James H.M. Sprayregen, P.C. Paul M. Basta Stephen E. Hessler Brian S.

Lennon KIRKLAND & ELLIS LLP 601 Lexington Avenue New York, New York 10022-4611 Telephone: (212) 446-4800 Facsimile: (212) 446-4900 and Anup Sathy, P.C. Marc J. Carmel (admitted pro hac vice) KIRKLAND & ELLIS LLP 300 North LaSalle Chicago, Illinois 60654-3406 Telephone: (312) 862-2000 Facsimile: (312) 862-2200 Counsel to the Debtors and Debtors in Possession UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK In re: INNKEEPERS USA TRUST, et al.,1 Debtors. ) ) ) ) ) ) ) Chapter 11 Case No. 10-13800 (SCC) Jointly Administered

DEBTORS OMNIBUS REPLY IN SUPPORT OF STALKING HORSE MOTION1 Innkeepers USA Trust and certain of its affiliates, as debtors and debtors in possession (collectively, the Debtors), hereby submit this omnibus reply (the Reply) in support of the Motion for Entry of an Order (I) Authorizing the Debtors to Enter into the Commitment Letter
1

The list of Debtors in these Chapter 11 Cases along with the last four digits of each Debtors federal tax identification number can be found by visiting the Debtors restructuring website at www.omnimgt.com/innkeepers or by contacting Omni Management Group, LLC at Innkeepers USA Trust c/o Omni Management Group, LLC, 16161 Ventura Boulevard, Suite C, PMB 606, Encino, California 91436. The location of the Debtors corporate headquarters and the service address for their affiliates is: c/o Innkeepers USA, 340 Royal Poinciana Way, Suite 306, Palm Beach, Florida 33480.

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with Five Mile Capital II Pooling REIT LLC, Lehman ALI Inc., and Midland Loan Services, (II) Approving the New Party/Midland Commitment Between the Debtors and Midland Loan Services, (III) Approving Bidding Procedures, (IV) Approving Bid Protections, (V) Authorizing an Expense Reimbursement to Bidder D, and (VI) Modifying Cash Collateral Order to Increase Expense Reserve [Docket No. 820] (the Motion). The following entities have filed objections to the Motion: the Ad Hoc Committee of Preferred Shareholders (the

Ad Hoc Committee), LNR Securities Holdings, LLC and the ML-CFC 2006-4 and CSFB 2007-C1 Trusts (collectively, LNR), TriMont Real Estate Advisors, Inc. (TriMont), Appaloosa Investment L.P. I, Palomino Fund Ltd., Thoroughbred Fund L.P., and Thoroughbred Master Ltd. (collectively, Appaloosa),2 CWCapital Asset Management LLC (CWC) and CIII Asset Management LLC (C-III and, together with CWC, CWC/C-III), and the official committee of unsecured creditors (the Creditors Committee).3 In further support of the Motion, the Debtors respectfully reply as follows:4

The Debtors note that for the reasons set forth in the Debtors Omnibus Limited Objection to Certificateholders Standing Requests [Docket No. 887], the Debtors dispute Appaloosa and LNRs standing to assert Objections to the extent such Objections are raised by these parties in their role as certificateholders. The following objections have been filed in response to the Motion: Limited Objection of Official Committee of Unsecured Creditors to the Motion [Docket No. 947] (the Creditors Committee Objection); Objection of Ad Hoc Committee of Preferred Shareholders to the Motion [Docket No. 965] (the Ad Hoc Committee Objection); Objection of the Trusts and LNR Securities Holdings, LLC to the Motion [Docket No. 966] (the LNR Objection); Objection of Appaloosa Investment L.P. I, Palomino Fund Ltd., Thoroughbred Fund L.P., and Thoroughbred Master Ltd. to the Motion [Docket No. 967] (the Appaloosa Objection); CWCapital Asset Management LLC and C-III Asset Management LLCs Limited Objection to the Motion [Docket No. 968] (the CWC/C-III Objection); Objection of TriMont Real Estate Advisors, Inc., as Special Servicer, to the Motion [Docket No. 969] (the TriMont Objection and, together with the Creditors Committee Objection, the Ad Hoc Committee Objection, the LNR Objection, the Appaloosa Objection, and the CWC/C-III Objection, the Objections and each objector, an Objector). Excluding the Creditors Committee Objection, all of the Objections were filed under seal in accordance with the Stipulated Order Authorizing the Filing of Pleadings with Respect to the Motion Under Seal [Docket No. 950].

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Introduction4 1. Through their Motion, the Debtors presented to the Court and their various

constituencies a proposed transaction with not only a meaningful degree of consensus, including the support of the Debtors two largest secured creditors, but also the potential to generate additional consensus.5 Since filing the Motion, the Debtors have worked to facilitate consensus with their remaining key constituencies, especially those with claims or interests in the Debtors seven hotel properties that are secured by individual mortgages (commonly referred to as the Seven Sisters). Among other things, the Debtors have coordinated site visits and facilitated negotiations between the parties to the Commitment Letter and the Ad Hoc Committee. 2. Global peace, however, has proven difficult to achieve. Nonetheless, the Debtors

have reached an agreement with Five Mile, Lehman, and Midland to modify the Five Mile/Lehman Bid as follows:6 The Debtors and Five Mile/Lehman and Midland have agreed to modify the Commitment Letter to remove the Seven Sisters from the Five Mile/Lehman Bid. The Five Mile/Lehman Bid will cover only the properties securing the

The facts and circumstances supporting this Reply are set forth in the Declaration of William Q. Derrough in Support of the Motion [Docket No. 821] (the Derrough Declaration), the Supplemental Declaration of William Q. Derrough in Support of the Motion [Docket No. 916] (the Supplemental Derrough Declaration), the Second Supplemental Declaration of William Q. Derrough in Support of the Motion, filed contemporaneously herewith (the Second Supplemental Derrough Declaration and, together with the Derrough Declaration and the Supplemental Derrough Declaration, the Derrough Declarations), the Declaration of Marc Beilinson in Support of the Motion, filed contemporaneously herewith (the Beilinson Declaration), and the Declaration of Lawrence J. Ruisi in Support of the Motion, filed contemporaneously herewith (the Ruisi Declaration). Capitalized terms used herein but not otherwise defined shall have the meanings ascribed to such terms in the Motion. See Motion at p. 4. These terms will be subject to final documentation in the form of a revised Commitment Letter and revised Bidding Procedures, which the parties have agreed to work on expeditiously in good faith. Five Mile/Lehman has informed the Debtors that they are willing to agree to the modifications to reduce the risk of delay in these Chapter 11 Cases and the administrative costs associated therewith and accordingly conditioned the modified Five Mile/Lehman Bid on the hearing on the Motion commencing no later than March 9, 2011. Similarly, the proposal to increase recoveries to unsecured creditors assumes the Creditors Committee has agreed by 11 a.m. ET on March 7, 2011. (The Creditors Committee has indicated they may have a response as early as tomorrow.)

5 6

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Fixed Rate Loan and the Floating Rate Loan (the Fixed Rate Pool and Floating Rate Pool, respectively). Five Mile/Lehman will not be the stalking horse bidder for the Seven Sisters. The Debtors will continue to market the Seven Sisters independent of the Fixed Rate Pool and Floating Rate Pool. Five Mile/Lehmans equity commitments and Midland's stapled financing will remain unchanged (provided that the Sources and Uses Table annexed to the Term Sheet will be adjusted to reflect the modified Five Mile/Lehman Bid other than the new cash requirement of $174.1 million). Subject to the Creditors Committee agreeing to support the modified Five Mile/Lehman Bid, unsecured creditors with claims against the Fixed Rate Pool Debtors and Floating Rate Pool Debtors will share in a distribution of up to $3.75 million, but not to exceed a recovery of 65% of the face amount of allowed general unsecured claims against such Debtors. Apollo will contribute $375,000, all of which will be included in the amounts distributed to unsecured creditors of the Fixed Rate Pool Debtors and Floating Rate Pool Debtors. Apollo will retain whatever rights it may have with respect to Debtors and property that are not covered by the modified Five Mile/Lehman Bid. To the extent modified bidding procedures agreed to by Five Mile/Lehman and Midland with respect to the modified Five Mile/Lehman Bid (the Modified Bid Procedures) are approved before the March 29, 2011 omnibus hearing, the Debtors will seek, and Five Mile/Lehman and Midland will support, an extension of exclusivity to no later than June 30, 2011. The Debtors reserve their rights to seek additional extensions and Five Mile/ Lehman and Midland reserve their rights to oppose such extensions or to move to terminate exclusivity. The Commitment Letter will be revised to include a termination event in favor of Five Mile, Lehman, and Midland in the event the Debtors do not file a plan encompassing the revised bid by April 8, 2011. Nothing in the modified Five Mile/Lehman Bid will impact the rights of any person or entity with respect to the $7.4 million in cash that is currently held in a bank account of Debtor Innkeepers USA Limited Partnership, which is not subject to the revised bid. No amount of the cash will be distributed under the modified Five Mile/Lehman Bid. Confirmation of the plan encompassing the modified Five Mile/Lehman Bid will not be tied to the confirmation of any plan related to the Seven Sisters Debtors and the company agrees to seek confirmation for such Debtors accordingly. 4
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 3.

