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Case 13-10125-KJC

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Page 1 of 13 Docket #0747 Date Filed: 4/3/2013

IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE Chapter 11 In re: SCHOOL SPECIALTY, INC., et al., Debtors. Case No. 13-10125 (KJC) (Jointly Administered)

THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS OF SCHOOL SPECIALTY, INC. AND ITS AFFILIATED DEBTORS, Plaintiff, v. BAYSIDE FINANCE, LLC, H.I.G. BAYSIDE CAPITAL, and H.I.G. BAYSIDE DEBT & LBO FUND II, L.P., Defendants. Adv. Pro. No. 13- _____ (KJC)

COMPLAINT The Official Committee of Unsecured Creditors (the Committee) of School Specialty, Inc. (School Specialty) and its affiliated debtors and debtors-in-possession in the abovecaptioned Chapter 11 cases (collectively, the Debtors), by and through its undersigned counsel, as and for its Complaint, alleges on actual knowledge as to its own status and actions and on information and belief as to all other matters as follows: NATURE OF THE ACTION 1. This action is to avoid and recover, pursuant to 11 U.S.C. 544, 548 and 550, a

fraudulent transfer in the amount of $1,193,717 (the Fraudulent Transfer) made by School

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Specialty to Bayside Finance, LLC, H.I.G. Bayside Capital and/or H.I.G. Bayside Debt & LBO Fund II, L.P. (collectively, Bayside) on or about October 25, 2012, representing an Early Payment Fee which Bayside alleges was due under the Term Loan Credit Agreement (defined below) in connection with a $3 million prepayment of the Term Loan (defined below). 2. The provision of the Term Loan Credit Agreement pursuant to which the

Fraudulent Transfer was made the Make Whole Provision (defined below) constitutes an unenforceable provision under New York law. Because the Fraudulent Transfer was not a payment on account of a valid and legally enforceable antecedent debt, School Specialty did not receive reasonably equivalent value or fair consideration in exchange for it. In addition, School Specialty: (i) was insolvent at the time of the Fraudulent Transfer, or became insolvent as a result of it; (ii) was engaged in a business or a transaction, or was about to engage in a business or a transaction, for which its remaining assets were unreasonably small in relation to the business or transaction; and/or (iii) intended to incur, or believed or reasonably should have believed it would incur, debts beyond its ability to pay as they became due. Thus, the Fraudulent Transfer may be avoided under 11 U.S.C. 544 and 548 (and applicable state fraudulent transfer law) and may be recovered from Bayside under 11 U.S.C. 550. 3. In addition, because the Fraudulent Transfer was made pursuant to an

unenforceable provision of the Term Loan Credit Agreement, (i) Bayside would be unjustly enriched if permitted to retain the payment and/or (ii) a failure of consideration occurred with respect to the Term Loan Credit Agreement. Accordingly, Bayside must disgorge the amount of the Fraudulent Transfer to the Debtors.

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PARTIES 4. Plaintiff is the Official Committee of Unsecured Creditors in the above-captioned

Chapter 11 cases. The Committee has standing to bring this adversary proceeding pursuant to the following Orders of this Court: Final Order Authorizing (I) Replacement Postpetition Secured Financing Pursuant to 11 U.S.C. 105(a), 362 363(b), 364(c)(1), 364(c)(3), 364(d)(1), 365(e) and 507, (II) Grant of Certain Equal and Ratable Liens and Superpriority Claims to the Ad Hoc DIP Lenders, and (III) Repayment of Existing Postpetition Financing and Prepetition Secured Financing Pursuant to 11 U.S.C. 363 dated as of March 14, 2013 (the Final Replacement DIP Order), 19(c); and Final Order (I) Authorizing Debtors to (A) Obtain Postpetition Financing Pursuant to 11 U.S.C. 105, 361, 362, 364(c)(1), 364(c)(3), 364(d)(1), 364(e) and 507 and (B) Utilize Cash Collateral Pursuant to 11 U.S.C. 363, (C) Grant Priming Liens and Superpriority Claims to the DIP Lenders, (D) Provide Adequate Protection to Prepetition Secured Parties Pursuant to 11 U.S.C. 361, 362, 363 and 364, and (E) Use Cash Collateral and Proceeds of the ABL DIP Facility to Repay Obligations Arising Under the Prepetition ABL Credit Agreement and (II) Granting Related Relief dated as of February 26, 2013 (together with the Final Replacement DIP Order, the Final DIP Orders), 23(c). 5. Defendant Bayside Finance, LLC, is a Delaware limited liability company with a

