UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE

UNITED STATES BANKRUPTCY COURTFOR THE DISTRICT OF DELAWARE

. CHAPTER 11In re: .

. Case No. 08-11637 (KG)BOSCOV'S, INC., et al., .

. 824 Market Street Debtors. . Wilmington, DE 19901

.

. September 5, 2008. . . . . . . . . . . . . . . . 10:03 a.m.

TRANSCRIPT OF TRIALBEFORE HONORABLE KEVIN GROSS

UNITED STATES BANKRUPTCY COURT JUDGE

APPEARANCES:

For Debtor: Richards, Layton & Finger, PABy: DANIEL J. DeFRANCESCHI, ESQ.

PAUL N. HEATH, ESQ.LEE E. KAUFMAN, ESQ.CORY D. KANDESTIN, ESQ.

One Rodney Square920 North King StreetWilmington, DE 19801

Jones, DayBy: BRAD B. ERENS, ESQ.

ROBERT E. KREBS, ESQ.77 West WackerChicago, IL 60601

Audio Operator: JENNIFER PASIERB

Proceedings recorded by electronic sound recording, transcriptproduced by transcription service.

_______________________________________________________________

J&J COURT TRANSCRIBERS, INC.268 Evergreen Avenue

Hamilton, New Jersey 08619E-mail: [email protected]

(609) 586-2311 Fax No. (609) 587-3599

2

J&J COURT TRANSCRIBERS, INC.

APPEARANCES (CONT'D):

For Official Committee of Cooley, Godward, Kronish, LLPUnsecured Creditors: By: RICHARD S. KANOWITZ, ESQ.

MICHAEL KLEIN, ESQ.The Grace Building1114 Avenue of the AmericasNew York, NY 10036-7798

Potter, Anderson & Corroon, LLPBy: STEVEN M. YODER, ESQ.Hercules Plaza1313 North Market StreetWilmington, DE 19801

For Bank of America, NA: Womble, Carlyle, Sandridge & Rice, LLCBy: JOHN H. STROCK, ESQ.222 Delaware Avenue, 15th FloorWilmington, DE 19801

For Ritz Camera: Morris, Nichols, Arsht & Tunnell, LLPBy: DEREK C. ABBOTT, ESQ.1201 North Market St., 18th FloorP.O. Box 1347Wilmington, DE 19899-1347

For U.S. Trustee: Office of the U.S. TrusteeBy: WILLIAM HARRINGTON, ESQ.844 King Street, Suite 2313Wilmington, DE 19801-3509

3


I N D E X PAGE

WITNESSES FOR DEBTORMICHAEL JOSEPH HUGHES Direct Examination by Proffer 38 Cross-Examination by Mr. Harrington 41 Cross-Examination by Mr. Erens 58

EXHIBITS ID. EVD.