These terms will be subject to final documentation in the form of a revised Commitment Letter, which shall be negotiated in good faith.

The Debtors respectfully submit that the modifications should render most, if not

all, of the Objections moot. For example, the Ad Hoc Committee has consistently stated that preferred shareholders in these Chapter 11 Cases have three sources of value: (a) the $7.4 million in cash located in a bank account at Innkeepers USA Limited Partnership; (b) the Seven Sisters; and (c) non-debtor KPA Raleigh LLCs 49% ownership interest in non-debtor Glenwood Raleigh LLC. See Ad Hoc Objection, 5. With the modifications to the Five Mile/Lehman

Bid, these sources of value remain untapped.7 With respect to the Ad Hoc Committees assertion that the preferred shareholders are entitled to any equity value in the 65 properties comprising the Fixed Rate Pool and Floating Rate Pool see Ad Hoc Objection, 6, there is simply no basis on which any party can conclude at this time that any such equity value exists. 4. To the extent any Objections remain in the wake of the modifications, the Debtors

respectfully submit those Objections should be overruled. At the core of each Objection is the desire to impose the Objectors own business judgment on the Debtors. At the core of each of these Objections is the Objectors desire to impose their own business judgment on the Debtors. Among other things, the Objectors argue that: They would have run a different marketing process for a stalking horse bidder. See, e.g., LNR Objection, 13-14. They believe an enterprise-level restructuring is inappropriate under the circumstances of these cases. See, e.g., Ad Hoc Committee Objection, 7-13. They would not have agreed to certain aspects of the Bidding Procedures, including, among other things, the Lehman Cash-Out, the 70% debt-tocapitalization ratio (the 70% Debt-to-Cap Ratio), the bid allocation methodology, and the bid increments. See, e.g., LNR Objection, 22-34.

The Debtors sought to have all parties associated with the Commitment Letter waive rights to the $7.4 million as an additional concession. The Debtors were unsuccessful but understand that such a waiver would not have resolved any additional objections to the Motion, including those of the Ad Hoc Committee.

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They would not have agreed to the Bid Protections, including the Break-Up Fee and Expense Reimbursement. See, e.g., Appaloosa Objection, 18-21. They would not have agreed to the Bidder D Expense Reimbursement. See, e.g., TriMont Objection, 68-70.

Given the complexities of these Chapter 11 Cases, it is to be expected that reasonable minds differ as to the optimal process for arriving at a value-maximizing transaction. The Debtors are attempting to restructure nine secured mortgage loans (many of which are further complicated by subsequent sale into the tumultuous CMBS market), two mezzanine loans, multiple series of preferred shares, and the claims of unsecured creditors each with their own (often divergent)

interests. But so long as the Debtors continue to manage their businesses and maintain the exclusive right to file a plan of reorganization, the responsibility of selecting a plan sponsor stalking horse falls squarely on the Debtors shoulders and the governing law is clear that the

stalking horse decision should be judged in terms of the reasonableness of the Debtors business judgment. In the seven weeks since filing the Motion, the Debtors have continued to evaluate the Five Mile/Lehman Bid through two distinct lensesthe Debtors continued marketing process and the extensive discovery conducted in connection with the hearing on the Motion and the Debtors continue to believe that, especially given the recent modifications, the Debtors pursuit of the Five Mile/Lehman Bid (as modified) and the other relief requested in the Motion is a sound exercise of business judgment. 5. In addition to challenging the Debtors business judgment, the Objectors argue the

Motion should be denied because the Commitment Letter amounts to a sub rosa plan meant to deprive parties of their rights to object to the confirmation of the Debtors plan. But the Commitment Letter (as it will be amended) is only a starting point, and the transactions contemplated therein will only be effectuated (if at all) after the Debtors have filed and obtained approval of a disclosure statement and after the Court has confirmed a plan of reorganization. At 6
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this stage, the Debtors are only seeking authority to enter into a binding agreement that locks in a baseline bid. All parties retain whatever rights they may have to object to any disclosure statement and plan filed in connection with the Five Mile/Lehman Bid (or other Successful Bid). 6. Similarly, many of the Objections, including those related to substantive

consolidation, the appropriateness of the releases contemplated by the Term Sheet, and the allocation of recoveries to creditors are premature. In any event, none of the Objectors have raised issues that would render a plan that encompasses the modified Five Mile/Lehman Bid patently unconfirmable. As such, the Court should not entertain plan-related objections until the appropriate time. 7. For these reasons and the reasons set forth in the Motion, the declarations filed in

support thereof, and below, the Debtors respectfully request that the Court authorize the Debtors to enter into the revised Five Mile/Lehman Bid and approve the other relief requested in the Motion. Supplemental Background Information8 8. Since filing the Motion more than seven weeks ago, the Debtors and their

advisors have actively continued their marketing process to subject the Five Mile/Lehman Bid to a thorough market test and attract overbids.9 Among other efforts: The Debtors financial advisors, Moelis & Company LLC (Moelis) compiled a list of more than 200 potential buyers.10 Moelis made contact with 200 of these parties and sent teasers to approximately 120 parties.11

The Debtors provided a thorough summary of the Five Mile/Lehman Bid and their efforts to obtain that bid in the Motion. See Second Supplemental Derrough Decl. at 5-11. Id. at 9. Id.

9 10 11

7
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The Debtors have executed over 30 non-disclosure agreements and have responded to detailed diligence requests from approximately 30 potential investors.12 (As of the date hereof, approximately 55 potential buyers have told Moelis that they are not interested in pursuing a transactions with the Debtors, either on an enterprise or nonenterprise basis.) Moelis has also reached out to nine potential financing sources, four of which have executed non-disclosure agreements.13 The Debtors circulated a more detailed and updated process letter (the FollowUp Process Letter) to potential bidders, which reiterated that, in addition to superior enterprise-based transactions, the Debtors are willing to consider all valuemaximizing restructuring proposals, including those for pools of assets or individual assets.14 To be clear, the Follow-Up Process letter was in no way a change of course, as certain of the Objectors suggest. The Debtors have always been willing to consider proposals of all kinds and the marketplace was well aware of that fact.15 In addition, the Debtors issued a press release on January 24, 2011, announcing the Five Mile/Lehman Bid and the related Motion.16 The press release was published by a number of media outlets, including The Wall Street Journal and Bloomberg, and described and further highlighted the Debtors continued pursuit and consideration of all value-maximizing proposals, including non-enterprise based proposals. From January 24-January 26, 2011, representatives of Moelis attended the American Lodging Investment Summit Conference in San Diego, California (the ALIS Conference) to promote or generate potential investor interest. At the ALIS Conference, Moelis representatives engaged with numerous potential buyers to discuss the investment opportunity in acquiring the Debtors enterprise or their

12 13 14

Id. Id. See Notice of Filing of Process Letter [Docket No. 856]; Supplemental Derrough Decl. at 8.

Redacted

16

See Supplemental Derrough Decl. at 9. In addition, the press release is attached as Exhibit C to the Supplemental Derrough Declaration.

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individual assets. In addition to seven scheduled meetings with prospective investors, Moelis conducted several ad hoc discussions with potentially interested parties during the ALIS Conference.17 9. Due in large part to these efforts, the Debtors have received six competing bid

proposals, including the following: On January 12, 2011 (just prior to the filing of the Motion), the Debtors received a proposal from the Ad Hoc Committee for the Seven Sisters that proposed reinstatement of the loans securing each of the seven hotels.18 Redacted

10.

The submission of these multiple bids, and their varying structures Redacted is clear evidence there was no

confusion in the market as to the Debtors desire to receive bids of all kinds (despite certain Objectors statements suggesting otherwise). 11. To date, the Debtors have produced almost 4,000 documents containing 35,000

pages to the Objectors. And Five Mile, Lehman, Midland, and the Objectors have produced nearly 10,000 documents containing almost 220,000 pages to the Debtors. During the two-week
17

Id. at 12.

