the debtor-in-possession's usual familiarity with the business it had already been managing at the time of the bankruptcy filing, often making it the best party to conduct operations during the reorganization. See Sharon Steel, 871 F.2d at 1226. The facts here, however, militate against invoking this presumption. The Icahn interests took control over Marvel's management six months after the chapter 11 filing. We are not confronted with a debtor who possesses extensive familiarity with the company's operations. It is therefore inappropriate to suggest that the usual presumption should be applied to a Johnny-come-lately debtor-in-possession, especially one that is also a substantial creditor.
The district court determined that the Icahn interests were "unable to resolve conflicts" with creditors of the estate. On the basis of this acrimony, it ordered the appointment of a trustee. We hold that the district court did not abuse its discretion because (A) this acrimony rises to the level of "cause" under § 1104(a)(1), and (B) a trustee would serve the best interests of the parties and estate.

Note that the foundation was 1104(a)(1), not (3) in Marvel. And that's cause. Yet the judge says he isn't relying on (1) but on (3) and that he isn't finding fault with SCO. Why not? Or more accurately, what is the foundation for why not? And (3) is best interests of the creditors and the estate. It says absolutely nothing about the customers, yet the judge writes that his decision was influenced by the needs of customers. The facts in Marvel were not like anything in the SCO case, where SCO isn't wearing two hats, and neither are IBM and Novell, who don't get to decide anything anyway, so it's not applicable or comparable. Not only that, note what the ruling said in Marvel:

We expressly hold that there is no per se rule by which mere conflicts or acrimony between debtor and creditor mandate the appointment of a trustee. In this case, rather, we are faced with circumstances in which the Icahn interests, themselves creditors of the Perelman holding companies, are currently in control of the debtor at the same time that the debtor proposes reorganization plans. In this position, although the Icahn interests are technically and officially fiduciaries to all creditors, they would also be placed in an awkward position of evaluating their own indenture and debt claims. Having found that this unhealthy conflict of interest was manifest in the "deep-seeded conflict and animosity" between the Icahn-controlled debtor and the Lenders and in the lack of confidence all creditors had in the Icahn interests' ability to act as fiduciaries, the district court did not depart from the proper exercise of discretion when it determined sufficient cause existed under § 1104(a)(1) to appoint a neutral trustee to facilitate reorganization.

Emphasis added by me. In Marvel, acrimony was getting in the way of a reorganization:

Moreover, we are impressed by the persuasive reasoning in In re Cajun Elec. Power Coop., Inc., 74 F.3d 599, 600 (5th Cir.) (adopting on rehearing the opinion of dissent in 69 F.3d at 751), cert. denied, 117 S. Ct. 51 (1996), in which the court upheld a trustee appointment based on a finding of acrimony. In that case, the debtor-in-possession's interests conflicted with those of its creditors to such an extent that "the appointment of a trustee may be the only effective way to pursue reorganization."

If SCO were in fact seeing to be rehabilitated, then relying on the case might make sense. But SCO is not. So why would it matter if there are conflicts? In a conversion to Chapter 7, it becomes a non-issue. And can a judge force a debtor to be rehabilitated, after it says it isn't going to try?

P.S. There is no "IBM Linux operating system", as the judge wrote. How can you get so many facts wrong and end up right? Well, you can, but it's hard.

: )

So, in all honesty, I think this is an extremely appealable ruling. Or more exactly, it would be if IBM and Novell hadn't said a Chapter 11 trustee was OK. How do you appeal getting what you said was OK, even if you got it for some illogical reasons? Of course, they didn't ask for a limited Chapter 11 trustee, whose main job appears to be to evaluate SCO's litigation chances and maybe handle an auction.

Update: SCO's comment to the Salt Lake Tribune's Tom Harvey:

In a short statement, SCO said company and its lawyers were reviewing the ruling "and determining the next steps. We're pleased the motion to covert to Chapter 7 [liquidation] was denied."

[ Update: Here's where you can track Federal spending on contracts, OMB Watch, to see if it's true the Navy can't fly its jets without SCO software. There is a 2005 contract with the DOD for $6,286 for "70: Automatic data processing equipment" and described as "SPACE AND NAVAL WARFARE SYSTEMS". ]

Here's the Opinion, as text, followed by the Memorandum:

********************************

UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE

In re

THE SCO GROUP, INC., et al.,

Debtors.