place of business, inter alia, at 600 Fifth Avenue, 24th Floor, New York, NY 10020. 6. Defendant H.I.G. Bayside Capital is a special situation investment firm and an

affiliate of private equity firm H.I.G. Capital, LLC, with a place of business, inter alia, at 1450 Brickell Ave., Miami, FL 33131. 7. Defendant H.I.G. Bayside Debt & LBO Fund II, L.P., is a Delaware limited

partnership with a place of business, inter alia, at 1450 Brickell Ave., Miami, FL 33131.

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JURISDICTION 8. This Court has jurisdiction over this adversary proceeding pursuant to 28 U.S.C.

157 and 1334. 9. 10. Venue is proper in the District of Delaware pursuant to 28 U.S.C. 1409. This is a core proceeding pursuant to 28 U.S.C. 157(b). FACTUAL ALLEGATIONS A. The Term Loan Credit Agreement And The Make Whole Provision 11. On May 22, 2012, School Specialty and each of the other Debtors entered into a

credit agreement (the Term Loan Credit Agreement) with Bayside, as administrative agent, collateral agent, and the sole lender. Under the Term Loan Credit Agreement, Bayside agreed to make a term loan (the Term Loan) to the Debtors in an aggregate principal amount of $70 million, at an annual interest rate equal to the three-month LIBOR, with a 1.5% floor, plus 11.0%. The Term Loan Credit Agreement is governed by New York law. 12. Pursuant to the Term Loan Credit Agreement, in the event of prepayment or

acceleration of the Term Loan during the first year and a half of the Term Loan (including following default and acceleration), the Debtors were required to pay an Early Payment Fee (as defined in the Term Loan Credit Agreement) (the Make Whole Provision) to Bayside, which was computed by discounting the future stream of interest payments between the earlier of the date on which principal is prepaid or accelerated and December 31, 2015, at the applicable Treasury rate plus 50 basis points. 13. The Make Whole Provision differs materially from other prepayment provisions

found in the market. In particular, the Make Whole Provision uses the present value of the Term Loans interest stream beyond the end of the 18-month make whole fee period, notwithstanding that the Early Payment Fee is equal to a 6% fixed call price the day after such period ends. In 4

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contrast, typical debt instruments with similar make whole fee provisions only take into account (for the present value computation) the interest stream up to the last day during which the make whole fee applies and add the present value of the fixed call fee to calculate the total prepayment fee. B. The AIM Note And The Fraudulent Transfer 14. During the summer and fall of 2012, the Debtors, confronting a period of

constrained liquidity, sought to implement certain strategies aimed at raising cash for the company. As part of these efforts, the Debtors began to explore the possibility of selling a promissory note of AIM Education, Inc. (the AIM Note), a bankrupt entity whose obligation to School Specialty under the AIM Note was approximately $5.56 million. 15. Ultimately, on or about October 25, 2012, the Debtors sold the AIM Note to a

third party for $3 million. Pursuant to the terms of the Term Loan Credit Agreement, the Debtors were required to immediately turn this $3 million over to Bayside to pay down the outstanding principal balance of the Term Loan from $70 million to $67 million. Pursuant to the Make Whole Provision, as a consequence of the $3 million pay down of the Term Loan, the Debtors were required to make a contemporaneous payment to Bayside in the amount of $1,193,717 (or 39.8% of the prepaid Term Loan amount). Further, the Debtors monthly interest savings from the $3 million prepayment of the Term Loan totalled only $31,250. 16. Thus, as a result of the AIM Note sale, School Specialty had to pay approximately It is the

$4.2 million to achieve a $3 million principal reduction of the Term Loan.

approximately $1.2 million excess payment the Fraudulent Transfer that is the subject of this Complaint.