Redacted

19 20 21

See Second Supplemental Derrough Decl. at 9. Id. at 23. Id. at 22.

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period beginning on February 14, 2011, 12 potential witnesses were deposed, including, among others, Larry Ruisi (a member of the Board and the Independent Committee), Schuyler Hewes (another Board member), Marc Beilinson (the Debtors chief restructuring officer), William Q. Derrough of Moelis, the Debtors financial advisor, the financial advisors for each of Five Mile, Lehman, Midland, and LNR, and an expert witness proffered by TriMont. 12. In the midst of this litigation preparation, Lehman (with the consent of Five Mile

and Midland) sent the Debtors two letters proposing possible modifications to the Five Mile/Lehman Bid. On February 15, 2011, Lehman sent the first letter to the Debtors (the First Modification Letter) proposing certain modifications. See Second Supplemental Derrough Decl. 17. On February 21, 2011, counsel for the Debtors responded to the First Modification Letter and made it clear they had no intention of eliminating any of the hard-fought concessions already obtained for the benefit of the constituents, as the Debtors were actively focused on building, not undermining, consensus.22 The Debtors reiterated their requests to Lehman and Five Mile to continue to engage the Ad Hoc Committee in constructive negotiations regarding the Seven Sisters.23 (The Debtors had previously made several similar requests to the Ad Hoc Committee.) 13. On February 22, 2011, Lehman sent a second letter to the Debtors (the

Second Modification Letter) revising their proposed modifications. See id. 20. The First and Second Modification Letters led to discussions with the Board and Independent Committee, including at a meeting of the Board on March 2, 2011, and further negotiations with Five Mile/Lehman. Ultimately, the Debtors, at the direction of the Board and Independent

22 23

Id. Id.

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Committee, agreed with Five Mile/Lehman and Midland on the modifications to the Five Mile/Lehman Bid described in paragraph 2 above. 14. Again, the Debtors believe these modifications resolve a number (or all) of the

issues raised in the Objections and improve the potential for a consensual plan process. Improved Recovery for Seven Sisters 15. Certain of the Objectors suggest the Debtors deliberately ignored any equity value

the Seven Sisters may have in negotiating the terms of the Five Mile/Lehman Bid and essentially consented to Five Mile/Lehman gaining control of the Seven Sisters without providing fair consideration through the Five Mile/Lehman Bid. As an initial matter, the modifications to the Commitment Letter and the Bidding Procedures render such Objections moot. Regardless, this allegation in the Objections is simply not true, as evidenced by the additional value delivered to the Seven Sisters from Five Miles initial November 24, 2010 proposal (the November Five Mile Proposal) to the Commitment Letter and Term Sheet. Specifically, the proposed

distributions to the Seven Sisters evolved as follows through the Debtors process: With respect to the Residence Inn Mission Valley, the distribution to LNR, as special servicer for the Residence Inn Mission Valley Mortgage Loan, increased from $39.1 million in the November Five Mile Proposal to $47.2 million in the Five Mile/Lehman Bid. This distributionin the form of a new noteamounts to full payment of principal. With respect to the Residence Inn Tysons Corner, the distribution to LNR, as special servicer for the Residence Inn Tysons Corner Mortgage Loan, increased from $20.8 million in the November Five Mile Proposal to $25.1 million in the Five Mile/Lehman Bid. This distributionin the form of a new noteamounts to full payment of principal. With respect to the Hilton Homewood Suites San Antonio, the distribution to LNR, as special servicer under the Hilton Homewood Suites San Antonio Mortgage Loan, increased from $20.0 million in the November Five Mile Proposal to $24.1 million in the Five Mile/Lehman Bid. This distributionin the form of a new noteamounts to full payment of principal.

11
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With respect to the Hilton Doubletree Washington D.C., the distribution to LNR, as special servicer for the Hilton Doubletree Washington D.C. Mortgage Loan, increased from $21.1 million in the November Five Mile Proposal to $25.5 million in the Five Mile/Lehman Bid. This distributionin the form of a new noteamounts to full payment of principal. With respect to the Anaheim Hilton, the distribution to CWCapital, as special servicer for the Anaheim Hilton Mortgage Loan, remained constant at $13.0 million in both the November Five Mile Proposal and the Five Mile/Lehman Bid. With respect to the Residence Inn Anaheim (Garden Grove) (Garden Grove), the distribution to LNR, as special servicer for the Residence Inn Anaheim (Garden Grove) Mortgage Loan, remained constant at $25.3 million in both the November Five Mile Proposal and the Five Mile/Lehman Bid. With respect to the Hilton Ontario, the distribution to C-III, as special servicer for the Hilton Ontario Mortgage Loan, remained constant at $8.0 million in both the November Five Mile Proposal to $8.0 million in the Five Mile/Lehman Bid. The Debtors also worked to achieve consensus with C-III regarding the treatment

16.

of the mortgage securing the Hilton Ontario under the Five Mile/Lehman Bid. Since early in the Debtors Chapter 11 Cases, the Debtors and their advisors have been in discussions with counsel to C-III, the special servicer for the Hilton Ontario, regarding a number of matters concerning the Hilton Ontario, including the fact that the Hilton Ontario was in receivership prior to the Petition Date. As part of those discussions, the Debtors have agreed that the property manager for the Hilton Ontario that was retained to manage the property as part of the receivership can remain the property manager throughout the Chapter 11 Cases (subject to the Debtors rights to terminate that relationship, if appropriate). The arrangement has also allowed the property manager to maintain control of the cash held as of the Petition Date as well as the cash generated by the Hilton Ontario during the Chapter 11 Cases. As C-III is aware, this arrangement has resulted in the property manager chosen by C-III preparing all of the necessary financial information and retaining all of the cash generated by the Hilton Ontario, less the distributions

12
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that have been made to operate the hotel; the cash generated by the Hilton Ontario remains in the control of the property manager and does not flow to the Debtors master concentration accounts. 17. The Commitment Letter already made clear that the Debtors would have the

ability to remove the Hilton Ontario property from the plan without resulting in any termination of the Commitment Letter. See, e.g., Commitment Letter, Termination Events (including carveouts to the Termination Events, where necessary, for the Chapter 11 case[s] of...KPA HI Ontario, LLC, which is the legal entity that owns the Hilton Ontario). To that end, the Debtors and their advisors have communicated to counsel to C-III that C-III can opt-out of the treatment described in the Commitment Letter and, instead, receive control and ownership of its collateral as part of the plan upon its effective date. To date, counsel to C-III has not provided a formal response to the Debtors proposal. Reply I. The Debtors Decision to Pursue the Five Mile/Lehman Bid Is Subject To the Business Judgment Standard. 18. Section 363(b)(1) provides, in relevant part, that [t]he trustee, after notice and a

hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate. 11 U.S.C. 363(b)(1). Section 363(b) does not specify a standard for determining when it is appropriate for a court to authorize the use, sale, or lease of property of the estate. However, the United States Court of Appeals for the Second Circuit has required that the authorization of such use, sale, or lease of property of the estate, not in the ordinary course of business, must be based upon the sound business judgment of the debtor. See Official Comm. of Unsecured Creditors of LTV Aerospace and Defense Co. v. LTV Corp. (In re Chateaugay Corp.), 973 F.2d 141, 143 (2d Cir. 1992); Comm. of Equity Sec. Holders v. Lionel Corp. (In re Lionel Corp.), 722 F.2d 1063, 1070 (2d Cir. 1983) (requiring some articulated business justification to approve 13
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the use, sale, or lease of property outside the ordinary course of business). In that regard, [w]here the debtor articulates a reasonable basis for its business decisions (as distinct from a decision made arbitrarily or capriciously), courts will generally not entertain objections to the debtors conduct. Comm. of Asbestos-Related Litigants and/or Creditors v. Johns-Manville Corp. (In re Johns-Manville Corp.), 60 B.R. 612, 616 (Bankr. S.D.N.Y. 1986). 19. When applying the business judgment rule, courts give great deference to the

substance of the directors decision and will not invalidate the decision, will not examine its reasonableness, and will not substitute its views for those of the board if the latters decision can be attributed to any rational business purpose. In re Global Crossing Ltd., 295 B.R. 726, 744 (Bankr. S.D.N.Y. 2003) (citing Paramount Commcns Inc. v. QVC Network Inc., 637 A.2d 34, 45 n.17 (Del. 1994). Of course, reasonable minds can (and often do) differ as to the appropriate course of action in chapter 11 cases. However, such disagreement is insufficient to support the denial of the Motion.24 Instead, the business judgment standard requires that the Objectors demonstrate the Debtors business judgments were not attributable to rational business purposes.25 The Objectors cannot and do not make such a showing. Rather, as demonstrated in the Motion, the Derrough Declarations, the Beilinson Declaration, the Ruisi Declaration, and the depositions of the Debtors management, advisors, and board members, the business judgments made by the Debtors in connection with the stalking horse process and the Motion have all been

24

See In re Weaver Oil Co., Inc., No. 08-40379, 2008 WL 8202063, at *3 (Bankr. N.D. Fla. 2008) (holding that a debtor need not have overwhelmingly persuasive evidence of its business judgment only that the evidence not be so unreasonable that it could not be based on sound business judgment because reasonable minds can differ). See In re Global Crossing, 295 B.R. at 744-45 (holding that the debtors board of directors faced with uncertainties no matter which option they chose satisfied the business judgment standard in making their decision by being mindful of their duties, employing the right standard, soliciting the input of their advisors, and making their decision based on a lengthy consideration of the relevant facts and options).