NONE

4


(Call to Order of the Court)1

THE COURT: Good morning, counsel. Please be seated. 2

Thank you.3

MR. ERENS: Good morning, Your Honor.4

THE COURT: Good morning, Mr. Erens. How are you?5

MR. ERENS: Good. How are you?6

THE COURT: Very well. Thanks.7

MR. ERENS: Good. Brad Erens, E-r-e-n-s, on behalf8

of the debtors. I have with me in court Mr. Robert Krebs of9

Jones, Day, also on behalf of the debtors.10

THE COURT: Good morning.11

MR. ERENS: Mr. Paul Heath, from the Richards, Layton12

firm --13

THE COURT: Mr. Heath.14

MR. ERENS: -- on behalf of the debtors.15

THE COURT: Thank you.16

MR. ERENS: You want other appearances or --17

THE COURT: No. I think we're ready to proceed. I18

do it a little differently. I just wait until people speak.19

MR. ERENS: Okay. That's fine.20

THE COURT: That way, they don't know -- that way,21

they aren't confused about whether to appear or enter their22

appearance or not.23

MR. ERENS: Okay. No, that's fine. Your Honor, if24

you recall at our last hearing, there were some issues between25

5


our banks and Ritz Camera.1

THE COURT: I do.2

MR. ERENS: As I understand it, those issues have3

been resolved. It's not, per se, on the agenda, but we thought4

we would just have Mr. Abbott from -- representing Ritz, just5

indicate to the Court what the resolution was.6

THE COURT: Yes.7

MR. ERENS: So that he could be excused thereafter.8

THE COURT: Please. That would be fine. Mr. Abbott,9

good morning.10

MR. ABBOTT: Good morning, Your Honor. Derek Abbott,11

here for Ritz Camera Centers, Inc. Your Honor, happily putting12

it off a week, I think I'll allow the parties to work through13

the issues. As we discussed last week, although it took a14

little longer than we'd all hoped, there's now a segregation15

concept in place.16

So all the cash that the Ritz folks get in their17

stores, they are depositing directly in their own bank account. 18

They're still providing reporting, et cetera, to Ritz, but19

that's been done between the businesses on an acceptable basis. 20

The lenders, first lien lenders, Your Honor, did -- or DIP21

lender, Bank America, raised an issue as early as Tuesday or22

Wednesday, and their concern was that although they appreciated23

and have no objection to the idea of going forward on a24

segregated basis, they were concerned that there might be some25

6


challenge to them to disgorge funds that may have been received1

from the debtors that were actually initially our property, and2

there's a modest amount of controversy about how that would3

work.4

We've worked it out, Your Honor, with the debtors,5

and the lenders I think are happy with it. Your Honor may6

recall that you granted the debtors the authority to pay pre-7

petition amounts due to folks like Ritz.8

THE COURT: Yes.9

MR. ABBOTT: And they had been making some payments. 10

They were a little behind, but as of this morning we had11

reconciled the pre-petition amounts down to a negligible amount12

and I understand that today the debtors are going to send both13

the pre-petition amounts due and post-amounts due August 23rd.14

THE COURT: Good.15

MR. ABBOTT: Via check through Fed-Ex that we should16

have Monday, probably, Your Honor. And so what that means is17

that we will have just a few days of issue and then we'll get18

on a regular cycle. So it's mitigated, you know, substantially19

all of the risk that the banks might have had.20

They're comfortable with those payments being made,21

as I understand it. The debtors are comfortable. My client's22

comfortable. So we're going to be paid our money and, Your23

Honor, I don't think there's going to be any reason to be back24

in front of you on this issue in the future. Obviously, we25

7


know how to get there if we need to.1

THE COURT: Of course.2

MR. ABBOTT: But all's well that ends well, it3

appears, Your Honor.4

THE COURT: Good, Mr. Abbott. I'm pleased.5

MR. ABBOTT: Thank you, Your Honor.6

THE COURT: I'm pleased that it was resolved this way7

and that Ritz can go forward with some comfort here.8

MR. ABBOTT: Yes, Your Honor. May I be excused?9

THE COURT: You may.10

MR. ABBOTT: Thanks.11

THE COURT: We'll miss you, but you may be excused.12

(Laughter)13

MR. ERENS: Okay.14

THE COURT: Mr. Erens, yes, sir.15

MR. ERENS: Then that takes us back to the agenda.16

THE COURT: Yes.17

MR. ERENS: Item number one on the agenda was a18

continued matter, retention of KPMG, which I understand is19

being resolved between the U.S. Trustee's Office and KPMG, and20

is probably going to be on for hearing, if necessary, next21

week.22

THE COURT: Okay.23

MR. ERENS: But hopefully, a hearing, actually, is24

not necessary. So that gets us to the actual matters for25

8


today. We have a short agenda, obviously. Item number one is1

the application of the debtors to retain Lehman Brothers as2

their investment banker.3

This application was filed around the petition. 4

We've spent significant time talking to the U.S. Trustee's5

Office, as well as the committee, as well as Lehman, to get6

sort of everybody finalized with the form of order approving7

the application, and I'm happy to announce that we are there.8

THE COURT: Good.9

MR. ERENS: As is sort of typical for this case, at10

least, we've got a revised form of order that we'd like up, the11

clean and black-line.12

THE COURT: Certainly. That would be fine,13

Mr. Erens. Thank you.14

(Pause)15


MR. ERENS: In terms of the changes, there's several17

and they're not insignificant in terms of substance. Take the18

Court through the substantive ones. In paragraph 3 of the19

revised order, the original Lehman application provided that20

Lehman would be authorized to provide a fairness opinion in21

connection with a sale transaction.22

Again, Lehman had a pre-petition relationship, so23

that was relevant then. It remained in the letter, but the24

U.S. Trustee's Office raised some issues in connection with25

9


that, and we decided as a result just to strike that from the1

scope of services.2

THE COURT: Okay.3

MR. ERENS: I just don't imagine a fairness opinion4

would be necessary. That's what Your Honor is for if we do a5

sale. Paragraph 4, there's some minor modifications to the6

revisions, the indemnification provisions of the engagement7

letter. To make them consistent with applicable law and United8

Artists, we -- the language you see in 4(a), (b), (c) and (d)9

was in the original order; just kind of the lead-in the U.S.10

Trustee wanted to change slightly, just to make it clear.11

THE COURT: Okay.12

MR. ERENS: In paragraph 6 of the order -- this is13

probably the most substantive provision -- Lehman has agreed in14

connection with this that its pre- and post-petition fees15

pursuant to the engagement letter, including all the monthlies,16

already paid to Lehman or paid to Lehman in the future and any17

sale success fee will not exceed $3 million. So they've capped18

their fees, other than expenses, at $3 million.19

THE COURT: Okay.20

MR. ERENS: Which we think is a significant21

concession. The other substantive items starting in paragraph22

8, there were some discussions among the parties as to under23

what kind of sale Lehman would get a fee. And the committee24

wanted to make clear and I think it was always the intent, it25

10


just wasn't really in the letter, that if for some reason this1

company were to liquidate, which we obviously hope is not the2

case, that -- and we do a GOB, for instance, for the entire3

company -- that is not the type of sale that would trigger a4

Lehman fee.5

THE COURT: Okay.6

MR. ERENS: However, just to be clear, to the extent7

that we go forward on a going concern sale, that Lehman gets8

that to the table, we file with the Court, and for some reason9

thereafter let's say the committee said, you know what, we10

changed our mind, we want to liquidate the company -- I don't11

really expect that to happen, obviously -- but if that did12

happen, Lehman wanted to confirm and everybody thought this was13

fair and Mr. Kanowitz will clarify this -- that in that14

circumstance Lehman has done its job.15

It has brought a buyer to the table in a deal that we16

signed and brought to the Court. So even if that weren't the17

end result of the case, Lehman would gets it fee in that18

circumstance.19

THE COURT: Okay.20

MR. ERENS: I don't know if Mr. Kanowitz wants to21

clarify that point at this time. Okay. Paragraph 9, the --22

was negotiated between Lehman and the U.S. Trustee's Office23

making clear that Lehman will file fee applications and that24

the U.S. Trustee's Office has discretion with respect to the25

11


fees under 330, the reasonable standard, not 328(a).1

Paragraph 10 is sort of the nuance. Notwithstanding2

the engagement letters, which says that the monthly -- monthly3

payments are "non-refundable," okay, the monthly fees being4

paid by the debtors to Lehman will be subject to disgorgement5

if for some reason the Court thought disgorgement were6

necessary. So for instance, if there were a Lehman conflict7

that weren't disclosed --8

THE COURT: Right.9

MR. ERENS: -- okay, and it came up after the fact10

and so Your Honor said, well, you didn't disclose this so you11

never should have been retained, all your fees should be12

disgorged, the U.S. Trustee's Office just wanted to make clear,13

and everybody thought this was fair, that the fact that the14

engagement letter said that monthlies were "non-refundable,"15

did not mean Your Honor did not have the authority to force16

that disgorgement.17

THE COURT: Okay.18

MR. ERENS: So nobody disputes that.19

THE COURT: Good.20

MR. ERENS: And then paragraph 12 of the revised21

order is some clarifications with respect to time-keeping and22

the like. Number one is -- the Lehman engagement letter said23

that Lehman will keep time in half-hour increments and made24

some other sort of very minor comments about how that time25

12


would be kept.1

The U.S. Trustee's Office has said, look, we'll let2

you keep your time in half-hour increments, even though, of3

course, you know, the lawyers don't do that. But we're not4

agreeing that you can -- that there's any standard about how5

much detail and the like; you'll file your applications and6

we'll tell you if we think the detail is sufficient.7

THE COURT: Excellent.8

MR. ERENS: And if it's not, we may object. And the9

second point was that given that Lehman is a flat fee10

professional, a straight 250,000 a month, it didn't seem like11

it was necessary to have a hold-back. It's not clear what that12

hold-back would be in the case of Lehman.13

So it has been provided in this order that Lehman14

will not be subject to the 20 percent hold-back in the interim15

compensation order. That doesn't mean, of course, their fees16

are not subject to challenge at the interim and final hearings. 17

And again, the U.S. Trustee has reserved on reasonableness18

grounds with respect to those fees.19

THE COURT: Very well.20

MR. ERENS: So that's the revisions to the Lehman21

order. With that, we would ask Your Honor, unless you have any22

questions, to approve the order and they will be officially23

retained in this case for the sale process, which is still the24

centerpiece of this case at this point.25

13


THE COURT: Okay, Mr. Erens. Thank you. Mr.1

Kanowitz, good morning.2

MR. KANOWITZ: Good morning, Your Honor. For the3

record, Richard Kanowitz, Cooley, Godward, Kronish, proposed4

counsel for the official committee of unsecured creditors. 5

Very briefly, again, with respect to the sale, concept and the6

definition of sale and liquidation proceeds, there were lots of7

discussions and lots of emails on this, and while the language8

is --9

THE COURT: It becomes difficult as you start to get10

into it.11

MR. KANOWITZ: Yes. It becomes difficult, but I12

think the intent is there, as Mr. Erens explained it. Another13