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C.

The Unenforceability Of The Make Whole Provision And Payments Arising Thereunder 17. On January 28, 2013 (the Petition Date), each of the Debtors filed voluntary

petitions for relief under Chapter 11 of Title 11 of the United States Code, 11 U.S.C. 101 et seq. (the Bankruptcy Code) in this Court. Since the Petition Date, the Debtors continue to operate and manage their businesses as debtors-in-possession. On February 5, 2013, the United States Trustee appointed the Committee. 18. On March 6, 2013, the Committee filed with this Court an amended motion to

disallow (the Amended Motion to Disallow) an Early Payment Fee in the amount of approximately $25 million (the Make Whole Payment) asserted by Bayside to be due pursuant to the Make Whole Provision of the Term Loan Credit Agreement.1 19. The facts and circumstances surrounding the Make Whole Payment make clear

that it is plainly disproportionate to any actual damages that Bayside could have reasonably expected to incur from the early payment of the Term Loan. These include: (i) that it amounts to more than 37% of the $67 million outstanding principal balance under the Term Loan; (ii) that the formula employed to calculate it differs from virtually every other make whole premium in

The Committee initially filed a motion to disallow the Make Whole Payment on February 25, 2013. The Amended Motion to Disallow was filed shortly thereafter to make certain minor modifications to the original motion. Since the filing of the Amended Motion to Disallow, Bayside has filed an objection and agreed to reduce the amount sought pursuant to the Make Whole Provision from $25,054,001.06 to $23,774,487.17 to account for January and February 2013 interest under the Term Loan Credit Agreement that has now been paid to Bayside. See Objection of Bayside Finance, LLC to Amended Motion of the Official Committee of Unsecured Creditors to Disallow Bayside Finance, LLCs Asserted Make Whole Payment, p. 13 n.11. On April 2, 2013, the Committee filed a reply to Baysides objection in support of the Amended Motion to Disallow. Notably, the Committee asked Bayside to stipulate that the approximately $1.2 million payment subject to this Complaint be resolved as part of the contested matter concerning the Make Whole Payment. Bayside refused to so stipulate, forcing the Committee to file this Complaint. 6

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the market in that it is based upon the full amount of interest which will accrue for the entire three-and-one-half-year stated term (based on a December 2015 maturity), even though School Specialty is permitted to prepay the Loan with only a substantially stepped-down fixed fee after 18 months; (iii) that it assumes that interest would accrue during the 14-month period after the likely maturity (October 2014) of the Term Loan, and (iv) that it assumes Bayside can only reinvest the funds it receives at a 0.78% return. 20. Similarly, the Fraudulent Transfer, also arising under the Make Whole Provision,

amounts to more than 39.8% of the $3 million prepaid Term Loan amount and is plainly disproportionate to any actual damages that Bayside could have reasonably expected to incur from such early payment. 21. Therefore, the Make Whole Payment and Fraudulent Transfer constitute

unenforceable penalties under New York law. 22. The Amended Motion to Disallow also argues that the Make Whole Payment

should be disallowed because: (i) it does not constitute a reasonable charge under 11 U.S.C. 506(b); and (ii) it is disallowable as a claim for unmatured interest under 11 U.S.C. 502(b)(2). The hearing before this Court on the Amended Motion to Disallow is presently scheduled for April 5, 2013. 23. Pursuant to the Final DIP Orders, the principal of the Term Loan was repaid on or

about February 27, 2013, and an amount approximately equal to the claimed Make Whole Payment was set aside in an escrow account pending resolution of the make whole dispute by this Court. 24. The Courts determination on the issue of whether the Make Whole Payment is an

unenforceable penalty in connection with the contested matter initiated by the Amended Motion