25

14
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made based on extensive (and appropriate) consideration of the relevant facts and options and for rational business purposes.26 II. The Decision To Pursue The Five Mile/Lehman Bid Is A Sound Exercise Of The Debtors Business Judgment. 20. The Debtors believe that the many benefits afforded by the modified Five

Mile/Lehman Bid make it an attractive option for the Debtors and their estates. Those benefits include the following: The Five Mile/Lehman Bid (as modified) has the highest implied enterprise value of all received bids and the highest value for both the Fixed Rate Loan and the Floating Rate Loan; The Five Mile/Lehman Bid provides baseline recoveries for all the constituents participating in the deal and an opportunity for additional recovery pursuant to the Overbid Allocation; The Five Mile/Lehman Bid has a lower execution risk in that it is supported by secured creditors holding more than $1 billion of the approximately $1.29 billion in prepetition secured debt and holding mortgages on 64 of the Debtors 71 hotels; Five Mile, Lehman, and Midland have already completed their due diligence; Five Mile and Lehman are well-qualified investors with extensive knowledge of the Debtors business given their position in the Debtors capital structure, including their status as debtor-in-possession lenders; The Five Mile/Lehman Bid offers the prospect of a reorganized enterprise with a deleveraged capital structure, significantly improved liquidity, and controlling equity holders with familiarity of the Debtors business; In connection with the Five Mile/Lehman Bid, Midlandthe Debtors largest secured creditorhas agreed to provide stapled financing in the amount of $622.5 million to bidders that maintain a debt-to-capitalization ratio of no more than 70%, and a willingness to increase the amount of financing provided certain leverage ratios are preserved; Midland has also agreed that, pursuant to the Midland/New Party Commitment, prior to the Auction, it will support alternative restructuring transactions that are on the same or better terms under certain circumstances;

26

See Derrough Dep. 177:15-20, 272:15-25, 273:2-22, Feb. 14, 2011; Beilinson Dep. 29:3-25, 30:2-31:4, Feb. 16, 2011; Ruisi Dep. at 40:21-41:19, 46:2-6, 49:19-50:5, 52:8-15, Feb. 15, 2011.

15
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As modified, the Five Mile/Lehman Bid allows the Debtors the flexibility to consider individual restructuring proposals with respect to each of the Seven Sisters; The Five Mile/Lehman Bid contains a broad fiduciary out provision that allows the Debtors the flexibility to explore and pursue alternative transactions at any time; and The Five Mile/Lehman Bid has been subjected to a thorough market test since it was filed, and will be subject to an additional 45-day marketing period, as well as Overbids at an Auction.

See Derrough Decl. at 43-52; Second Supplemental Derrough Decl. at 26-30. A. 21. The Best Evidence Of The Appropriateness Of The Debtors Decision To Pursue The Five Mile/Lehman Bid Is The Marketing Process. Perhaps the best evidence of the soundness of the Debtors business judgment in

entering into the Commitment Letter are the results of the Debtors robust marketing process, which began almost six months ago. See In re G.S. Distribution, Inc., Case No. 05-14576 (Bankr. S.D.N.Y. Oct. 20. 2005) (holding that a sale lacks reasonable business judgment when a debtor conducts a hasty business analysis and marketing process); see also In re Cloverleaf Enterprises, Inc. Case No. 09-20056 (Bankr. D. Md. Apr. 2, 2010) (holding that a sale lacks reasonable business judgment when a debtor conducts an exclusive marketing process); In re Gulf Coast Oil Corp., 404 B.R. at 424 (The principal justification for 363(b) sales is that aggressive marketing in an active marketing assures that the estate will receive maximum benefit.). 22. The Debtors have run a process carefully designed to secure the best stalking

horse bid possible and submit that proposal to a vigorous market test to ensure it is the best available. As described in detail in the Derrough Declarations, the Debtors first identified five potential stalking horse candidates. The Debtors, in consultation with Moelis, made a

determination it would be more efficient to start with a smaller group and then approach a larger

16
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group with a fully baked baseline bid that the Debtors believed reflected the market value of the Debtors various properties. 23. The Debtors selected the initial five stalking horse candidates based on their

(a) availability of funds; (b) breadth and depth of experience within the lodging sector; (c) familiarity with the bankruptcy process; and (d) ability to execute due diligence in a timely manner.27 By focusing on this group of stalking horse candidates initially, Moelis and the Debtors were able to concentrate their efforts on facilitating the stalking horse candidates development of the strongest restructuring proposals possible. These intensive efforts included, among other things, facilitating over 120 site visits by the stalking horse candidates and over 25 diligence calls with sales, general, and/or regional managers of the Debtors hotels.28 In

addition, Moelis held numerous conference calls with the stalking horse candidates to exchange views, to solicit feedback, and to facilitate the formulation of offers.29 This level of focus and dedication on behalf of the Debtors management, advisors, and employees would not have been possible if the universe of initial stalking horse candidates expanded in the way requested by the Objectors.30 In addition, as stated by Mr. Derrough at his deposition, by focusing on a smaller number of potential stalking horses, the Debtors were able to encourage participation by ensuring that, to serve as the stalking horse, each potential bidder would not have to outbid a daunting number of competitors.31

27 28 29 30

See Derrough Decl. at 8. Id. at 11. Id.

Redacted Redacted 17

31

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24.

As a result of this concentrated initial process conducted at the direction of the

Board and after consideration of all relevant factors, four of the five stalking horse candidates submitted stalking horse proposals, each of which contemplated an enterprise-level restructuring.32 Following the receipt of these proposals, the Debtors engaged in extensive negotiations with Bidder D and Five Mile/Lehman (the two stalking horse candidates that had submitted the most attractive of the initial proposals).33 Redacted

Five Mile/Lehman submitted its revised proposal, which increased the value originally proposed in Five Mile/Lehmans initial proposal by more than $40 million and garnered the support of Midland, the Debtors largest secured creditor.36 In total, after Five Mile submitted its initial proposal in August 2010, the Debtors successfully negotiated three subsequent proposals from Five Mile or Five Mile/Lehman and were able to generate an additional approximately $100 million in enterprise value. 25. Shortly before filing the Motion, the Debtors followed through with their long-

stated plan of expanding the scope of their marketing efforts to include over 200 potential investors. Through the Follow-Up Process Letter, the Debtors reiterated to the market that they would consider any and all proposals and provided an update regarding the adjournment of the

32 33 34 35 36

See Derrough Decl. at 13. Id. at 13, 17, 22, 24-26, 30, 32, and 38. Id. at 15-17, 20. See Ruisi Decl. at 38-44. Id. at 24-28, 30-32, 35, 38-39.