concept that I think is clear and embedded there but may not be14

is that in the event that there was a split deal, a going15

concern part and their liquidation part, that it would be our16

position that this makes clear that the sale is not for any17

type of going out of business sale, in whole or part, and18

therefore, their success fee, if you will, would be on the19

going concern part.20

If we had a disagreement, though, about how you21

calculate that, obviously, we'd come back to the Court, but22

there's no reason to belabor the point here. I think the23

language is as best it can be when you have innumerous parties24

looking at it in drafting.25

14


THE COURT: And trying to keep it under 100 pages.1

MR. KANOWITZ: Yeah, and 100 emails.2

THE COURT: That's right. I can imagine.3

MR. KANOWITZ: So with that, Your Honor, I agree with4

Mr. Erens' recitation of how this came to be and the intent of5

the parties as drafted.6

THE COURT: Thank you, Mr. Kanowitz.7

MR. KANOWITZ: Thank you.8

THE COURT: And I thank the Office of the United9

States Trustee for its diligence in reviewing the application,10

and I am prepared to enter the order.11

MR. ERENS: All right. Thank you, Your Honor. That12

takes us to item number two, also another professional13

retention. This is the debtors' application to employ Hilco14

Real Estate, LLC, as its real estate consultant, nunc pro tunc15

to August 21st, which is the day we filed the application.16

We had not retained them sort of unofficially at the17

beginning of the case. We started the process after we filed. 18

Obviously, the debtors are a retailer. They have lots of19

leases. They have -- already are in the process of closing 1020

locations. The debtors, as any retailer, are looking at all21

options in terms of maximizing value, including renegotiations22

with landlords and the like, in addition to, if necessary in23

this case, trying to get consents to extend from landlord the24

210-day period which we now have to assume or reject leases.25

15


So Hilco is being retained for that and other1

purposes set forth in the application. There was discussion2

between Hilco and the U.S. Trustee's Office regarding the form3

of order. There were some minor modifications made, and again,4

I can hand up the clean and black-line and go through that.5

THE COURT: Yes, let's do that, Mr. Erens. It's6

helpful. Thank you.7

MR. ERENS: The first change, which is really just an8

error, I guess, on everybody's part, which is the original9

application and original engagement was filed that the10

appraisal work that Hilco's going to do on our leases would be11

$400 per location. And we're not quite sure how that happened,12

but the deal was $40,000 for the entire lease portfolio, which13

is about $1,000 per location.14

THE COURT: Okay.15

MR. ERENS: You know, I apologize for that. So in a16

corrected form of engagement letter, or at least application,17

our correction was filed a few days ago with the Court so that18

everybody at least knew several days before the hearing that19

this was the real deal.20


MR. ERENS: And to my knowledge, none of the parties22

have raised any issues with respect to that. We are talking to23

the creditors' committee as to whether we're really going to go24

forward with the valuation, but everybody's agreed if we do,25

16


this will be the fee.1

THE COURT: Okay.2

MR. ERENS: The paragraph 5 of the revised order is3

just clarification requested by the United States Trustee's4

Office that Hilco will file with the Court no later than the5

30th day of the month for which compensation was paid a6

statement of the fees and serve it on the -- sort of the key7

notice parties. So there'll be more fee reporting.8

You know, often when we have professionals like this9

it's sort of a lot of time and expense and not really a lot of10

value to have them file sort of everything the lawyers do, for11

instance.12

THE COURT: Right.13

MR. ERENS: They're not billing at all on an hourly14

basis. All their fees are transaction-based.15

THE COURT: Exactly.16

MR. ERENS: If they do an appraisal it's this amount. 17

If they get consents it's this amount, et cetera. And then the18

final major change is paragraph 8, which deals with sort of a19

disclosure regarding relationships and the like, Hilco is20

entitled, as set forth in paragraph (a), actually, affiliates21

of Hilco are entitled to bid on the properties that they're --22

you know -- they're sort of looking at, they're talking to23

landlords about, and the U.S. Trustee's Office has gotten24

comfortable with that.25

17


However, with the proviso put in here which is that1

to the extent an affiliate bids or purchases a property that's2

subject to the engagement letter in this application, the U.S.3

Trustee's office does reserve the right to review whether that4

all of a sudden starts to render Hilco disinterested or5

interested, I guess.6

THE COURT: Okay.7

MR. ERENS: No longer disinterested. We will8

obviously monitor that. We don't want to lose our real estate9

consultant. We think they're going to form -- or act in an10

important way in this case. So since we are the party who11

would be selling and they would be the party buying we have the12

ability to say, look, we don't want to sell to you because you13

got better things to do in this case then being buying our14

properties.15

THE COURT: Right.16

MR. ERENS: We don't expect this to happen or come up17

as an issue, but obviously, we have to -- the U.S. Trustee's18

Office has to anticipate possibilities, and we appreciate that.19

THE COURT: Absolutely, and I appreciate it, as well.20

MR. ERENS: So that was all in terms of changes to21

the Hilco order, and again, with that, we'd ask Your Honor to22

approve the application.23

THE COURT: And I do, and I will sign the order.24

MR. ERENS: Okay. Thank you. That takes us to the25

18


final and main item for today's agenda, which is the debtors'1

motion for approval of a senior executive incentive plan. We2

do have one objection from the United States Trustee's Office;3

no other objections.4

As we note in the motion, this plan is being5

supported by the creditors' committee. It was negotiated and6

discussed extensively with the creditors' committee prior to7

filing the motion. I think what makes sense in terms of8

proceeding, unless Your Honor disagrees, is let me just spend a9

couple minutes talking about the program.10

The program's pretty simple. So it's not like we11

need to spend a lot of time describing it. And what I'd like12

to do is address sort of more generally the United States13

Trustee's issues, although obviously, they want to speak for14

themselves. And then either at that time or later I'd like to15

make a proffer on behalf of Michael Hughes, the company's chief16

restructuring officer, who is here, as to what he would testify17

to in support of this plan.18

If Your Honor wants the actual testimony or if the19

United States Trustee wants the actual testimony, we're happy20

to put that on, but I think in terms of efficiency a proffer21

will be fine, and then obviously, Mr. Hughes is here for -- to22

be available for cross-examination.23

THE COURT: Good. Let me see if I can dispel one24

concern that the United States Trustee expressed, their office. 25

19


The UST's Office was concerned about the Court in effect1

delegating responsibility to the committee, I think, in2

determining whether or not the events that trigger the bonuses3

have occurred.4

And it's -- I think it's clear, but I just want to5

make certain for my own -- in my own mind that it's clear that6

the committee has to approve of the transaction being submitted7

to the Court, but it's ultimately subject to the Court's8

approval whether a sale meets the requirements, whether the9

other triggering event meets the requirements and so on. Is10

that correct?11

MR. ERENS: Absolutely.12

THE COURT: Yes.13

MR. ERENS: Without question. You know, it's14

obviously the debtors' view that this is an incentive plan. 15

The U.S. Trustee's Office has taken a position it's a retention16

plan.17

THE COURT: Right.18

MR. ERENS: We think because of the time thresholds19

it's clearly an incentive plan, but beyond that, the20

committee's support is another hurdle, and it's effectively a21

proxy for value.22

THE COURT: Right.23

MR. ERENS: We don't think it's a good idea, frankly,24

Your Honor, to be filing incentive plans that say, oh, the25

20


company has to sell its assets for x million dollars, because1

we're in the process of negotiating right now with several2

buyers a sale of the company.3

The second we put that number in the public record4

those buyers are going to go directly to that number and not a5

higher number. So clearly, we don't think it maximizes value,6

nor is it in the interest of the estate to be throwing out7

numbers.8

We, of course, could file I suppose something under9

seal. There's been criticisms I know in the press around doing10

key employee plans under seal. So we avoided that issue, as11

well, and we think it simplifies it. Look, the committee is12

the residual owner of this company right now.13

If we put a sale in front of them for value and we14

are negotiating with them and talking to them every day on15

these issues, if they think it's the best deal that the company16

can get, then we think that is the best proxy for value, and we17

think management will have satisfied its obligation to maximize18

value and get the best price.19

Putting price targets for the reason I mentioned we20

think really is not a good idea and will not maximize value,21

but will simply have buyers focus on a price which may not be22

the highest price we can get for the company. So that's in23

large part why the committee threshold is in there.24

It's simple, it makes sense and, you know, the25

21


committee as representing the unsecured creditors in this case,1

really should be the ones to say, this deal is sufficient for2

you to proceed in court. Obviously, it's Your Honor's3

prerogative to decide whether that sale should be approved for4

any number of reasons.5

THE COURT: Very well. Good.6

MR. ERENS: Okay. All right. So let's get to the7

plan. Obviously, the plan's pretty straightforward. It covers8

six senior executives of the company. It is a sale or plan9

incentive plan. The six executives would get a bonus in the10

event that the company's able to consummate a sale that is11

supported by the committee by January 6, 2009, or is able to12

consummate a plan also supported by the committee by February13

28th, 2009.14

We gave a little bit more time for the plan because,15

obviously, plans take a little bit more time than 363 sales. 16

the payments would be made on the later of -- or I should say17

the earlier of, I guess, six months after the consummation of18

the transaction or the termination of the employee.19

The aggregate amount of payments, if earned, would be20

$1.45 million for the six executives collectively, which is21

approximately one-tenth of one percent of the company's22

historical revenue; a little bit higher now. Since we've23

closed 10 stores our going forward revenue will be somewhat24

lower, except to the extent the company's sales improve over25

22


time, and that our 39-store base approaches what our 49-store1

base was doing only a few months ago.2

As indicated in the motion, prior to the petition3

date senior executives had an EBITDA plan, an incentive plan. 4

So incentive plans are something that this company has had for5

sometime. Basically, these executives were paid a percentage,6

again, of their base compensation, to the extent the company as7

a whole met those EBITDA targets.8

The reality of the situation now, not surprisingly,9

is given the meltdown in the retail industry -- I mean, you10