Chapter 11

Case Number 07-11337 (KG)
(Jointly Administered)
Related Docket Nos.: 750, 751, 815 & 881

ORDER

The Court has pending before it the following motions:

(1) Motion of the United States Trustee to Convert Cases to Cases Under Chapter 7 (D.I. 750) (the "OUST's Motion");
(2) Motion of International Business Machines Corporation (D.I. 751) (the "IBM Motion");
(3) Novell Inc.'s Motion for Conversion (D.I. 753) (the "Novell Motion"); and
(4) Motion for Sale of Property Outside the Ordinary Course of Business Free and Clear of Interests and for Approval of Assumption and Assignment of Executory Contracts and Unexpired Leases in Conjunction With Sale (D.I. 815), as amended (D.I. 881) (the "Sale Motion").

The Court has carefully considered the parties' submissions and conducted an evidentiary hearing. The Court has issued a Memorandum Opinion.

For the reason set forth in the Memorandum Opinion, IT IS ORDERED that:

1. The Oust's Motion, the IBM Motion, the Novell Motion and the Sale Motion are DENIED.

2. The Court directs the Office of the United States Trustee to appoint a Chapter 11 Trustee.

Dated: August 5, 2009

[signature]
KEVIN GROSS, U.S.B.J.

*********************************
*********************************

UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE

In re

THE SCO GROUP, INC., et al.,

Debtors.

Chapter 11

Case Number 07-11337 (KG)
(Jointly Administered)
Related Docket Nos.: 750, 751, 815 & 881

MEMORANDUM OPINION¹

SCO Group, Inc. and affiliated entities ("SCO" or "Debtors") filed these bankruptcy cases on September 14, 2007, seeking relief under Chapter 11 of the Bankruptcy Code. 11 U.S.C. §§ 101, et. seq. The Court has before it for decision the following motions (collectively, (1), (2) and (3) are referred to as the "Movants" and the "Conversion Motions"):

(1) Motion of the United States Trustee to Convert Cases to Cases Under Chapter 7 (D.I. 750) ("OUST" and "OUST's Motion");

(2) Motion of International Business Machines Corporation (D.I. 751) ("IBM" and "IBM's Motion");

(3) Novell [Inc.'s] Motion for Conversion (D.I. 753) ("Novell" and "Novell's Motion"); and

(4) Motion for Sale of Property Outside the Ordinary Course of Business Free and Clear of Interests and for Approval of Assumption and Assignment of Executory Contracts and Unexpired Leases in Conjunction With Sale (D.I. 815), as amended (D.I. 881) (the "Sale Motion").

The Court held a lengthy evidentiary hearing on July 27, 2009 (the "Hearing"), and has concluded that the cases require the appointment of a Chapter 11 trustee.

I. JURISDICTION

The Court has jurisdiction over this matter under 28 U.S.C. §§ 157 and 1334. This is a core proceeding under 28 U.S.C. § 157(b). Venue is proper in this district under 28 U.S.C. §§ 1408 and 1409. The statutory predicate for the relief requested herein is 11 U.S.C. § 1112(b).

II. FACTS

These bankruptcy cases arose from and primarily seek to preserve litigation between Debtors and parties over rights to computer operating systems.² A brief discussion of the litigation (collectively, the "Litigation") is therefore both necessary and appropriate.

A. The Litigation

1. Debtors v. Novell

In 1995, Debtors' predecessor-in-interest purchased Novell's UNIX operating system which became one of the world's most successful operating systems. Debtors and Novell