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hearing on the Motion and extended pre-hearing marketing period.37 Certain of the Objectors, including LNR, mischaracterize the Debtors Follow-Up Process Letter as a change in process or as a revised strategy. But the fact of the matter is that nothing changed. As counsel for the Debtors stated on the record almost four months ago at the November 12, 2010 hearing to consider the Debtors exclusive period to file a plan: [A]ny proposal or proposals that will maximize value will be considered. Moelis is the sole banker conducting the restructuring process but constituents are encouraged to forward to Moelis and the debtors any party that may be interested in bidding on the entire enterprise, the fixed rate pool, the floating rate pool, or other properties. See 11/10/10 Hrg Tr. at 19:7-13. The suggestion by certain Objectors that the Debtors have somehow changed course is simply not supported by the record. 26. The Debtors have now been in contact with nearly 200 of the identified potential

investors and have evaluated the six new proposals received (and described above). Redacted the messaging that Moelis has received from other potential bidders throughout the process, proves that the Five Mile/Lehman Bid is the best available stalking horse proposal for the Debtors at this point in time. 27. Moreover, these proposals (as well as Moeliss experience throughout the

process) demonstrates that no confusion exists in the marketplace as to the Debtors marketing process or willingness to accept bids for less than the entire enterprise. Further, as described in the Second Supplemental Derrough Declaration, discussions between the Debtors financial advisors and potential bidders shed further light on the success of the marketing process.38

37 38

See Supplemental Derrough Decl. at 8. See Second Supplemental Derrough Decl. at 12-13.

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28.

Notably, assuming the Court approves the Bidding Procedures, there will be

another approximately 45 days, during which the Debtors will continue to aggressively solicit overbids. In total, potential bidders will have had approximately 90 days notice from the date of the filing of the Motion to submit bids. Compared to most chapter 11 sale processes, this amount of time should be more than adequate to market the company fully.39 29. With an initial focused search for a stalking horse, a subsequent 45-day period

prior to the hearing, and yet another 45-day marketing period to come, the Debtors respectfully submit that the marketing process evidences the Debtors sound business judgment in selecting the Five Mile/Lehman Bid. 30. In addition, the Board and the Independent Committee have been intimately

involved throughout the stalking horse selection process. There were at least 18 meetings of the full Board or Independent Committee during the approximately three-month period between September 20, 2010 and December 23, 2010. This does not include the innumerable informal conversations between the Board and Independent Committee and the Debtors management and advisors. In connection with these meetings and conversations, the Board and Independent Committee were provided with extensive information and detail regarding the stalking horse

39

See In re Verified Identity Pass, Inc., Case No. 09-17086 (SMB) (Bankr. S.D.N.Y. Dec. 23, 2009) [Docket No. 33] (approving 35-day marketing period); In re AmericanWest Bancorporation, Case No. 10-6097 (PCW) (Bankr. E.D. Wash., Nov. 3, 2010) [Docket No. 64] (approving 26-day marketing period); In re Foamex Int'l Inc., Case No. 09-10560 (JKC) (Bankr. D. Del. Apr. 9, 2009) [Docket No. 305] (approving 35-day marketing period); In re Extended Stay, Case No. 09-13764 (JMP) (Bankr. S.D.N.Y. Apr. 23, 2010) [Docket No. 975] (approving 24-day marketing period); In re Finlay Enters., Inc., Case No. 09-14873 (JMP) (Bankr. S.D.N.Y. Aug. 20, 2009) [Docket No. 120] (approving 28-day marketing period). Because of the voluminous nature of the orders cited in this footnote and in paragraph 47 below and the deposition transcripts cited throughout this Reply, they are not attached to the Motion. Copies of these orders, transcripts, and any unreported decisions cited herein are available on request of the Debtors counsel.

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proposals received by the Debtors and performed their own analysis based on the information received.40 B. 31. It Is A Sound Exercise Of The Debtors Business Judgment To Pursue The Transaction Contemplated By The Five Mile/Lehman Bid. Throughout these Chapter 11 Cases, the Objectors have continuously taken issue

with the Debtors preference for an enterprise-level restructuring. The Debtors respectfully submit that the decision to pursue an enterprise-level restructuring is supported by an articulated business justification.41 The Debtors based their decision to focus initially on pursuing an enterprise-level restructuring proposal on a conclusion by the Board after considerable deliberation and input from the Debtors advisors and the Independent Committee.42 In deciding to focus on an enterprise-level reorganization, the Board considered, among other things: (a) the relatively lower cost of capital given the Debtors size and the diversity of their assets; (b) the ability to take advantage of tax and cost of capital benefits of the public REIT status of a reorganized enterprise; (c) economies of scale for corporate and management functions; and (d) operational and management benefits of brand and geographic diversity. An enterprise-level restructuring provides significant benefits due to the integration of the Debtors business across important business functions.43 For example, senior management sits at parent-level entities, where, among other things, it manages consolidated aspects of the Debtor-entities, plans shortand long-term financing, maintains franchiser affiliations that reflect longstanding relationships
40 41

See Ruisi Decl. at 51-52.

Redacted

42 43

See Derrough Decl. at 6. See Second Supplemental Derrough Decl. at 28-29.

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and the significant number and strong locations of many of the Debtors hotels, arranges property management contracts, and plans for and implements property improvement programs and other capital projects throughout the enterprise.44 32. Despite the Debtors continued belief that an enterprise-level transaction will

maximize value for the Debtors estates, they continue to encourage any and all transactions, regardless of structure and have expressed clearly to the marketplace, both in conversations with interested parties as well as in the Follow-Up Process Letter,45 that any and all bids are welcome. To that end, the Debtors negotiated the modifications to the Five Mile/Lehman Bid that are described above. Moreover, to the extent the Debtors receive a proposal that maximizes value but is not enterprise-based or is otherwise inconsistent with the Five Mile/Lehman Bid, the fiduciary out contained in the Bidding Procedures provides the Debtors with the flexibility to pursue such a proposal.46 C. 33. It Is An Appropriate Exercise Of The Debtors Business Judgment To Seek To Implement The Bidding Procedures. The Debtors also submit that seeking approval of the Bidding Procedures is

appropriate. As an initial matter, there is no basis for the Objectors assertions that the Bidding Procedures are designed to confuse the market or chill bidding. Redacted

44

See generally Amended Declaration of Dennis Craven, Chief Financial Officer of Innkeepers USA Trust, in Support of First Day Pleadings [Docket No. 33, as supplemented by Docket No. 516]. See Notice of Filing of Process Letter, Attachment at 3 (To be clear, the Company can and will continue to fully consider other value-maximizing restructuring proposals it may receive before or after the Hearing, including proposals for superior enterprise-based transactions, asset pools, or individual assets. As such, we encourage you to submit and we will consider enterprise and non-enterprise-level bids that maximize value, including proposals for pools and individual assets.) (emphasis in original). See Bidding Procedures at 12 (Upon the determination by the Debtors directors, trustees, or members, as applicable, and upon advice of counsel, no term or provision of the Term Sheet or the Commitment Letter shall prevent, amend, alter, or reduce the Debtors ability to exercise their fiduciary duties under applicable law.).

45

46

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34.

Moreover, the Bidding Procedures are appropriate and tailored to facilitate

competitive bids and were in no way created arbitrarily or capriciously. See In re JohnsManville Corp., 60 B.R. at 616. Indeed, as an initial matter, they were heavily negotiated. Given the circumstances of these Chapter 11 Cases, the Debtors insisted the Five Mile/Lehman Bid be subjected to a competitive process, and the Debtors fought hard to secure agreements from Lehman and Midland, in their capacity as creditors, to support overbids from entities other than Five Mile. Lehman and Midlands agreement to support overbids came at a price.

Specifically, Lehman and Midland would not agree to support any overbid that is not based on the capital structure contemplated by the Five Mile/Lehman Bid, does not incorporate the Lehman cash-treatment provision, or provides for more than a 70% debt-to-capitalization ratio. Given the benefits of the Five Mile/Lehman Bid, including its ability to foster consensus, the Debtors agreed to allow Lehman and Midland to condition their support for Overbids. And, at the same time, the Debtors fought hard for the flexibility to consider and pursue bids that do not satisfy these conditions, despite knowing they may not have the support of their two largest secured creditors if they were to pursue such a bid. 35. To be clear, the Debtors welcome bids from all potential investors whether

enterprise or not and whether they are based on the Five Mile/Lehman Bid or not. With value maximization in mind, the Debtors have publicly stated in open court, in the Follow-Up Process Letter, and in the Press Release that the Debtors are encouraging and considering all types of offers. To the extent the Debtors receive a non-qualifying bid that is less than enterprise-wide but provides greater value to the estates or otherwise greater value to their constituents than the Qualified Bids, the Debtors have expressly reserved the right to exercise their fiduciary duties and take necessary action, including exiting the Commitment Letter, re-designing the Auction

23
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procedures, or abandoning the Auction procedures entirely, all as appropriate under the circumstances to ensure value maximization. 36. The Objectors raise arguments with respect to certain other aspects of the Bidding