know, retailers are doing poorly across the boards, not just11

the ones in Chapter 11 -- and given the costs of this Chapter12

11 case, which are significant and which do reduce the EBITDA13

of the company, the company will not meet those targets.14

However, the executives are working, frankly, harder15

than ever and we will proffer that testimony. They are doing16

not only the normal job functions, which are made more17

difficult in Chapter 11, but they are taking on additional18

responsibilities, mostly surrounding the fact that the company19

is on a highly expedited basis looking for a transaction to get20

out of bankruptcy.21

I mean, there's always lots of criticism of some22

companies lingering in bankruptcy. Obviously, the exclusivity23

amendments were designed to help that process along, but that's24

18 months. We're looking to get out of this case or at least25

23


consummate a deal before the end of the year.1

So that would be four months in this case; that is2

the statutory exclusivity period, not any extended period. The3

law obviously is developing in this area, but Your Honor has4

opinions and there are some other opinions around as to what5

factors courts have looked at and presumably should look at6

with respect to assessing plans like this with -- if everybody7

agrees or if Your Honor agrees, as we state, that it is not a8

retention plan, that it is a plan subject to 363(b) of the9

Bankruptcy Code, that requires simply that the debtors10

demonstrate that it's a proper exercise of their business11

judgment, and/or it's subject to 503(c) of the Bankruptcy Code,12

which has a similar standard, justified by the facts and13

circumstances.14

Factors include, will the plan achieve the desired15

result or performance. Well, the plan is exactly targeted to16

the result that we're trying to achieve in this case. We're17

trying to get a plan and sale -- and/or sale, consummated in a18

relatively expeditious fashion.19

Well, that's what the plan does. If the sale or plan20

does not occur by the dates required there is no bonus. So we21

think it's clearly targeted to achieve a desired performance. 22

Is the cost reasonable? As I said, it is approximately one-23

tenth of one percent of the company's historical revenue.24

We think given the size of this company and the25

24


amount of assets at stake and the amount of value at stake for1

unsecured creditors the cost is reasonable. Another factor, is2

the scope fair. I'm not quite sure what that means, but I3

suppose in this context it may mean, you know, did we include4

55 employees for this plan? No.5

We included the top six senior executives, the6

parties who actually make a difference as to whether a sale is7

consummated or a plan is proposed and confirmed; that is, both8

acceptable to the committee and beneficial to the estate. 9

Another factor, and I think Your Honor has opinions on this --10

I should mention that -- it's not like the debtor has to11

satisfy all the factors.12

These are things courts consider that are relevant,13

obviously. Is the plan consistent with industry standards? 14

It's not quite clear what that means. What we would say on15

that at least is, as we cited in our papers, there are several16

cases that are fairly recent in this jurisdiction -- and we17

just checked this jurisdiction; we didn't check elsewhere --18

that had plans similar to this plan.19

THE COURT: Yes.20

MR. ERENS: Sale-based, incentive-based plans.21

THE COURT: Yes.22

MR. ERENS: Aisle Air, Advanced Marketing, Global23

Home, et cetera. There is a review of the process. What24

process did the debtor undertake to formulate and implement the25

25


plan. We will proffer and Mr. Hughes is here to testify, that1

the process was management proposed plans, submitted them to2

the board and the board of directors did not actually accept3

the debtors' original plans.4

The original plans for an incentive compensation in5

this case were for compensation in excess of what's being6

proposed today. So we were beaten back down by the board. And7

as a result, the board was not just a rubberstamp. The board8

seriously considered the programs management was proposing,9

told management to go back and rethink it a little bit, asked10

for less and that's what's happening today.11

Final standard that's set forth is what type of12

independent counsel did the company have in terms of13

formulating and implementing the plan. We don't say this in14

our papers and it's not a mystery. We did not hire a15

compensation consultant. Sure, we could have hired someone,16

spent another $100,000 of the estate's money to have them17

indicate whether they thought it was reasonable to propose a18

plan for $1.45 million, or even a plan for, in our five, $1.5519

million.20

So you know, we think while hiring a consultant, a21

benefits expert is sometimes appropriate, maybe for a more22

difficult and complicated plan, maybe for something that's23

going to go over for a longer period of time. We don't think24

it should be sort of a source of full employment for25

26


professionals in bankruptcy, and we didn't think that that1

money would really be well spent.2

We, Jones, Day, spent significant time with the3

company discussing how incentive plans work in bankruptcy these4

days. We consulted with the committee. The committee gave us5

and the company feedback and we think that is sufficient,6

independent counsel for purposes of this plan.7

We would note that in the Global Home case Your Honor8

did indicate that it wasn't necessary in that case for the9

debtor to have hired a consultant, that the plan could be10

approved nonetheless. So as a result of that we think the plan11

can be approved and should be approved.12

As we set forth in our papers and for the reasons I13

just mentioned, the plan is not subject to 503(c). It is not a14

retention plan. It is not just for people to stay. It is for15

senior management to get a deal done on a highly expedited time16

frame.17

And we think that is a sufficient incentive that18

would both maximize value and is not a lay-up by any means in19

this case, and we'll proffer that testimony, as well. And20

therefore, we think the plan can and should be approved under21

section 363(b) of the Bankruptcy Code, and to the extent22

applicable, 503(c) of the Bankruptcy Code.23

I think at this point it makes sense to turn it over24

to the U.S. Trustee and then we can go into the proffer.25

27


THE COURT: Okay. Thank you, Mr. Erens. 1

Mr. Harrington, good morning, sir.2

MR. HARRINGTON: Good morning, Your Honor. For the3

record, William Harrington, from the Office of the United4

States Trustee. A couple tings, Your Honor. We do not have an5

objection to the use of a proffer as long as we have the6

opportunity to cross-examine --7

THE COURT: Certainly.8

MR. HARRINGTON: -- following the proffer. But I did9

want to clarify a couple of issues that I think could short-10

circuit any cross-examination that we have. It's my11

understanding, and I guess I would ask that the debtors12

stipulate, to the following items.13

It's my understanding that there's no dispute that14

the six executives covered by this plan are insiders. It's my15

understanding that there's no dispute that this plan is outside16

of the ordinary course of business. And it's my understanding17

that because the debtors don't believe 503(c)(1) applies, that18

they made no effort to satisfy the standards in 503(c)(1), and19

are not presenting any evidence today that they can satisfy20

503(c)(1).21

MR. ERENS: Let me address that. In terms of22

stipulating the six executives are insiders, here's what I'd23

say. It's not clear to me that some of these are insiders,24

some of them may be, but for the purpose of this hearing and25

28


only for the purpose of this hearing we are willing to say that1

they'll be treated as insiders. So 503(c) is applicable.2

For instance, you know, the company's director of3

stores, is that person an insider? Probably not; probably not. 4

But you know, the senior management is in it together. 5

Everybody's going to stand or fall together. So we're happy to6

basically say, let's consider whether this plan can be approved7

under 503 even though we don't think some of these parties are8

insiders.9

THE COURT: Is --10

MR. ERENS: I don't want to be bound in some later11

proceeding.12

THE COURT: Understood.13

MR. ERENS: Okay.14

THE COURT: The Court will not be making a finding15

that they're insiders, but is that -- is that a problem,16

Mr. Harrington?17

MR. HARRINGTON: I just -- for a clarification, not18

that they're -- not that they're bound for future purposes that19

these people are insiders, but with respect to this plan they20

are being considered insiders?21

MR. ERENS: Correct.22

MR. HARRINGTON: That's fine.23

THE COURT: Good.24

MR. ERENS: Okay. I'm sorry. On the second point,25

29


is the plan outside the ordinary course, clearly, if it were in1

the ordinary course we wouldn't be seeking court approval; we'd2

just do it. In terms of did the debtors make efforts to3

satisfy 503(c)(1), I'm not quite sure what that means. Our4

position in this hearing is that 503(c)(1) is not applicable. 5

So I'm not sure what further we're being asked to state.6

MR. HARRINGTON: And I'm happy to do this by cross-7

examination. So I'll just -- I'll deal with that on cross-8

examination.9

THE COURT: Okay.10

MR. HARRINGTON: Your Honor, a couple of points. 11

It's our position, Your Honor, if this is not the plan covered12

by 503(c)(1), that there is no such plan in existence. 13

Basically, the triggers we're talking about here are14

requirements that the debtor has under its obligations as15

fiduciaries in the bank -- under the Bankruptcy Code.16

The debtor has an obligation to file a plan in a17

timely basis. The debtor also has obligations to maximize18

value for creditors, if it intends to liquidate its assets. So19

really, Your Honor, what we're approving here is a bonus plan20

which requires the debtors to satisfy their current21

obligations.22

And effectively, what that means is we've -- the23

debtors have determined that these are important personnel and24

that they need these individuals to stay around through25

30


confirmation of a plan and/or the liquidation of their assets. 1

And to do that they've created what in title only is an2

incentive plan, but in fact is nothing more than a key employee3

retention plan, and exactly the type of plan we would have seen4

before the enactment of the BAP CPA where employees that were5

essential to the business and the value of the business needed6

to stay in place through confirmation or through a sale of the7

assets, and that's what we have here, Your Honor.8

Your Honor, I don't think the debtors have answered9

the question Your Honor raised initially as to whether or not10

you are delegating your responsibility for giving this plan to11

the committee. Effectively, Your Honor, once this plan is12

approved the committee will be making the determination as to13

whether a satisfactory plan or whether a satisfactory sale has14

been consummated, and that's the sort of second hurdle, other15

than the timing hurdle, that is proposed with the various16

triggers.17

THE COURT: But there can be no sale, there can be no18

confirmation of a plan unless I'm satisfied that they are19

appropriate.20

MR. HARRINGTON: Absolutely, Your Honor, but whatever21

sale and whatever plan is proposed that Your Honor approves22

satisfies these triggers. There's no other requirement that23

the sale be at a certain level, and that we don't know today24

what the value -- effectively, Your Honor, if the value of the25

31


assets today to be sold are $100 million -- and I'm just1

picking numbers out of the air -- there's no incentive for the2