were (and remain) in litigation over a dispute involving the ownership of the UNIX copyrights. On May 28, 2003, Novell publicly announced that it, not SCO, owned the UNIX copyrights. Within hours of the announcement, according to SCO, its stock price plummeted. In January 2004, SCO sued Novell in Utah State Court for slander of title to the UNIX copyrights. Novell thereafter removed the case to the United States District Court for the District of Utah ("the Utah Court").³ Novell asserted counterclaims against SCO alleging breaches of an asset purchase agreement between Novell and SCO's predecessor-in-interest, The Santa Cruz Operation, seeking, inter alia, monetary damages for unjust enrichment and requesting an accounting. Novell then amended its counterclaim to seek, inter alia, imposition of a constructive trust over revenue SCO collected from certain of its customers. After the parties filed cross motions for summary judgment, the Utah Court denied SCO's motion for summary judgment and granted Novell's motion for summary judgment in part. The Utah Court held that imposition of a constructive trust was warranted and the amount of Novell's recovery would be determined following a trial. On the eve of that trial, in which Novell sought in excess of $37 million, SCO filed for bankruptcy. This Court granted Novell's motion to lift the automatic stay to enable the trial in the Utah Court to proceed. Following trial, the Utah Court awarded Novell $3.5 million. SCO appealed to the Tenth Circuit Court of Appeals. The parties argued the appeal on an expedited schedule and are presently awaiting a decision. SCO presented a credible prediction, based upon the

impending retirement of one of the judges sitting on the appeal, that the Tenth Circuit will issue a decision by the end of August 2009.

2. The IBM Litigation

The dispute between IBM and Debtors is considerably more complicated and does not require detailed discussion for purposes of the Court’s opinion. In its suit which is also pending before the Utah Court, SCO claims that IBM breached its UNIX source code licenses by disclosing restricted information in connection with IBM’s efforts to promote the IBM Linux operating system. The complaint includes claims for breach of contract, unfair competition, tortious interference and copyright infringement. IBM has counterclaimed for breach of contract, violation of the Lanham Act, unfair competition, intentional interference with prospective economic relations, unfair and deceptive trade practices, promissory estoppel and patent infringement. IBM subsequently voluntarily dismissed its claims for patent infringement. Both parties have filed multiple motions for summary judgement which have not been decided.

3. Other Litigation

There are three other actions pending involving SCO either as a defendant or plaintiff.

a. Red Hat, Inc., filed suit against SCO for a declaratory judgment that it has not infringed on copyrights nor misappropriated trade secrets, claiming that the Linux Operating System that it utilizes does not infringe on SCO’s UNIX intellectual property rights. Red Hat also claims that SCO engaged in false advertising, deceptive trade practices, unfair competition, tortious interference with prospective business opportunities, trade libel and

disparagement. The action is pending in the United States District Court for the District of Delaware⁴ and is presently stayed pending the outcome of the IBM Litigation.

b. SCO filed suit against AutoZone, Inc., an action pending in the United States District Court for the District of Nevada.⁵ SCO alleges that AutoZone ran versions of the Linux Operating System that violate SCO's copyrights. This action is also stayed pending the outcome of the IBM Litigation, Novell Litigation and Red Hat Litigation.

There is also a lawsuit pending in India filed in April 2003, claiming that SCO is obligated to repurchase certain software products and to reimburse the distributor for certain other operating costs. That action remains pending.

4. The International Court of Arbitration Proceeding

In April 2006, Novell and SuSE Linux, GmbH filed a request for arbitration in the International Court of Arbitration in France claiming that SCO granted SuSE the right to use SCO's intellectual property through SCO's participation in the United Linux Initiative in 2002 and that by virtue of Novell's subsequent acquisition of SuSE, Novell acquired SuSE's rights as a member of United Linux. The arbitration is stayed by virtue of the bankruptcy and this Court ruled that the automatic stay is applicable to the Arbitration.

B. SCO's Financial Situation

It is an understatement to stay that since the filing of their bankruptcy the Debtors financial situation has greatly declined. Their own Operations Monthly Operating Report for March 31, 2009 (D.I. 743), the latest Monthly Operating Report which Debtors have filed, shows that Debtors have lost $8,652,612 since filing, without taking into account reorganization costs. These losses compare to total assets of $8.3 million of which there is $728,537 of unrestricted cash and net accounts receivable of $1.4 million. The liabilities, in contrast, total $6.9 million (prepetition) and $4.84 million (postpetition). This reflects a 50% reduction of Debtors' assets since filing their cases. The Sale Motion is, in effect, Debtors' concession that they are no longer able to maintain their business operations. As discussed further below, Debtors are seeking the Court's approval of the sale of all of their assets except for their litigation claims and one business, Mobility, which is generating less than $100,000 in revenues per annum.