Procedures that the Debtors believe should be overruled as follows: Limits on Substantial Contribution Claims/Expense Reimbursement. Certain of the Objectors argue that the Bidding Procedures should not limit potential bidders rights to request expense reimbursement or assert substantial contribution administrative expense claims in these cases. The Debtors disagree. The Debtors have fostered an open and transparent plan process by openly marketing the company to approximately 200 parties. The Debtors cannot, however, allow this process to result in additional and uncapped administrative claims that must be borne by the Debtors estates. Midland Consultation Rights. LNR argues that Midlands consultation rights with respect to competing bids are inappropriate. The Debtors disagree. Midland is entitled to consultation rights as a result of its willingness to allow other bidders to use its stapled financing. The acceptance of a bid by the Debtors is subject to the Debtors sole discretion after consulting with Midland. Back-Up Bidder Provisions. TriMont argues that the back-up bidder provisions are onerous. The Debtors disagree. The back-up bidder provisions are consistent with similar terms in other bidding procedures approved by this Court and constitute a reasonable balancing of the Debtors desire to avoid the delay and expense of having to run a second Auction process. See, e.g., In re Mount Vernon Monetary Management Corp., Case No. 10-23053 (Bankr. S.D.N.Y. Dec. 6, 2010) [Docket No. 373]; In re RathGibson, Inc., Case No. 09-12452 (Bankr. D. Del. Mar. 26, 2010) [Docket No. 627]; In re Chemtura Corp., Case No. 09-11233 (Bankr. S.D.N.Y. Jan. 14, 2010) [Docket No. 1761]; In re Robbins Bros. Corp., Case No. 09-10708 (Bankr. D. Del. Mar. 27, 2009) [Docket No. 137]. Overbid Increments. TriMont argues that the overbid increment is too high. The Debtors disagree. The proposed overbid increment is appropriate considering the Debtors complex capital structure. Notably, the $15 million initial overbid incorporates payment of the Bid Protections so the Debtors estates are not harmed by any such overbid and the subsequent $5 million overbid increment is reasonable in relation to the implied enterprise value from the modified Five Mile/Lehman Bid. Deposit Requirements. Appaloosa argues that bidding will be chilled by allowing Five Mile/Lehman to cover the $20 million deposit requirement by pledging their recoveries on account of the debtor-in-possession financing but requiring other parties to provide a cash deposit. But for purposes of the deposit, Five Mile and Lehmans pledge of recoveries is only to the extent the debtor-in-possession financing facilities have been funded to the Debtors. In this manner, cash already has been provided to 24
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the Debtors and competing bidders should have to supply a similar amount of cash that the Debtors could recover from in the event of certain breaches by the competing bidder. D. 37. The Debtors Agreement To Pay The Bid Protections Is a Valid Exercise Of Their Business Judgment. The Debtors also submit that the Bid Protections are reasonable under the

circumstances. The Bid Protections, which consist of a $7 million Break-Up Fee and up to $3 million in Expense Reimbursement, are a relatively modest price to pay in exchange for a firm commitment to fund the Five Mile/Lehman Bid. This firm commitment is critical,

especially given the continued volatility present in todays real estate market. There is simply no guarantee that the value of the Debtors properties will increase from the values implied by the Five Mile/Lehman Bid. Five Mile/Lehman has agreed to assume such risk by allowing the Five Mile/Lehman Bid to be subjected to a continued marketing process and, thus, the Bid Protections are more than warranted, regardless of any preexisting involvement in the Debtors capital structure.47 38. As to be expected, these concessions did not come free of charge. The Debtors

and their advisors weighed the costs of the Bid Protections against the benefits of obtaining a $348.2 million commitment to either purchase equity or convert debt to equity and the more than $1 billion floor enterprise value of the Five Mile/Lehman Bid. The Debtors also considered whether the Five Mile/Lehman Bid could attract additional, higher, and better bidseffectively permitting the Break-up Fee to pay for itself (and, as described in the Second Supplemental

47

Redacted

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Derrough Declaration, the Debtors advisors have received strong indication that it can and will).48 In addition, as described below and in the Motion, the Debtors advisors believe the Bid Protections are comparable to similar fees approved in other restructuring transactions.49 Following this analysis, the Debtors and their advisors determined the Bid Protections were a reasonable means of securing value for their constituencies.50 Moreover, Midlandwhich

stands to bear the brunt of the Bid Protections cost in that they would be allocated approximately 70% of the Overbid proceeds otherwise earmarked to cover the Bid Protections consents to the payment of the Bid Protections. 39. It is well-settled in this District that break-up fees should be approved when

(a) the relationship between the parties is not tainted by self-dealing, (b) the fee does not hamper bidding, and (c) the amount of the fee is reasonable in relation to the size of the transaction. Official Comm. of Subordinated Bondholders v. Integrated Resources, Inc. (In re Integrated Resources, Inc.), 147 B.R. 650, 657 (S.D.N.Y. 1992), appeal dismissed, 3 F.4d 49 (2d Cir. 1993). In this case, each prong of the Integrated Resources test is met. First, no self-dealing has occurred between the Debtors and Five Mile, Lehman, or Midland. Second, the Debtors do not believe that the Break-Up Fee will hamper bidding. Third, the Break-up Fee and Expense Reimbursement together represent approximately 2.9% of Five Mile/Lehmans $348.2 million

48 49

See Second Supplemental Derrough Decl. at 13.

Redacted

50

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commitment to either purchase equity or convert debt to equity.51 Break-up fees that equate to approximately 3% of the overall equity/debt-conversion commitment are widely regarded as reasonable. The Debtors believe in their reasonable business judgment that the amount of the Break-Up Fee is appropriate, customary, and, in fact, de minimis in comparison to the immense benefit the Debtors receive by having a stalking horse bid in place. 40. Integrated Resources also acknowledges the downside risk that accompanies

allowing parties to challenge agreements to pay break-up fees outside appropriate consideration of the debtors commercial judgment. Ifa prospective bidder knows that courts prevent the debtor from paying a break-up fee, then it is more likely to abandon its bid, or, even worse, never to explore a bid in the first place. Id. at 663. Thus, [bidder] protections are granted when a bidder provides a floor for bidding by expending resources to conduct due diligence and allowing its bid to be shopped around for a higher offer. In re Metaldyne Corp., 409 B.R. 661, 670 (Bankr. S.D.N.Y. 2009). This standard is satisfied here. 41. The terms of the Five Mile/Lehman Bidincluding the Break-Up Fee and

Expense Reimbursementare the result of hard-fought negotiation by the Debtors and their advisors, and were subject to rigorous scrutiny by the Debtors management, advisors, Board, and Independent Committee for many weeks.52 Five Mile/Lehman originally requested

substantial bid protections and the Debtors were successful in reducing them substantially. But Five Mile/Lehman made clear that they would go no lower, and that the Bid Protections were a

51 52

See Derrough Decl. at 50.

Redacted

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necessary inducement to their agreement to act as stalking horse bidder.53 And the Debtors were understandably and justifiably unwilling to risk losing the substantial benefit of locking in a substantial baseline value for the Debtors assets. The Bid Protections lock in a committed stalking horse bid while permitting the Debtors to continue seeking higher and betters bids through the Auction process. [I]t is plausible to believe that an initial bid, ordinarily or perhaps even always, will provide a benefit to an estate because it will establish a floor price for the assets to be sold. In re Reliant Energy Channelview LP, 594 F.3d 200, 207 (3d. Cir. 2010). 42. As to the Objectors assertions that it is somehow improper to allow Lehman to

receive a portion of the Break-Up Fee and Expense Reimbursement, the allocation of the Bid Protections between Five Mile and Lehman is subject to an agreement between those two parties. Even if Lehman, as a major creditor, is already involved in the Debtors Chapter 11 Cases, the Debtors believe payment of a break-up fee to Lehman is warranted because Lehman has no affirmative obligation to submit a stalking horse bid or agree to support competing bids.54 43. In sum, the Debtors believe that Five Mile and Lehman should be entitled to the

Break-Up Fee in their capacity as bona fide bidders who have made the best offer for the Debtors assets, established a floor price for the assets, and continue to encourage competitive bidding by submitting their bid to the overbid process.

53

Redacted

54

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E. 44.

The Agreement To Pay The Midland Settlement Payment Is A Valid Exercise Of Their Business Judgment. The Commitment Letter contemplates inclusion of the Midland Release in a plan

of reorganization, pursuant to which Midland will release its claims against Apollo, including those related to the Apollo Guaranty.55 Pursuant to the Commitment Letter, Five Mile/Lehman will direct the reorganized Debtors to make a payment to Midland of $3 million (the Midland Settlement Payment) as settlement of Midlands claims against Apollo with respect to the Apollo Guaranty. 45. The Midland Settlement Payment benefits the Debtors estates in several ways.