debtors' personnel to do anything else other than to get this3

sale accomplished as fast as possible, irrespective of whether4

that maximizes value for the unsecured creditors, because if5

they did certain other things to meet $150 million trigger,6

that they would have the incentive to do those things.7

They don't have that incentive here. As long as the8

sale gets approved, they get paid. As long as the plan gets9

confirmed, they get paid. And they have a current obligation10

to maximize -- as fiduciaries of the estate they have an11

obligation to maximize value for creditors, and to get a plan12

confirmed. That's the whole purpose of Chapter 11.13

So Your Honor, that's where we stand. With respect14

to whether or not they needed a human resource consultant or a15

compensation expert, I think we can debate in large part the16

utility sometimes of the compensation experts that are brought17

in with respect to these plans.18

But what we don't have here, Your Honor, is, while19

they indicated in the motion that they did have a pre-petition20

bonus program, there is no indication as to what that program21

was, whether this is consistent with that program in any way,22

whether there is any -- whether there's any -- on relative23

terms how this program compares to any pre-petition program.24

THE COURT: Well, they've conceded it's not an25

32


ordinary course.1

MR. HARRINGTON: Right. So I don't think we --2

THE COURT: -- matter, so --3

MR. HARRINGTON: -- in that respect we have to go4

there, Your Honor. I think as long as they've conceded that we5

think 503(c) is triggered and that we're under the standards6

set forth in 503(c), although we dispute that it's 503(c)(3). 7

We think it's 503(c)(1).8

THE COURT: Understood. I certainly understand that,9

Mr. Harrington, and you will have an opportunity to cross-10

examine.11

MR. HARRINGTON: Thank you.12

THE COURT: But is it my understanding, we may13

proceed on the proffer subject to your cross-examination. Is14

that correct?15

MR. HARRINGTON: That's fine, Your Honor.16

THE COURT: Good. Mr. Kanowitz.17

MR. KANOWITZ: Your Honor, at your pleasure. Would18

you rather hear argument from me or a further explanation, or19

do you want to wait till the proffer?20

THE COURT: Let's hear the proffer, I think. That21

would be helpful. Thank you, Mr. Kanowitz. I'm always anxious22

to hear from you, but we'll hear the proffer first.23

MR. ERENS: Well, let me -- let me do one thing. Let24

me address some of the legal or sort of quasi-legal, quasi-25

33


factual issues, and then we'll put -- then I'll do the proffer1

and I'll make clear which is which, and then we can go forward.2

THE COURT: Good. Good. Yes.3

MR. ERENS: You know, the U.S. Trustee has raised4

some issues obviously in their papers. I just wanted to give5

them the opportunity to do that affirmatively, rather than6

characterizing their arguments, and I don't think they've7

raised anything new, which is fine.8

So let me address the specific points Mr. Harrington9

made and I think a couple others in their papers, because their10

papers are before the Court. Mr. Harrington said it's the11

debtors' obligation, fiduciary obligation and the like to file12

a plan and maximize value.13

Sure that is the case. The debtors are not breaching14

their fiduciary duties if they don't file a plan or consummate15

a sale in the first 90 to 120 days of the case. We think this16

is exceptional efforts, and as a result, we don't dispute our17

fiduciary obligations, but we're not just satisfying them here. 18

We think we're going well beyond to maximize value.19

Mr. Harrington said, oh, this is the same plan that20

we would have just filed pre-BAP CPA. I don't think that's21

true at all. Pre-BAP CPA we could have filed a plan before22

Your Honor that said, here are the six senior executives, we23

want to pay them the following bonus; we'll pay them at the end24

of the case, and the case could have been five years from now.25

34


Your Honor, obviously probably wouldn't have let it1

go that long, but there are time requirements here, and they2

are strict and they are soon. So clearly, there are hurdles3

here. Again, as we said in our papers, this is not a lay-up4

and we'll go into that further in the proffer and probably5

it'll come out in cross-examination.6

Value. Mr. Harrington said, hey, look, this is not7

an incentive plan because, you know, what if the assets are8

worth $100 million and the debtor proposes a plan for 80 -- or9

a sale for $80 million; he didn't create any value. Well, that10

again is what the committee is for.11

The committee's not going to let us go for a sale for12

$80 million if the assets are worth 100. In fact, that is13

exactly what is going on right now in this case. We are in14

term sheet stage with various buyers as to what they might be15

willing to do in terms of a sale, and as well as a plan of16

reorganization.17

And in fact, it is the case that we have taken18

already some term sheets to the committee and they've said, get19

more; that is not enough. We haven't actually said to them,20

this is as much as we think we can get, but before we go any21

further we want to know where you are in value, and the22

committee, through its professionals, has said no, get more;23

otherwise, we're not supporting that deal.24

So clearly, we think there are value thresholds by25

35


the committee being the -- sort of the -- the party who has to1

say yes, this is something we support before we file it with2

the Court. And as to the so-called fiduciary delegation issue3

raised, again, yeah, we would agree with Your Honor.4

If Your Honor does not approve -- let's say we put5

forward a plan, okay, and it's unconfirmable. You know, we get6

no votes in favor. I mean, I don't know how the committee7

would support it, and then we'd have no votes. But you know,8

just making up examples. If the plan's unconfirmable and it's9

not confirmed by February 28, 2009, there's no bonus.10

So we think it's pretty straightforward that we are11

creating value and there are thresholds here. Mr. Harrington12

asked and we are prepared to give the evidence on this as to13

how to -- the proposed payments here compared to prior plans. 14

I would indicate to the Court and I'll proffer the testimony15

that the bonuses are comparable to what the executives would16

have earned pre-petition, to the extent that the company met17

its targeted EBITDA.18

And I want to be clear on this: the company's pre-19

petition EBITDA plans had a range. So usually, there were five20

rungs, okay, and this was across the board for the senior21

executives. So if the company met the lowest rung, the easiest22

to achieve EBITDA, the executives would get a lower percentage23

of their base.24

Ans as the EBITDA amounts went up, those rungs went25

36


up, the executives would get a larger and larger percentage of1

their base pay as a bonus. These percentages in the -- in our2

current bonus plan are the percentages by and large that were3

in the middle tier, which the company viewed as the targeted4

EBITDA.5

The company's business plan said, if we do what we6

think we're going to do, we're going to meet tier three of7

five. And the percentages of base pay that would have been8

paid to the executives under the pre-petition plan are almost9

exactly the same percentages as is being proposed under the10

current sale/plan.11

So the idea is to make it comparable to the incentive12

plans that existed pre-petition, but the targets are different13

for the reasons we indicated. A couple other things I think14

were raised in the U.S. Trustee's objection itself, but I --15

actually, as I look at the list I think we've actually16

addressed all of them. So maybe there's nothing further to do.17

THE COURT: Yes.18

MR. ERENS: Other than go into the proffer. The only19

thing I'll say before we go into the proffer, as I said before20

but I want to make clear, we think the law as it's developing,21

not mostly in reported decisions, obviously there is some of22

that, but in terms of transcripts and deal structures that have23

been proposed before Your Honor and other judges in this24

jurisdiction, this plan is on all fours with other plans that25

37


have been approved, and we cite the specific cases that we were1

able to find quickly, which is Aisle Air, very similar set of2

facts, Global Home, not the plan that Your Honor approved and3

then wrote an opinion about, but a separate plan that was a4

sale-based incentive plan, Advance Marketing, and I think those5

are the three main cases that if you look at the facts of those6

cases they're almost identical to ours.7

Every case is slightly different, but the structures8

are very similar. It is a incentive plan that is triggered9

when the company effectuates either a deal through a sale or10

through a plan, and I believe, frankly, in all those other11

cases there were no time requirements.12

And in fact, I believe in some of those cases the13

debtor had already filed a motion for approval of stalking14

horse, or may have already obtained a stalking horse. So15

compared to those situations where you could say the deal is16

already baked, that there was going to be a deal presumably,17

because it was already on file and presumably the debtor wasn't18

going to file something that wasn't getting approved, here, we19

don't have a deal.20

We don't have a signed agreement with any party. 21

We're hoping to get there and hoping to get there as soon as22

possible, but it is not there right now. And there's no23

guarantee that we are going to be able to effectuate a sale or24

a plan in the time periods required.25

38


So compared to those other cases we think there is a1

higher hurdle than those approved plans. In terms of the2

proffer, again, Mr. Hughes, who is the company's chief3

restructuring officer, is here to testify to a number of items. 4

But in essence, his proffer would be as follows: that5

Mr. Hughes has a background in investment banking, and6

therefore is able to testify well and with experience as to the7

likelihood and difficulty of a sale or plan transaction in this8

case.9

That Mr. Hughes as the company's current chief10

restructuring officer is the party central to the deal11

structure, the deal process. He spends day to day dealing with12

the professionals and potential bidders or plan proponents;13

that as a result of the Chapter 11 case and this deal process14

not only he, but all the other executives subject to this plan,15

have experienced significantly higher job responsibilities and16

job demands.17

That they're own sort of day to day job, for lack of18

a better word, are made much higher by the demands of the19

Chapter 11 case generally, but that situation has been20

exacerbated even further, and to a large extent, a significant21

extent, by the fact that the debtor is now being asked and is22

agreeing to try to find a deal through a sale or a plan on a23

highly expedited basis.24

And that requires them to work significantly harder25

39


than they ever have and ever probably will for this company;1

that there is a clock on this case, so to speak; that the2

banks, the creditors and others have asked this company to try3

to find a deal on a quick basis, and that that has precipitated4

the increased job responsibilities, which again, are5

significant.6

That, and this is critical, based on his investment7

banking experience and his understanding of the company, which8

he knows inside and out at this point, that a deal in this9

case, while we think achievable and we're hopeful to get done,10

is by no means a lay-up and is difficult.11

In the current economic environment, in the current12

retail environment, finding someone to buy this company at a13

reasonable price is by no means easy, and it has been requiring14