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to Disallow would also govern whether School Specialty received reasonably equivalent value in return for the Fraudulent Transfer for purposes of this adversary proceeding. COUNT I DECLARATORY JUDGMENT (For A Declaration That The Make Whole Provision Is An Unenforceable Liquidated Damages Clause Under New York Law) 25. The Committee repeats the allegations in the foregoing paragraphs, which are

incorporated by reference as if set forth fully herein. 26. There is an actual controversy between the Committee and Bayside regarding

validity of payments purportedly arising under the Make Whole Provision. 27. Under New York state law, a prepayment premium or early termination fee is

analyzed as a liquidated damages provision. Liquidated damages provisions are enforceable where actual damages may be difficult to determine and the sum stipulated is not plainly or grossly disproportionate to the probable loss. 28. The reasonableness of the damages is determined as of the time the parties

entered the agreement and not at the time of the breach. 29. The Committee is entitled to a judicial declaration that the Make Whole Provision

is an unenforceable liquidated damages clause because the fee arising thereunder (the Fraudulent Transfer in the amount of approximately $1.2 million) is grossly disproportionate to Baysides probable loss (determined as of the time of the Debtors and Baysides entry into the Term Loan Credit Agreement) from the $3 million prepayment of the Term Loan.

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COUNT II AVOIDANCE OF CONSTRUCTIVE FRAUDULENT TRANSFER PURSUANT TO 11 U.S.C. 544(b) AND APPLICABLE STATE LAW 30. The Committee repeats the allegations in the foregoing paragraphs, which are

incorporated by reference as if set forth fully herein. 31. Section 544(b)(1) of the Bankruptcy Code authorizes the avoidance of any

transfer of an interest of the debtor in property that is voidable under applicable law by a creditor holding an allowable unsecured claim. 32. Upon information and belief, at all times relevant to this Complaint, there were

actual creditors of School Specialty who could have avoided the Fraudulent Transfer under applicable state law. 33. Because the Fraudulent Transfer was a payment pursuant to an unenforceable

provision of the Term Loan Credit Agreement (i.e., the Make Whole Provision), it was not a payment on account of a valid and legally enforceable antecedent debt. Thus, School Specialty did not receive a reasonably equivalent value or fair consideration in exchange for the Fraudulent Transfer. 34. School Specialty: (i) was insolvent on the time of the Fraudulent Transfer, or

became insolvent as a result of it; (ii) was engaged in a business or a transaction, or was about to engage in a business or a transaction, for which its remaining assets were unreasonably small in relation to the business or transaction; and/or (iii) intended to incur, or believed or reasonably should have believed it would incur, debts beyond its ability to pay as they became due.

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COUNT III AVOIDANCE OF CONSTRUCTIVE FRAUDULENT TRANSFER PURSUANT TO 11 U.S.C. 548 35. The Committee repeats the allegations in the foregoing paragraphs, which are

incorporated by reference as if set forth fully herein. 36. For the reasons stated above, the Fraudulent Transfer should be avoided under 11

U.S.C. 548(a)(1)(B). 37. The Fraudulent Transfer, made by School Specialty on October 25, 2012, was a

transfer of an interest of School Specialty in property that was made within two years before the Petition Date. 38. Because the Fraudulent Transfer was a payment pursuant to an unenforceable

provision of the Term Loan Credit Agreement (i.e., the Make Whole Provision), it was not a payment on account of a valid and legally enforceable antecedent debt. Thus, School Specialty received less than reasonably equivalent value in exchange for the Fraudulent Transfer. 39. School Specialty: (i) was insolvent on the date that the Fraudulent Transfer was

made, or became insolvent as a result of it; (ii) was engaged in a business or a transaction, or was about to engage in a business or a transaction, for which any property remaining with it was an unreasonably small capital; and/or (iii) intended to incur, or believed it would incur, debts that would be beyond its ability to pay as such debts matured. COUNT IV RECOVERY OF AVOIDED TRANSFER PURSUANT TO 11 U.S.C. 550 40. The Committee repeats the allegations in the foregoing paragraphs, which are

incorporated by reference as if set forth fully herein.

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41.