C. Bankruptcy Proceedings

The Debtors' bankruptcy cases have been fraught with difficulties and have not progressed after nearly 22 months. There was an unsuccessful effort to sell substantially all of their assets to York Management. Debtors filed an emergency sale motion and yet never submitted an executed asset purchase agreement. A second attempted sale to Stephen Norris Capital Partners, LLC, pursuant to a proposed plan likewise failed.

Debtors filed a Debtors' Joint Plan of Reorganization (D.I. 368) and Disclosure Statement (D.I. 369) in January 2009 which Debtors thereafter withdrew. Debtors later filed

an Amended Joint Plan of Reorganization (D.I. 654) and Second Disclosure Statement (D.I. 655) which Debtors likewise withdrew.

Despite their difficulties, Debtors sought and obtained three extensions of exclusivity (D.I. 329, 502, 562). Debtors sought a fourth extension of exclusivity which the Court denied, in large part because after two continuances of a hearing on the fourth exclusivity motion, exclusivity had already terminated. Accordingly, Debtors are proceeding without the exclusive right to file a plan of reorganization. It is clear that Debtors do not intend to file a plan. Instead, they have declared their intention to sell substantially all of their assets and thereafter seek to dismiss the bankruptcy cases.

D. The Sale Motion

In May 2009, the OUST, Novell and IBM filed the Conversion Motions. The Court scheduled the Conversion Motions to be heard on June 15, 2009, at 2:00 p.m. The Debtors appeared claiming they had just entered into a sale agreement (the "Sale Agreement") and told the Court that were the Court to approve the sale, Debtors would close the sale, dismiss the case, pay creditors in full and proceed with the Novell Litigation and the IBM Litigation. IBM and Novell objected, expressing the view that given Debtors' history during these cases, the Sale Agreement was a ploy to avoid proceeding on the Conversion Motions. The Court overruled the objection and agreed to consider the latest sale proposal in connection with the Conversion Motions. In fact, the Sale Agreement lacked necessary schedules and exhibits. Debtors did not file the Sale Motion until late on June 22. The Sale Motion proposes a sale to Unixis, Inc. ("Unixis"), of all of Debtors' assets except for its "Mobility" business, the

Litigation and such assets as are necessary for Debtors to prosecute the Litigation, assets which Debtors would transfer to Unixis when appropriate to do so. The sale price is $5.25 million consisting of a $250,000 cash deposit, a $2.15 million letter of credit to be drawn upon closing and a $2.85 million letter of credit as a payment toward any final judgment which Novell obtains.

III. DISCUSSION

These bankruptcy cases have been pending for 23 months. Were the Court to approve the Sale Motion, Debtors sole business would be the Litigation, putting aside the Mobility business which is of de minimis value. There would be no plan of reorganization and instead, all that the Debtors would have to show for their millions of dollars of post-petition losses is the Litigation. No one can fairly argue that the Court has not been patient with the Debtors. The Court is now unwilling to continue to wait while Debtors' losses mount and the Debtors intend to dismiss the Chapter 11 cases. During the Hearing on the Conversion Motions and the Sale Motion, Debtors' constant refrain of waiting for the Litigation to succeed reminded the Court of Samuel Beckett's play, Waiting for Godot. In that play, one of the characters says:

But that is not the question. Why are we here, that is the question. And we are blessed in this, that we happen to know the answer. Yes, in this immense confusion one thing is clear. We are waiting for Godot to come.

Debtors are waiting for "the dough" from the Litigation but the Court must take action to protect the estate and the creditors. The outcome and time to reach finality of the Litigation are both too uncertain, while the continuing losses are not.

A. The Sale Motion

A sale out of the ordinary course of business is governed by Bankruptcy Code 363(b)(1). Such a sale requires proof that:

(1) there is a sound business purpose for the sale; (2) the proposed sale price is fair; (3) the debtor has provided adequate and reasonable notice; and (4) the buyer has acted in good faith.

In re Delaware & Hudson Railway Co., 124 BR. 169, 176 (D. Del. 1991). Here, the Debtors offered no evidence of the fairness of the price and, indeed, the price is highly suspect as the sale was clearly a rushed, last ditch effort to avoid the Conversion Motions. There is no evidence that the sale price is fair because it is just enough for Debtors to dismiss their cases. The terms are equally, if not more, troublesome. Debtors are retaining the Mobility business that is virtually worthless, the letter of credit to pay a Novell judgment terminates on December 31, 2009, with no guarantee that the Novell Litigation will be concluded. Further, the Court is unable to find based on this record, the Debtors' history of unsuccessful sale efforts and this sale's peculiar and questionable timing that Unixis has acted in good faith.