First, while Midland alone holds the Apollo Guaranty, litigation over liability, if any, under that instrument already has been extensive and is likely to involve the Debtors and potentially other parties in interest in expensive and time-consuming litigation. Avoiding involvement in such matters is a tangible benefit to these estates. Second, the Midland Settlement Payment is part of the consideration to be received by Midland as part of its support for the Five Mile/Lehman bid. See Orion Pictures Corp. v. Showtime Networks, Inc. (In re Orion Pictures Corp.), 4 F.3d 1095, 109899 (2d Cir. 1993) (holding that a Courts analysis of business judgment should focus on whether the action would benefit the estate).56

55

As the Court is aware, in connection with the original Five Mile/Lehman enterprise-level bid, Apollo had previously agreed to waive certain recoveries in furtherance of a global settlement.. Given that the modified Five Mile/Lehman Bid no longer covers all of the Debtors, all parties, including Apollo and Series C Preferred Shareholders, retain their rights with respect claims and interests against the Debtors not subject to the modified bid.

56

Redacted 29

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F.

The Debtors Agreement To Reimburse Bidder Ds Expenses (In Connection With Bidder Ds Initial Proposal) Is A Valid Exercise Of Their Business Judgment. The Debtors respectfully submit that the Bidder D Expense Reimbursement is

46.

justified under the circumstances and is being made for a rational business purpose. See In re Global Crossing, 295 B.R. at 744. As described in the Derrough Declaration, the Debtors spent considerable time negotiating definitive stalking horse documentation with Bidder D prior to receiving the Five Mile/Lehman Bid.57 Bidder Ds participation in the stalking horse process generated significant value for the Debtors estates by motivating Five Mile/Lehman to increase the value of their bid by more than $40 million.58 Bidder D should be appropriately reimbursed for the cost of its value-generating participation in the stalking horse selection process in November and December 2010.59 Further, the Debtors remain hopeful that Bidder D will submit an Overbid at the Auction and believe that reimbursing the fees Bidder D incurred in pursuing its stalking horse bid increases that likelihood.60 Given the relatively modest amount of the

requested expense reimbursement for Bidder D, the Debtors respectfully submit it is a valid exercise of business judgment. 47. Expense reimbursements for prospective lenders and plan sponsors like Bidder D

are commonly approved in this and other districts as a reasonable exercise of a debtors business judgment. See, e.g., In re Tronox Inc., No. 09-10156 (ALG) (Bankr. S.D.N.Y. Nov. 10, 2009) [Docket No. 870] (authorizing debtors to reimburse due diligence expenses incurred by
57 58 59

See Derrough Decl. at 54. Id.

Redacted

60

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prospective lenders in connection with financing); In re Movie Gallery, Inc., No. 07-33849 (Bankr. E.D. Va. Dec. 4, 2007) [Docket No.1097] (authorizing debtors to pay fees and expenses of backstop party for proposed rights offering); In re Sea Containers Ltd., No. 06-11156 (Bankr. D. Del. Nov. 20, 2007) [Docket No. 1206] (authorizing debtors to pay diligence-related fees and expenses of prospective exit lenders up to $1.5 million); In re Tower Auto., Inc., No. 05-10578 (ALG) (Bankr. S.D.N.Y. Dec. 21, 2006) [Docket No. 1883] (authorizing debtors to pay $1.0 million in diligence fees to prospective new-money equity investors and to potential replacement DIP lenders); In re Tower Auto., Inc., No. 05-10578 (Bankr. S.D.N.Y. Oct. 25, 2006) (ALG) [Docket No. 1814] (authorizing debtors to pay up to $1.0 million in diligence fees to prospective new-money equity investors); In re Meridian Auto. Sys.-Composite Operations, Inc., No. 05-11168 (Bankr. D. Del. June 13, 2006) [Docket No. 1155] (authorizing debtors to pay diligence related fees and expenses of prospective exit lenders up to $600,000); In re Pliant Corp., No. 06-10001 (Bankr. D. Del. May 5, 2006) [Docket No. 666] (authorizing debtors to pay up to $500,000 in work fees and to provide a $700,000 deposit for expenses to prospective exit lenders). G. 48. The Debtors Entry Into The New Party/Midland Commitment Is A Valid Exercise Of Their Business Judgment. The Debtors continue to believe it is a valid exercise of their business judgment to

enter into and seek approval of an agreement that locks Midland in to supporting, as well as providing the Midland Financing to, replacement stalking horse bidders under certain circumstances. The New Party/Midland Commitment locks in Midlands agreement, in certain specified circumstances, to support alternative restructuring transactions that are on the same or better terms as contained in the Five Mile-Midland Agreement.61 Specifically, to the extent the
61

The Debtors are not aware of any Objection to the Debtors entry into the Midland/New Party Commitment.

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Five Mile/Lehman Bid is terminated because of a breach prior to the Auction, if the terms and conditions in the New Party/Midland Commitment are met, Midland will support and provide the Midland Financing to a replacement stalking horse bidder selected by the Debtors. The Debtors believe the New Party/Midland Commitment will make the prospect of overbidding a more attractive option to potential bidders and, in turn, maximize value for the benefit of the Debtors estates. As such, the Debtors respectfully submit entry into the New Party/Midland Commitment is an appropriate use of the Debtors business judgment. See In re Global Crossing 295 B.R. 726, 744 n. 58 ([T]he Court does not believe that it is appropriate for a bankruptcy court to substitute its own business judgment for that of the [d]ebtors and their advisors, so long as they have satisfied the requirements articulated in the caselaw.). H. 49. Modifying The Cash Collateral Order Is a Valid Exercise Of The Debtors Business Judgment. The Debtors proposed amendment to the Final Cash Collateral Order to increase

the Expense Reserve from $4.5 million to $18.5 million to provide the Debtors with the flexibility to satisfy certain closing and emergence costs, including potential success fees, is appropriate.62 See, e.g., In re First NLC Fin. Servs., LLC, No. 08-10632 [D.E. #232] (Bankr. S.D. Fla. Feb. 28, 2008) ([t]he use of Cash Collateral and adequate protection arrangements authorized hereunder have been negotiated in good faith and at arms length, and the terms of such Cash Collateral use and adequate protection arrangements are fair and reasonable under the circumstances [and] reflect the Debtors exercise of prudent business judgment). The Debtors carefully negotiated the increase in the Expense Reserve with Five Mile, Lehman, and Midland, and the Debtors anticipate that the Expense Reserve will be funded largely with excess cash
62

Redacted

32
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generated by the properties securing the Fixed Rate Loan (for which Midland is the special servicer) and the Floating Rate Mortgage Loan (on account of which Lehman holds its claims). While the Objectors allege the increase is an improper surcharge of the lenders collateral, the Court will recall that this issue was litigated and decided in the context of the Debtors use of Cash Collateral.63 Such use does not constitute an improper surcharge of any lenders collateral. All of the Debtors constituencies, including the Objectors, stand to benefit from the increase in the Expense Reserve, which will be used to fund the closing of a transaction that maximizes value to the benefit of all constituencies. See Gen. Elec. Credit Corp. v. Levin & Weintraub (In re Flagstaff Foodservice Corp.), 739 F.2d 73 (2d Cir. 1984) (holding that a secured creditors collateral c be surcharged, as long as there is a direct benefit to the secured creditor). III. The Objectors Allegations That The Debtors Or The Board Have Breached Fiduciary Duties In Pursuing The Motion Are Without Merit. 50. In making the decision to proceed with the Motion, the Debtors are attempting to

maximize value for the benefit of the constituencies of each of the Debtors. The Board generally had three restructuring courses of action to consider: (a) pursue an enterprise-level restructuring; (b) break up and sell their assets on a piecemeal basis; or (c) liquidate their assets. For the reasons set forth above, the Debtors chose to focus their initial efforts on obtaining a proposal for an enterprise-level restructuring based on the reasonable belief that doing so would maximize value of the estates as a whole (while making clear to the marketplace that any and all bids are welcomed).
63

See Final Order Authorizing the Debtors to (i) Use the Adequate Protection Parties Cash Collateral and (ii) Provide Adequate Protection to the Adequate Protection Parties Pursuant to 11 U.S.C. 361, 362, and 363, entered on September 2, 2010 [Docket No. 402, as amended by Docket No. 539] (the Final Cash Collateral Order); see also, e.g., Objection of C-III Asset Management LLC [Docket No. 254]; Objection of Wells Fargo Bank, N.A. [Docket No. 255]; Objection of CWCapital Asset Management LLC [Docket No. 257]; Objection of Appaloosa Investment L.P. I [Docket No. 279]; Debtors Omnibus Reply in Support of the Debtors Cash Collateral Motion, Cash Management Motion, Lehman DIP Motion, and Five Mile DIP Motion, and in Response to Objections Thereto [Docket No. 337].