As set forth above, the Committee is entitled to avoid the Fraudulent Transfer

pursuant to 11 U.S.C. 544(b)(1) and 11 U.S.C. 548(a)(1)(B). 42. Bayside was the initial transferee of the Fraudulent Transfer, the entity for whose

benefit the Fraudulent Transfer was made, and/or the immediate or mediate transferee of such initial transferee. Accordingly, the Committee is entitled to recover the Fraudulent Transfer from Bayside for the benefit of the Debtors estates. COUNT V UNJUST ENRICHMENT 43. The Committee repeats the allegations in the foregoing paragraphs, which are

incorporated by reference as if set forth fully herein. 44. Under applicable state law, where a defendant receives a benefit at the plaintiffs

expense under circumstances in which it would be unjust for the defendant to retain such benefit, unjust enrichment requires that the defendant return the benefit to the plaintiff or compensate the plaintiff for its loss. 45. Because the Fraudulent Transfer was paid by School Specialty pursuant to an

unenforceable provision of the Term Loan Credit Agreement (i.e., the Make Whole Provision), it would be unjust for Bayside to retain the payment at the expense of the Committees unsecured creditor constituents. Accordingly, Bayside must disgorge the amount of the Fraudulent Transfer to the Debtors. COUNT VI FAILURE OF CONSIDERATION 46. The Committee repeats the allegations in the foregoing paragraphs, which are

incorporated by reference as if set forth fully herein. 47. Under applicable state law, where a party performs under a contract and fails 11

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without his or her fault to receive in some material respect the agreed quid pro quo for that performance, a failure of consideration has occurred with respect to such contract. 48. The Fraudulent Transfer was paid by School Specialty to Bayside pursuant to the

Make Whole Provision, which provision constituted an unenforceable liquidated damages clause. As such, School Specialty was not obligated to perform under the Make Whole Provision. Through no fault of School Specialty, Bayside failed to provide anything of value to School Specialty in exchange for the Fraudulent Transfer. Accordingly, a failure of consideration occurred with respect to the Term Loan Credit Agreement, and Bayside is required to disgorge the amount of the Fraudulent Transfer to the Debtors.

REQUEST FOR RELIEF WHEREFORE, the Committee, against Bayside, requests relief as follows: (i) On Count I, entry of judgment by this Court declaring the Make Whole Provision

and Fraudulent Transfer are unenforceable penalties under New York law; (ii) On Count II, entry of judgment by this Court avoiding the Fraudulent Transfer

under the applicable state law and Section 544 of the Bankruptcy Code; (iii) On Count III, entry of judgment by this Court avoiding the Fraudulent Transfer

under Section 548 of the Bankruptcy Code; (iv) On Count IV, entry of judgment by this Court for recovery of the avoided

Fraudulent Transfer under Section 550 of the Bankruptcy Code; (v) On Count V, entry of judgment by this Court declaring that Bayside was unjustly

enriched by the Fraudulent Transfer and ordering disgorgement of the amount of the Fraudulent Transfer to the Debtors;

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(vi)

On Count VI, entry of judgment by this Court declaring that a failure of

consideration has occurred with respect to the Term Loan Credit Agreement and ordering disgorgement of the amount of the Fraudulent Transfer to the Debtors; (vii) On all Counts, entry of judgment by this Court awarding the Committee its

reasonable attorneys fees, any and all costs in bringing this action, and pre-judgment interest from the date of the Fraudulent Transfer at the maximum rate provided by law; and (viii) Such other and further relief as this Court deems equitable and just. Dated: April 3, 2013 Wilmington, Delaware VENABLE LLP By: /s/ Jamie L. Edmonson Jamie L. Edmonson (#4247) Darek S. Bushnaq (#5596) 1201 North Market Street, Suite 1400 Wilmington, Delaware 19801 Telephone: 302-298-3535 Facsimile: 302-298-3550 jledmonson@venable.com dsbushnaq@venable.com and BROWN RUDNICK LLP Robert J. Stark, Seven Times Square New York, NY 10036 Telephone: (212) 209-4800 rstark@brownrudnick.com Steven D. Pohl, One Financial Center Boston, MA 02111 Telephone: (617) 856-8200 spohl@brownrudnick.com Counsel for the Official Committee of Unsecured Creditors

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