the debtors to spend, with their professionals, significant15

time and efforts, and will continue to require the debtors to16

spend significant time and efforts getting that deal done; not17

only getting that deal signed up, but getting that deal through18

the Court and consummated with the buyer, and that the same19

applies with respect to a deal that would be structured as a20

plan.21

And then Mr. Hughes would also testify on two other22

points that I raised; number one, that the management team that23

structured this plan originally did take the plan to the board,24

that the board has approved the plan and that the original25

40


plans taken to the board were not the plans necessarily being1

proposed to the Court today; that management originally asked2

for materially greater compensation in this case and that that3

was rejected by the board and was finally negotiated to a level4

that is being proposed today, subject to modifications that5

were made by the committee, specifically the need for committee6

support for the sale or plan before the triggers would be met.7

And then secondly, as I said before, that the bonuses8

proposed as a percentage of base pay are comparable in most9

cases to the percentages that apply in a company's pre-petition10

EBITDA plans during normal periods, and that the targeted11

EBITDA was effectively the percentage of base that is being12

proposed today with respect to the sale/plan bonus structure.13

So Mr. Hughes would proffer -- or excuse me --14

Mr. Hughes would testify to all those items if he were to15

testify, and I think at that point it's fair to then turn it16

over to cross-examination, unless some other people have17

questions or Your Honor has questions.18

THE COURT: Thank you, Mr. Erens. Mr. Harrington,19

would you like to cross-examine now?20

MR. HARRINGTON: I would, Your Honor.21

THE COURT: All right. Mr. Hughes, if you'll step22

forward, sir. Thank you. And if you'll get into the witness23

stand and remain standing while you're there while you're24

sworn.25

41Hughes - Cross


THE CLERK: State your name for the Court and spell1

your last name.2

THE WITNESS: Michael Joseph Hughes, H-u-g-h-e-s.3

THE CLERK: Raise your right hand and place your left4

hand on the Bible.5

MICHAEL JOSEPH HUGHES, DEBTORS' WITNESS, SWORN6

THE CLERK: You may be seated.7

THE COURT: You may proceed when ready,8

Mr. Harrington.9

CROSS-EXAMINATION10

BY MR. HARRINGTON:11

Q Good morning, Mr. Hughes.12

A Good morning.13

Q My name's William Harrington. I'm with the office of the14

United States Trustee. With respect to the six individuals15

covered under this plan, have any of those individuals16

indicated to you that they have another job offer from any --17

A I have not discussed that with them personally, no.18

Q Okay. So you have no -- you don't have another job offer,19

do you, outstanding?20

A I do.21

Q What is that job offer?22

A An investment position.23

Q And are you leaving the company?24

A I am -- that's not my current intent.25

42Hughes - Cross


Q But to your knowledge, none of the other five individuals1

have job offers?2

A I really couldn't speak to it. To my knowledge, no.3

Q You have no evidence of that?4

A I do not have any evidence of that.5

Q Did you instruct anyone -- who developed this plan?6

A I think it was generally the senior management as7

presented to the board for approval.8

Q And were you involved in the development of this plan?9

A I was.10

Q Did you instruct anyone to do an analysis of whether the11

payments made under this plan were equal to 10 times the amount12

of the mean transfer obligation to similar type transfers given13

to nonmanagement employees?14

A I did not.15

Q And to your knowledge do you know if it is?16

A I do not.17

Q And you didn't ask anyone to do a calculation or an18

analysis of whether or not similar transfers to nonmanagement19

employees were equal to 25 percent of the amount, where this20

plan exceeds 25 percent of the amount of similar transfers to21

nonmanagement employees?22

A I did not.23

Q Okay. You're familiar with other retailers that are24

proceeding in Chapter 11 currently?25

43Hughes - Cross


A Yes.1

Q And generally speaking, is it ordinary for retailers to2

have positive EBITDA while they're proceeding in Chapter 113

proceedings?4

A I would think it depends on the facts and circumstances.5

Q But this company is -- after it had restructured by6

conducting GOB sales at its nonperformance stores this company7

is performing well financially?8

A I think this company long-term has the opportunity to9

perform well. I think the company has a short-term liquidity10

position. If you looked at this year with professional fees11

and such I think you'll see minimal EBITDA.12

Q But you will see positive EBITDA?13

A Based upon the DIP budget you would see positive EBITDA.14

Q And you have experience in other Chapter 11 retail cases?15

A I do not.16

Q Do not. You're familiar with other Chapter 11 retail17

cases?18

A I am.19

Q Do you know if those companies have positive EBITDA,20

generally?21

A I would think it varies.22

Q With respect to selling a company, is it more difficult to23

sell a company with positive EBITDA or negative EBITDA?24

A Well, I think there's a lot of other facts and25

44Hughes - Cross


circumstances. Certainly, I think the economic environment,1

the banking environment has a lot to do with it.2

Q But I --3

A And I would say you have different types of buyers, and4

there are a set of buyers who look at distressed companies and5

-- I'd be hard pressed to say one's easier than the other.6

Q All other things being equal, though, would you prefer to7

purchase a company that has positive EBITDA or negative EBITDA?8

A Positive EBITDA.9

Q Are you familiar with the job responsibilities of all of10

the individuals covered under the plan?11

A Yes, generally.12

Q Starting with Mr. Boyer, what are his job13

responsibilities?14

A Mr. Boyer is a director of stores.15

Q What does that mean?16

A He has five or six regional managers who report to him and17

reporting to those five or six regional managers are all the18

store managers. So he's the day to day operations of the19

store.20

Q And what would be his responsibility in connection with21

the plan of reorganization?22

A Really, what he got extensively involved in -- with was23

the GOB sale, and I know we say we went through that process. 24

We ran the auction and we had a 108, but practically speaking,25

45Hughes - Cross


it takes a lot more than that because we're working on how to1

exit the store, how to minimize the costs that we have to pay2

to a landlord, what do we do with the FF&E, and you know, he3

talks to me very frequently. So I would say that he's spending4

a significant amount of his time coordinating that GOB sale.5

Q Okay. But his responsibilities are related to store6

operations and the GOB sale?7

A Correct.8

Q What does he do specifically with respect to getting a9

plan confirmed in this case?10

A I think his involvement was in the thought of the CEO and11

including him in the plan, was that he had extensive12

involvement in the GOB sale.13

Q But he has no specific involvement in designing or the14

implementation of a plan of reorganization?15

A I would say that's true.16

Q What were his job responsibilities prior to the filing?17

A Day to day operations of the store.18

Q And other than his new responsibilities with respect to19

the GOB sale, they're similar to what he's -- the obligations20

he's performing currently?21

A I would say that's fair.22

Q What about Mr. Krieger?23

A Mr. Krieger is the chief merchandising officer, and he is24

responsible for the marketing, the buyers' report to25

46Hughes - Cross


Mr. Krieger and basically -- I'm not sure he has a title, but1

functions more as a president. I think he does have the title.2

Q What were his job responsibilities before the filing?3

A Well, that's basically what I described, is that he was in4

advertising and buyers' control of -- not control of inventory5

at levels, but determining what product to buy.6

Q Specifically with respect to the design or implementation7

of a plan of reorganization, what responsibilities would he8

have?9

A He is extensively involved in the meetings with10

prospective buyers. Obviously, they want to get his input from11

the day to day operations and prospects for the store. He's12

also extensively involved, which is critical to our success, to13

get to the point where we can get a transaction done,14

hopefully.15

He's interacting with the trade -- security and trade16

credit, negotiating terms and conditions, vendor allowances. 17

So you know, from the plan of reorganization to get from point18

a to point b, he's intimately involved with the trade, and from19

the point of trying to effectuate a transaction I would say20

he's integral to -- for a private equity firm to understand the21

company.22

Q With respect to his involvement with the trade, he would23

have had similar involvement with the trade pre-petition?24

A As you know, my experience is since April, but my pre-25

47Hughes - Cross


disposition is that he had involvement with the trade, but it1

is a day to day, constant -- the time allocation of the trade2

from his perspective has increased greatly.3

Q But pre-petition he would have had -- he would have been4

the person responsible for interacting with the trade with5

respect to merchandising?6

A In a different manner, correct.7

Q And while he's carrying out his responsibilities with8

respect to being a chief merchandiser -- merchandising officer,9

he doesn't have specific input into the design of the plan of10

reorganization, does he?11

A I might not be following that question, because I'm not12

sure any of us have specific input into the design of the plan,13

but --14

Q Who's designing the plan?15

A Right now, we're going down the path to secure a16

transaction. So we haven't really got to that plan design17

phase yet, if indeed it's a standalone basis.18

Q You're aware that the debtors had approved today an19

application to employ Lehman Brothers, an investment banker?20

A Correct.21

Q Correct? And what is Lehman Brothers being employed to22

do?23

A To help us identify candidates, negotiate with and24

effectuate a transaction.25

48Hughes - Cross


Q And are they leading that effort?1

A I think it is a team effort with all advisors involved.2

Q Do either Mr. Krieger or Mr. Boyer have any responsibility3

for identifying buyers?4

A No.5

Q Moving on to Mr. Flamholtz (phonetic), what is his role6

with the company?7

A He is inventory management and control.8

Q What does that mean?9

A He is determining inventory levels, doing the merchandise10

plan, determining what type of inventory we buy, when.11

Q And what involvement would he have in the design or12

implementation of a plan of reorganization?13

A I don't think he would.14

Q What interaction would he have with respect to Lehman15

Brothers in connection with the sale of an asset?16

A Well, again, the senior management of the company of which17

he's part of, as -- if Lehman identifies potential investors he18

participates in those meetings. I would also tell you what's19

critical in his role right now is the fact that our financial20

resources are limited, that we have to go and re-prioritize21

what we're buying and when.22

And he is interacting extensively with potential23

buyers, trying to explain the comps or sales decline relative24

to inventory decline and so forth like that. So his inter --25

49Hughes - Cross


inter-reaction with Lehman is due diligence requests related to1

specific requests of potential buyers.2

Q And pre-petition, he would have been responsible for3

managing the inventory based on whatever financial constraints4

the debtors had pre-petition as well, correct?5