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51.

Certain of the Objectors, including the Ad Hoc Committee, alleged that the Board

and the Debtors officers breached their fiduciary duties in pursuing the Five Mile/Lehman Bid. The Debtors dispute those allegations. While it is, of course, true that the Board owes duties to its preferred shareholders, the Board cannot ignore the impact of its decisions on the Debtors enterprise and their other constituencies.64 Nevertheless, recognizing the dissatisfaction of the

Ad Hoc Committee with the Five Mile/Lehman Bid, and in an attempt to foster consensus, the Debtors worked hard after filing the Motion to facilitate a global deal that the Ad Hoc Committee would find agreeable. Specifically, the Debtors arranged site visits for the financial advisors to the Ad Hoc Committee between February 8 and 17, 2011, facilitated discussions in early February 2011 between members of the Ad Hoc Committee and the principals of Five Mile and Lehman regarding a potential resolution, and facilitated discussions between the members of the Ad Hoc Committee and other potential bidders to explore the possibility of working together to submit a bid. 52. Despite these efforts, the Debtors were unable to reach consensus with the Ad

Hoc Committee and certain of the other Objectors. In any event, the Debtors submit that the modifications to the Five Mile/Lehman Bid should appease the Objectors for the reasons stated above. IV. The Commitment Letter Does Not Constitute A Sub Rosa Plan. 53. Certain Objectors argue the Commitment Letter is an impermissible sub rosa

plan. It is not. Sub rosa plans are transactions that dictate the terms of any future plan of

64

See e.g., In re Adelphia Commns Corp., 327 B.R. 143, 154-55 (Bankr. S.D.N.Y. 2005) (approving a four-way joint settlement on account of, among other things, appropriate consideration of the good of the enterprise as a whole and finding that [a]ny suggestion that the Boards actions were a breach of fiduciary duty would be frivolous); see also In re Gen. Growth Props., Inc., 409 B.R. 43, 63 (Bankr. S.D.N.Y. 2009) (holding that a judgment on an issue as sensitive and fact-specific as whether to file a Chapter 11 petition can be based in good faith on consideration of the interests of the group as well as the interests of the individual debtor).

34
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reorganization, constrain parties in exercising their confirmation rights, and/or seek to allocate the distribution of proceeds from a transaction to creditors without otherwise requiring the satisfaction of the disclosure and confirmation standards of chapter 11 of the Bankruptcy Code. See, e.g., In re General Motors Corp., 407 B.R. 463, 495 (Bankr. S.D.N.Y. 2009); see also Motorola, Inc. v. Official Comm. of Unsecured Creditors, (In re Iridium Operating LLC), 478 F.3d 452, 461 (2d Cir. 2007) ([T]he reason sub rosa plans are prohibited is based on a fear that a debtor-in-possession will enter into transactions that will, in effect, short circuit the requirements of [C]hapter 11 for confirmation of a reorganization plan.). The Commitment Letter embodies none of those traits. 54. The Commitment Letter is only a starting pointa bid selected in the Debtors

reasonable business judgment as the stalking horse to be subjected to an additional 45-day marketing period and a hopefully spirited Auction intended to maximize value. The Debtors have deliberately structured their process to encourage the emergence of an Overbid that renders the bid contained in the Commitment Letter obsolete. Regardless, in no way are the Debtors seeking to constrain any party from exercising their confirmation rights or to otherwise circumvent the Chapter 11 process. The Debtors will file and seek approval of a disclosure statement and solicit votes on a plan of reorganization in accordance with Bankruptcy Code requirements. 55. This Court recently overruled an objection by a junior lender in In re Boston

Generating that argued the sale transaction in those cases was a sub rosa plan. 440 B.R. 302, 341 (Bankr. S.D.N.Y. 2010) (Here, the proposed sale of the Debtors assets is not a sub rosa plan of reorganization. The Debtors assets are simply being sold; the First Lien Lenders will receive most of the proceeds in accordance with their lien priority; and remaining consideration

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will be subsequently distributed under a plan. As the Court has held, the proposed Sale Transaction has a proper business justification and is not calculated to evade the plan confirmation process.). To suggest that Boston Generating stands for the proposition that a transaction is an improper sub rosa plan when it goes beyond merely directing distribution of sale proceeds in accordance with their lien priority; and remaining consideration [to] be subsequently distributed under a plan.as the LNR Objection doesis, in the Debtors respectful opinion, an overstatement. 56. Consistent with the Boston Generating holding, the Commitment Letter has a

proper business justificationto secure a baseline bid for a restructuring that will result in a significant de-leveraging of the Debtorsand is not calculated to evade the plan confirmation process. In fact, all plan protections remain intact. At the appropriate times, parties in interest will have the opportunity to raise whatever arguments they may have to the adequacy of any disclosure statement and/or the confirmability of any plan. V. Plan Objections Are Premature At This Time. 57. The Objections raise a litany of arguments that need not be addressed at this

juncture of the Debtors restructuring process and are more appropriately considered in connection with a hearing on the adequacy of a disclosure statement or confirmation of a reorganization plan. The Debtors are keenly aware of the likelihood of a dispute over the valuation of certain of their assets. The Objectors should not be able to short circuit the Debtors restructuring process with unsupported (and self-serving) assertions of insufficient or misallocated value. The remainder of the Debtors marketing and auction process will dictate the true value of the Debtors assets, and the Debtors will conduct a comprehensive valuation analysis in advance of confirmation. The confirmation hearing will provide a suitable forum for the Objectors to defend their independent valuations and convince the Court that a treatment 36
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contemplated by an approved disclosure statement and filed plan is insufficient. See, e.g., In re Keisler, No. 08-43321, 2009 WL 1851413, *5 (Bankr. E.D. Tenn. 2009) (questions concerning the valuation of the Debtors assets and amount of a lenders secured claim are strictly confirmation issues). But now is not the time. 58. Likewise, the issues raised regarding substantive consolidation and allocation of

overbids are unquestionably premature. These issues will only come to bear when (and if) the Debtors seek approval of a filed disclosure statement and plan. Indeed, the disclosure statement and plan that the Debtors currently are finalizing with Five Mile, Lehman, and Midland does not contemplate substantive consolidation. The assertion by the Objectors that the Motion should be denied because the Objectors think it is premised on substantive consolidation is premature and a red herring and, therefore, should be ignored. 59. Finally, the Motion does not seek approval of the releases described in the

Commitment Letter. The Commitment Letter merely provides an outline for the structure of the releases to be incorporated into a plan that embodies the terms of the Five Mile/Lehman Bid. The Debtors will provide the Court and other parties in interest with ample opportunity to review any filed plan of reorganization and the releases included therein. As noted by this Court and others, the consideration of plan releases generally is among issues that can and should be raised at confirmation. Hrg Tr. 164:6-9, In re NR Liquidation III Co. (f/k/a Neff Corp.), Case No. 10-12610 (Bankr. S.D.N.Y. July 12, 2010); see also, Hrg Tr. 126:10-19, In re Chemtura Corp., Case No. 09-11233 (Bankr. S.D.N.Y. July 21, 2010) (courts have developed a pretty traditional way of handling objections to the breadth of releases, which is for objectors to reserve the right to address at confirmation).

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Conclusion For the foregoing reasons and those stated in the Motion, the Derrough Declarations, the Beilinson Declaration, and the Ruisi Declaration, the Debtors respectfully request that this Court overrule the Objections and grant the relief requested in the Motion. New York, New York Dated: March 5, 2011 /s/ Brian S. Lennon James H.M. Sprayregen, P.C. Paul M. Basta Stephen E. Hessler Brian S. Lennon KIRKLAND & ELLIS LLP 601 Lexington Avenue New York, New York 10022-4611 Telephone: (212) 446-4800 Facsimile: (212) 446-4900 and Anup Sathy, P.C. Marc J. Carmel (admitted pro hac vice) KIRKLAND & ELLIS LLP 300 North LaSalle Street Chicago, Illinois 60654-3406 Telephone: (312) 862-2000 Facsimile: (312) 862-2200 Counsel to the Debtors and Debtors in Possession

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