The Court is also very disturbed that the Sale Agreement contains a provision (which Movants refer to as a "poison pill") requiring the transfer of assets to Unixis upon conversion or appointment of a trustee. Here, again, the Sale Motion calls into question whether the sale has a sound business purpose and raises doubts of the parties' good faith. There is

simply no record upon which the Court can find that the Sale is in the best interests of the creditors and the estate. The Sale Motion is denied as falling short of the required standards.⁶

B. The Conversion Motions

The Conversion Motions are premised on Bankruptcy Code Section 1112(b), which provides, in relevant part, that:

(1) [On request of a party in interest, and after notice and a hearing, absent unusual circumstances specifically identified by the court that established that the requested conversion or dismissal is not in the best interests of creditors and the estate, the court shall convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, if the Movants establishes cause.
* * *
(4) For purposes of this subsection, the term "cause" includes (A) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation;
* * *
(B) Gross mismanagement of the estate; [or]
* * *
(J) Failure to file a disclosure statement, or to file or confirm a plan, within the time fixed by this title or by an order of this court[.]

Section 1112(b) is clear that the Court must dismiss or convert Debtors' case if Movants' establish "cause" which is defined in Section 1112(b)(4). See, e.g., In re Products Int'l Co.,

395 BR. 101, 107-09 (Bankr. D. Ariz. 2008).⁷ The only "but" to the mandatory conversion or dismissal is if a debtor can prove the existence of "unusual circumstances specifically identified by the court" showing that dismissal or conversion is not in the best interests of the creditors and the estate. (The emphasized words, "creditors and estate," are significant to later discussion in this opinion.)

The Movants have proven been cavil that "cause" exists. Debtors are, and do not deny, suffering substantial and continuing losses to and diminution of the estate. The losses are staggering. In addition, Debtors have no reasonable likelihood of rehabilitation. It is beyond peradventure that Debtors have abandoned rehabilitation by seeking to sell its operating business (except for Mobility which produces minimal revenues) and committing thereafter to dismiss its cases. So much for rehabilitation. In addition, Debtors have not filed a disclosure statement or confirmed a plan within the time allowed in Section 1121, and do not intend to do so.

The Debtors point out that the Court must also consider the unusual circumstances that establish that dismissal or conversion are not in the best interests of the estate. These circumstances include the impact upon shareholders, employees and customers. The Debtors argue that customers may be especially harmed because conversion would result in SCO's inability to maintain, service and upgrade its products. Customers depending on SCO

include McDonald's restaurants, many smaller companies and the U.S. Navy's ability to launch F-18 fighter jets.

The Court is concerned about the impact of conversion on other constituencies, particularly because the Court did not consider the merits of the Litigation based upon the objection of IBM. The Court finds that the Litigation is an "unusual circumstance" which militates against conversion. Whether pursuit of the Litigation is in the best interests of creditors and the estate is something a Chapter 11 trustee must investigate.

There is no question that the Movants have established the requisite "cause" for dismissal or conversion. The Court, however, has found that an "unusual circumstance" exists and that conversion is therefore not in the best interest of the creditors and the estate. Debtors, as an alternative to conversion, request that the Court appoint an examiner.

Debtors' suggestions of the appointment of an examiner or dismissing the cases rather than converting them do not appeal to the Court. An examiner would leave Debtors' management in charge of these cases and only add to the cost of Debtors' bankruptcy. Dismissing the cases will negate an opportunity for an unprejudiced party to evaluate the sale to Unixis and the merits of the Litigation. The Court is persuaded that neither dismissal nor conversion are in the best interests of creditors and the estate. Instead, the Court will order the OUST to appoint a Chapter 11 trustee.