A Yes.6

Q Russell -- and I'm not going to --7

A Deam (phonetic).8

Q Deam, what are his responsibilities?9

A Russ is the CFO of the company.10

Q What were his responsibilities pre-petition?11

A Typical chief financial officer role, preparation of12

financial statements, audit, tax returns, that type of thing.13

Q What role would he play in the design or implementation of14

a plan?15

A I don't think he'd be -- as I said, we really haven't gone16

down that road yet.17

Q Okay. And what are your responsibilities?18

A I'm the chief restructuring officer.19

Q And you were retained when?20

A April of this year.21

Q And you're retained in what capacity?22

A To be an EVP of capital development. My role was to be23

the financial person over the CFO.24

Q Is that similar to what your role is today as a CRO?25

50Hughes - Cross


A It is not.1

Q What's different?2

A I am spending most of my time interacting with potential3

buyers on due diligence, spending a lot of time in court here. 4

I would tell you that the role I have today is not what I5

envisioned when I signed up.6

Q What was your role in April and May of this year?7

A April and May, when I first took the position at the8

company I knew the financial condition, although I will tell9

you I maybe did not know the severity of it. I spent a lot of10

time looking at strategic alternatives other than bankruptcy,11

which may have included, you know, raising capital, looking at12

ways to refinance the debt structure of the company, and very13

honestly, looking at the bankruptcy as a strategic alternative.14

Q So analyzing how to restructure the company?15

A Correct.16

Q And post-petition while you're doing that in bankruptcy17

you're still analyzing how to restructure the company either18

through a sale or a plan of reorganization?19

A To a much lesser extent, yes.20

Q And I think you've answered this question already, but21

what's your role in designing the plant?22

A I think you're right, I've answered it. I -- there's --23

it's really not at that stage yet.24

Q And what's your responsibility for bringing buyers to the25

51Hughes - Cross


table with respect to a transaction?1

A I've identified some potential subdebt providers, but as2

far as providing private equity buyers I have not identified3

any.4

Q And that primary responsibility is on Lehman Brothers?5

A I think it's primarily on Lehman Brothers, but I would say6

-- and I've been on both sides of the table as an investment7

banker and as a principal -- there has to be someone on the8

company's side to really control that process, and I don't say9

this in an unkind way, but to control the investment banking10

process. So I think a company would be remiss to let that run11

by itself and I do think there has to be somebody who manages12

it.13

Q And who -- are you that someone?14

A I am that someone.15

Q But Lehman Brothers has primary responsibility for16

identifying various buyers?17

A Under the direction of the company, correct?18

Q What about Kenneth Laken?19

A Ken Laken obviously is a CEO and all those individuals20

that we have previously discussed report to him, and he has a21

typical CEO role. Maybe I'm anticipating your next question,22

but his role has changed in that he is, again, interacting with23

a lot of potential buyers on the due diligence side, and24

interacting with both Jones, Day and Lehman much more on a day25

52Hughes - Cross


to day basis.1

Q But pre-petition he would have had overall responsibility2

for running the company?3

A That's correct.4

Q And he still has overall responsibility for running the5

company?6

A That's correct.7

Q And again, you've probably answered this question, but8

what is his role in the design or implementation of a plan of9

reorganization?10

A None at the current time.11

Q Is he responsible for bringing any buyers to the table?12

A He actually has identified a couple of potential buyers,13

yes.14

Q But again, primary responsibility for identifying buyers15

would be Lehman Brothers?16

A Well, I'll stand by my first answer. I think under the17

direction of the company, yes.18

Q Under the terms of this plan are there any requirements as19

to what need to be contained in a plan or -- plan of20

reorganization in this case currently envisioned?21

A I'll go to Mr. Erens' earlier comment. I think the -- the22

sort of the barometer to see whether the plan is acceptable is23

the unsecured creditors' committee approved by the Court. So24

is there a financial criteria or something like that? There is25

53Hughes - Cross


not. But there are so many moving parts here.1

I mean, we actually very early on looked at that in a2

very broad way, and maybe there's financial guys smarter than3

me, but -- and there are -- but I think that we really could4

come up with a way to quantify that plan.5

Q And assuming that the committee signs off on a6

transaction, is there any current requirement as to a level of7

proceeds that need to be achieved under this plan?8

A Well, I can't speak for the committee, but I would think9

financially you would say that it would have to be better than10

the liquidation plan, or at least that's what the analysis of11

the unsecured creditors would say.12

Q But there's no requirement in this plan that it be better13

than the fire sale liquidation?14

A I guess I'd go to the -- sort of the logic point of it. 15

If it wasn't, why would it get approved? I mean, I guess --16

Q But contractually in terms of this plan, there's no17

requirement; if the committee signed off on such a sale this18

plan would be approved?19

A If the committee signs off on it, it would be approved,20

correct.21

Q And so if we had an -- and again, I'm just using22

hypothetical numbers -- an $80 million plan that the committee23

signs off on and it's -- the sale of the assets -- or an $8024

million sale that's completed by January 6th, the individuals25

54Hughes - Cross


covered by this plan would be entitled to their bonuses?1

A At an $80 million sale -- and I know you're using2

hypotheticals -- no, I don't think we'd get approved. I -- you3

know -- it's a much greater size at stake than that.4

Q But --5

A But if your -- if the question is, could the committee6

make a -- an inappropriate financial decision and approve the7

plan to the benefit of the management? I suppose that that8

could happen. Don't know why it would happen, but I guess it9

could happen.10

Q And specifically, though, under the terms of this plan11

there is no numerical target in which the company needs to meet12

current --13

A No, there's not.14

Q And the company currently has letters of intent from15

various buyers?16

A We have some initial term sheets, yes.17

Q From multiple parties?18

A We currently have two, I believe.19

Q And is that for sale of all the assets?20

A Yes, substantially all the assets.21

Q In addition to the same criteria that applies to the other22

five individuals covered under the plan, you also have a23

separate trigger covered under the plan, correct?24

A Correct.25

55Hughes - Cross


Q And that trigger is you receive 50 percent of your bonus1

for the consummation of a non-going concern transaction?2

A That's correct.3

Q And under the terms of the plan what are the parameters of4

that transaction?5

A Again, I think the parameter would be -- would have to be6

approved by the unsecured creditors' committee and ultimately7

the Court.8

Q But there's no current definition of what constitutes a9

sale of non-going concern assets contained in the plan?10

A No, there isn't.11

Q And there's no numerical requirement that a certain dollar12

threshold has to be met with respect to that transaction?13

A Again, I would say there are so many moving parts that to14

come up with a dollar threshold would be -- I couldn't do it at15

this point in time.16

Q So as we stand here today, with respect to that17

transaction it's your understanding that as long as the18

committee's signed off on it and that was approved by the19

Court, you would receive your bonus?20

A That's correct.21

Q Do you know if the executives covered under this plan22

received bonuses in 2007?23

A In 2007 I believe they did.24

Q Do you know what those bonuses were?25

56Hughes - Cross


A Mr. Laken did not receive a bonus in '07, and I believe1

the bonuses of the others were in that 30 to 40 percent range.2

Q Did they meet their EBITDA targets?3

A That is my understanding, that the plan was based upon an4

EBITDA level.5

Q And do you know if they met that --6

A That would have been the EBITDA level for '06. They would7

have been paid in '07, right.8

Q Did they receive bonuses in 2008 for the EBITDA levels in9

2007?10

A No.11

Q And that's because they failed to meet the EBITDA12

targets --13

A Correct.14

Q -- for 2007? Do you have an understanding as to whether15

or not they met the EBITDA targets for 2006?16

A I really don't know.17

Q When you first came to the company was there a bonus plan18

in effect that had EBITDA targets?19

A Yes.20

Q And the company's not going to make those EBITDA targets,21

correct?22

A No.23

Q And were those EBITDA targets established by the board of24

directors?25

57Hughes - Cross


A I believe so.1

Q Or were they approved by the board of directors?2

A I believe they were approved by the board.3

Q And I'm going to ask the similar questions that I asked4

for the plan of reorganization with respect to the sale5

transaction. What involvement would Mr. Boyer have in6

connection with a sale transaction?7

A Well, it is -- he is involved somewhat on preparing. I8

don't know that specifically he's been involved in any of the9

due diligence meetings, but certainly, as that progresses he10

would participate in the due diligence from buyer -- potential11

buyers looking at the stores.12

Q And is it fair to say that primarily it's important that13

he stays with the company --14

A Yes.15

Q -- through a sale process?16

A Yes.17

Q And completes his ordinary job responsibilities in18

connection with the sale -- with the running of the company19

during that time?20

A I think that's fair.21

Q Would the same be true of Mr. Krieger?22

A Yes.23

Q Would again the same be true of Mr. Flamholtz?24

A Yes.25

58Hughes - Cross/Redirect


Q Mr. Deam?1

A Yes.2

Q Yourself?3

A Yes.4

Q And Mr. Laken?5

A Yes.6

MR. HARRINGTON: Your Honor, I have no further7

questions.8

THE COURT: Thank you, Mr. Harrington. Any follow-9

up, Mr. Erens?10

MR. ERENS: Yes, please.11

REDIRECT EXAMINATION12

BY MR. ERENS:13

Q Mr. Hughes, I want to talk a little bit about each of the14

executives again --15

A Okay.16

Q -- sort of clarify some of the facts. You testified that17

Mr. Boyer was intricately involved in the currently underway18

GOB process?19

A Correct.20

Q In your opinion, based on your knowledge of what's going21

on with this company, what would have happened if that GOB22

process has not been consummated?23

A Consummated in conjunction with the bankruptcy? Well,24

those --25

59Hughes - Redirect


Q Yes. Meaning, what position would the company be in if it1

was not able to consummate that GOB sale?2

A From a liquidity perspective we would be very much3

constrained. That GOB sale net after payment of the bank freed4

up about 6 to $7 million, which we used to buy inventory.5

Q Do you have an opinion as to whether the debtor would have6

gotten its debtor-in-possession financing facility if it had7

not been able to consummate the GOB sale?8

A I know it was a condition precedent. I believe it was --9

it may have been a covenant, but that was a requirement of the10

banks, to have that GOB sale complete.11

Q And in your opinion what would have been the impact on the12

sale process if the debtors had not obtained the debtor-in-13

possession credit facility?14

A I don't think we'd have a sales process, per se.15

