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HIVE EXCLUSIVE: Update Hits Potential Roadblocks to Emerging From Chapter 11

21 Sep, 2001 By: Joan Villa

Objections to Video Update's proposed reorganization may derail the chain's hopes of a fast-track emergence from Chapter 11 next month.

A Video Update franchisee wants more details on how Movie Gallery, which has no franchises, will run Update's franchises. The franchisee is also concerned that some Gallery stores would violate a no-competition clause in the original Update franchise agreements.

Also, the other senior creditor in the Update bankruptcy says it isn't receiving enough compensation for its investment.

St. Paul, Minn.-based Video Update had hoped to emerge from bankruptcy in late October as a wholly owned subsidiary of the nation's No. 3 rental chain, Movie Gallery, based in Dothan, Ala., according to a disclosure statement filed July 31.

A Delaware's U.S. Bankruptcy Court hearing to address objections scheduled for Sept. 11 was pushed back to Sept. 24 following the attack on the World Trade Center and the Pentagon.

“We don't see any more delays” beyond the two-week setback, insists Michael Lastowski, of the Wilmington, Dela., firm Duane, Morris & Heckscher, one of Video Update's attorneys.

However, two parties that have objected to the reorganization plan have asked for changes that could extend the reorganization process.

One is a Video Update franchisee with 14 stores in Virginia and nine in New Hampshire. That party's court filing says Movie Gallery has failed to explain how it will absorb and run a franchise operation following reorganization. Movie Gallery intends to take over Video Update's remaining 300 corporate stores and some 38 franchisees after purchasing 92% of Video Update's outstanding $125 million debt in May, according to its reorganization filing. However, Movie Gallery doesn't currently operate franchises.

“We don't think people can weigh in on the plan yet because we don't think there's enough information provided to the public,” explains attorney Marshall Martin of Willcox & Savage, for retailer William J. Busching, who has two separate franchise agreements.

Further, Martin believes that Busching's exclusive territories will be compromised because his stores will now have to compete against nearby Movie Gallery locations. As the franchisees' new parent company, Gallery will now have access to “valuable and proprietary information concerning the franchisees' operations, strategies and sales levels,” the objection states.

A second objection filed Aug. 29 from senior secured creditor and bank group Sterling (Cayman) Ltd., which owns the other 8% of the $125 million Video Update debt, disputes the plan's proposed payment of $736,000 plus interest to Sterling to settle the claim.

That sum, the objection asserts, “is simply based upon Movie Gallery's purchase of 92% of the bank group debt for $9.2 million on May 2” and is “irrelevant” to bankruptcy law precedent that the company's value be set when the company emerges from Chapter 11.

Sterling's filing says Video Update has been valued much higher. In its disclosure statement, Video Update forecasted its total asset value would be $76 million as of the “confirmation date” for the reorganization plan, according to the filing.

In addition, Sterling asserts that Video Update has failed to explain “why it is equitable for Movie Gallery to receive a 100% ownership interest” in the newly reorganized company, when both Gallery and Sterling have been classified as members of the same “class” and require equal treatment under bankruptcy law. In return for 100% ownership of the newly reorganized company, Movie Gallery would give up its $8.46 million settlement.

Video Update executives did not return calls seeking comment. However, the chain's 40-page response filed with the court Sept. 6 calls the objections “unfounded.”

“Sterling Cayman's objection is a highly transparent attempt to exact an unjustified premium on its undersecured claim,” the response states. “Moreover, if the Debtor's assets had a value of $76 million as claimed by Sterling Cayman, then it is truly shocking that 18 out of 19 former members of the bank group sold their rights as secured and unsecured creditors of the debtors for merely $8.5 million at the recommendation of their professional advisors.”

With regard to the franchisees, Update reiterated its “intention to assume all or substantially all of the franchise agreements,” but did not provide details of how a franchise division would operate. The filing urges the court to overrule the objections since franchisees “are not holders of claims that will be entitled to vote to accept or reject the plan.”

At the Sept. 24 hearing, Judge Judith Wizmur will either rule on the objections or require further information or a revision of the proposed plan, potentially pushing back confirmation into November or December, Martin says.

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