The Movants insist that only a neutral party should control the process and make the necessary decisions. The Court fully agrees. Where the Court differs from the Movants is that the Movants seek appointment of a Chapter 7 trustee. The Court is convinced that a

Chapter 11 trustee better serves the interests of creditors and the estate. At the request of IBM, the Court ruled that it would not consider evidence concerning the merits of the Litigation. IBM was correct that the Court could not decide the merits of the Litigation without conducting a mini-trial and even then, the Court's conclusions would not be more than guesswork of the outcome. Accordingly, the Court is unable to opine on whether the Debtors should continue to pursue the Litigation, but cannot ignore the significance and potential benefit to SCO of the Litigation. The "potential" of the Litigation must, however, be weighed against the reality of the cost. A trustee will be in a better position to make that assessment without the personal and emotional investment of SCO's management. Similarly, a Chapter 11 trustee can evaluate an asset sale independent of Debtors' management's pursuit of the Litigation.

The Court's decision to appoint a Chapter 11 trustee sua sponte is based upon Bankruptcy Code Section 1104(a)(3) and In re Marvel Entertainment Group, Inc., 140 F.3d 463 (3rd Cir. 1998). There, the Third Circuit Court of Appeals discussed the strong preference for leaving a Chapter 11 case in the hands of the debtor because of its familiarity with its business. The Court of Appeals nonetheless found that the acrimony between debtor's management and its creditors justified the Chapter 11 trustee's appointment. Here, the strife between Debtors and IBM and Novell in hard fought litigation makes a considered decision by Debtors on the handling and disposition of the cases unlikely. The Court therefore orders the appointment of a Chapter 11 trustee in the best interests of the creditors and the estate.

The Court fully respects the OUST's authority and ability to select an appropriate trustee. The Court's "two cents," however, is to suggest that the OUST consider appointing a retired judge or litigator since the analysis of the Litigation will serve as the trustee's principal responsibility.

IV. CONCLUSION

The Court's decision is not intended as a criticism of Debtors' efforts or conduct. SCO found their UNIX operating system under attack and sought redress through litigation. Their principal adversaries, IBM and Novell, are wealthy and have used their deep pockets in the Litigation and in these bankruptcy cases to Debtors' disadvantage. As creditors, IBM and Novell are entitled to act in their self-interest and that is what they are doing. The reality is that eliminating Debtors' litigation against them is far more valuable to IBM and Novell than any recovery from Debtors in the bankruptcy cases. The interests of Debtors' other creditors may differ.

The fact remains that Debtors have lost money and have abandoned rehabilitation. They have "bet the Company" on the Litigation. The Court's decision to appoint a Chapter 11 trustee will enable an independent fiduciary to assess the Litigation with the confidence of the Court and without the doubts raised by Debtors' adversaries in the Litigation.

An Order consistent with this Opinion will issue.

Dated: August 5, 2009

KEVIN GROSS, U.S.B.J.

¹ This Opinion constitutes the findings of fact and conclusions of law pursuant to Federal Rule of Bankruptcy Procedure 7052. To the extent any of the following findings of fact are determined to be conclusions of law, they are adopted, and shall be construed and deemed, conclusions of law. To the extent any of the following conclusions of law are determined to be findings of fact, they are adopted, and shall be construed and deemed, as findings of fact.

² Operating Systems, in simplistic terms, enable software programs to run on computer hardware. They also allow multiple software programs to run simultaneously.

³ The litigation is captionedThe SCO Group, Inc. v. Novell, Inc., Case No. 2:04CV00139 ("the Novell Litigation").

⁴ The case is captioned Red Hat, Inc. v. The SCO Group, Inc., Civil No. 03-772 (the "Red Hat Litigation").

⁵ The case is captioned The SCO Group, Inc. v. AutoZone, Inc., CV-S-04-0237-RCJ-LRL (the "AutoZone Litigation").

⁶ After the Hearing, Debtors wrote to the Court to report that Debtors were now prepared to subject the Sale to an auction, under the auspices of an examiner. The Court's ruling means a trustee will review the Sale Motion and take independent action as a fiduciary.

⁷ Congressional intent that "shall" really does mean "must" in the convert or dismiss provision is readily apparent. In 2005, Congress removed the word "may" from Section 1112(b) and substituted "shall" if a moving party establishes "cause." Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8. 119 Stat. 23 (2005). Congress clearly intended to make conversion or dismissal mandatory upon proof of "cause."

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The Order - A Chapter 11 Trustee is to be Appointed

Authored by: Anonymous on Wednesday, August 05 2009 @ 02:55 PM EDT

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