Q Okay. And you testified that the proceeds of the GOB sale16

were used to pay down the secured banks?17

A Correct.18

Q And what effect did that have on abilities -- the ability19

of the company to buy inventory?20

A Well, it was, in addition to being able to pay down the21

banks as required under the formula, there was supplemental22

amounts that were freed up to purchase inventory. What we23

tried to do with that was pay so much in advance and then use24

the line that we had available to buy more. So it was critical25

60Hughes - Redirect


to securing inventory.1

Q In your opinion is it important to prospective buyers that2

the debtor be able to continue to buy inventory?3

A Absolutely.4

Q Do you think if the debtors do not have available funds to5

buy inventory that buyers would be willing to purchase this6

company on a going concern basis?7

A I do not.8

Q Okay. The buyers that you've talked to, have they9

indicated interest in negotiations with landlords and/or10

reviewing physical store locations?11

A Yes.12

Q Would Mr. Boyer be involved in that process?13

A Yes, he would.14

Q And what would he do in that process?15

A He would coordinate the visits, and the -- as far as the16

leases, we have another individual who would probably be17

involved in that also.18

Q Okay. And how many stores does the company have?19

A Currently 39.20

Q And so it would be Mr. Boyer's job to coordinate with21

buyers, potential inspections of 39 stores?22

A That's correct.23

Q Okay. Let's talk about Mr. Krieger. Prior to the24

petition date, to your knowledge, did Mr. Krieger spend -- or25

61Hughes - Redirect


prior to sort of a state in time before the petition date, let1

me say that, did Mr. Krieger spend any real time trying to2

actually get product into the company? Was that a difficult3

process?4

A No.5

Q Okay. Did that become a difficult process?6

A Yes, it did.7

Q Is it a difficult process today?8

A Yes, it is.9

Q Do you believe Mr. Krieger is spending significant time10

trying to get product into the company today?11

A I do.12

Q And how would you describe the amount of time it appears13

he's spending?14

A I would say greater than 50, and I would guess more like15

75 percent.16

Q Okay. Though you probably answered this question, I'll17

ask it again in connection with Mr. Krieger as opposed to Mr.18

Boyer. Do you think it's important to prospective buyers that19

the company be able to continue to procure inventory?20

A Absolutely.21

Q And is that a minor item or is that a major item?22

A That is very much a major item. I mean, comp store sales23

are contingent upon having the inventory, and you know, we can24

explain away somewhat the comp store sales decline, but25

62Hughes - Redirect


inventory is obviously critical.1

Q Okay. Let's go on to Mr. Flamholtz. If you could repeat2

again what his role in the company is?3

A He is in charge of inventory management and control.4

Q And that's means sort of what?5

A Well, he's spending some of his time doing exactly what6

Mr. Krieger's doing, interfacing with vendors. But also, re-7

forecasting the merchandising plan to understand what and when8

we can buy inventory.9

Q And how many vendors does the company have, approximately?10

A 3,000.11

Q 3,000 vendors. Okay. Thank you. Let's go onto to Mr.12

Deam, the company's chief financial officer.13

A Yes.14

Q In terms of his role in the sale process, how would you15

describe that?16

A Extensive.17

Q And what does he do on a sort of day to day basis in18

connection with that? Again, not his normal role of CFO --19

A Right.20

Q -- of the company.21

A Right.22

Q Just in the sale process.23

A We have several parties, I would say, you know, a handful24

that are fairly active. We've created a data room through25

63Hughes - Redirect


Lehman, but the due diligence requests that are coming in are1

continuous, and he is spending a significant portion of his2

time on the due diligence requests of buyers.3

Q Would you -- how would you describe the volume of4

information that Mr. Deam and his office have provided to5

buyers?6

A Very, very significant.7

Q Okay. Does the company have a internal legal department?8

A No.9

Q So is there anybody in the company who has a legal10

background who can assist Mr. Deam in providing due diligence11

materials?12

A No.13

Q Okay. Let's go on to yourself just for a minute. I think14

there was some testimony that some of the stuff you're doing15

today, some of the job responsibilities, have some similarity16

to what you were doing pre-petition, although there's17

significant differences. Is that correct?18

A That's correct.19

Q Would you describe your job responsibilities as easier or20

harder than they were pre-petition?21

A I would say harder.22

Q A lot harder?23

A A lot harder.24

Q Okay. Thank you. There's some discussion about a plan of25

64Hughes - Redirect


reorganization, and I think it was your testimony that it's a1

little bit preliminary because the company has not designed the2

plan. Is that correct?3

A That's correct.4

Q In your view, would a plan of reorganization for this5

company require that some party, i.e., a plan proponent, infuse6

the company with capital?7

A I really don't say -- see how this company could survive8

without some infusion of capital.9

Q Okay. So it's -- to the extent the company is going to10

design a plan of reorganization, would it be your testimony11

that that plan would require someone to acquire the stock of12

the reorganized entity through infusing capital to purchase13

that stock?14

A Or corner of the assets, yes.15

MR. HARRINGTON: Your Honor, please -- just16

objection. I think his prior testimony was they haven't gone17

down that road. So this is speculation.18

MR. ERENS: It -- the source of inquiry by the U.S.19

Trustee's Office is what involvement parties would have in a20

plan.21

THE COURT: Yes.22

MR. ERENS: I think Mr. Hughes testified, and we're23

not disagreeing, that we're not quite at the point of24

specifically designing the plan, but it would be our view that25

65Hughes - Redirect


we know what that plan will provide, more or less.1

THE COURT: I'm -- I'll overrule the objection. I'll2

allow the testimony here because I think it does go to the3

issue of participation eventually in plan preparation.4

BY MR. ERENS:5

Q Okay. So general structure of the plan, it would be your6

testimony, that the plan proponent would buy the stock of the7

organized entity by putting money into the company?8

A Or buy the assets, I guess, right.9

Q Okay. Now, in your view is that an acquisition of the10

company?11

A From the buyer's perspective? It's -- we talk about12

having an investor, but at the end of the day it's pretty much13

an acquisition of the company.14

Q Okay. So is there really a -- at the end of the day -- a15

fundamental difference in this case between a sale of the16

company through a 363 and an acquisition of the company by a17

plan of reorganization?18

A No.19

Q So to the extent plan proponents show up do you believe20

that the company and its executive subject to this plan would21

be doing some of the same, or really, a lot of the same22

interaction with those buyers, even though the deal on the23

table would be a plan?24

A That's correct.25

66Hughes - Redirect


Q Okay. Thank you. There's some discussion about the role1

of Lehman Brothers in this process. Has Lehman Brothers2

brought to the table all of the potential acquirers the3

company's dealing with right now?4

A They have not.5

Q Okay. So the company has brought forward some of those6

buyers?7

A That's correct.8

Q Okay. There was some discussion of the creditors'9

committee, as well. You testified that the company is sort of10

in the expression of interest or term sheet stage of a sale11

process?12

A Correct.13

Q Has the company submitted those expressions of interest to14

the creditors' committee?15

A Yes.16

Q Has the creditors' committee indicated in any case that17

their potential support for deals reflected by those term18

sheets would be contingent upon the purchase price in those19

term sheets going up?20

A Absolutely.21

Q Okay. Thank you. Based on your view of the situation22

before you in the company and your investment banking23

experience, would you view a sale, that is, to a plan here, a24

363 sale, as a hard or difficult deal relative to all the deals25

67Hughes - Redirect


you've done in your life?1

A I would say probably a little bit more difficult.2

Q Okay. There was finally some discussion regarding the3

trigger separately for yourself --4

A Yes.5

Q -- in the event of an on-going -- non-going concern6

transaction. I just want to clarify, it was your testimony7

that that trigger would be reached if the liquidation deal was8

supported by the creditors' committee. Is that correct?9

A Correct.10

MR. ERENS: Okay. I don't think I have any further11

redirect, Your Honor.12

THE COURT: Thank you, Mr. Erens.13

MR. HARRINGTON: I have nothing further, Your Honor.14

THE COURT: Mr. Harrington. Anyone else? Okay. 15

Mr. Hughes, you may step down.16

THE WITNESS: Thank you.17

(Witness excused)18

MR. ERENS: I guess we're onto the argument phase.19

THE COURT: Yes, we are.20

MR. ERENS: We've made most of the arguments, or I've21

made most of the arguments before, but I think I'll reiterate a22

couple things that I think are still true, based on the23

testimony.24

THE COURT: Exactly.25

68


MR. ERENS: First of all, there were some questions1

of Mr. Hughes in the testimony regarding the standards of2

503(c)(1). We think that's irrelevant because we indicated our3

belief, and I think it's well-supported by the facts and4

circumstances here that 503(c)(1) does not apply.5

We've said before but we reiterate, there is a proxy6

for value here. It is the committee's support. The committee7

is not going to support a deal here that does not maximize8

value, and the testimony showed already that the company taken9

expressions of interest to the committee to say, we'd like to10

go forward on this deal and the committee has said, yes, maybe,11

but you'd better get the price up.12

That would be exactly what everybody would expect13

here, and that is what will occur here. So there is a proxy14

for value. There are thresholds. It is not any deal we put in15

front of this Court that will trigger a bonus in this case. We16

had mentioned also in terms of "precedent," and I realize these17

are all unreported orders. So they don't have any binding18

effect on anyone, including yourself even if they're your own19

orders.20

THE COURT: Right.21

MR. ERENS: That other plans that we've cited in our22

papers did not have dollar thresholds. They were thresholds23

that deals had to get done. I don't think they had any time24

frames. Deals have been approved if the transaction gets25

69


approved. Here, we do have a threshold. Committee support is1

the value threshold. The time frame, though, is extremely2

important. That is not a lay-up. We have to get a sale done3

or a plan done within a quick period of time.4

We're not breaching our fiduciary duties if we don't5

do that. That would be extraordinary efforts in our view in6

this case. In terms of the executives' involvement in this7

process, we think the testimony, especially on redirect, made8

clear that each of these executives is integral to the sale or9

plan process.10

I don't think there's any dispute that Mr. Hughes is11

highly important to that process, that Mr. Laken as the CEO of12

the company is highly important to that process, that Mr. Deam13

as the CFO of the company and a functional equivalent of the14

internal legal department, frankly, is highly important to that15

process.16

I think the U.S. Trustee's Office is trying to make a17

point that it might be their belief that Mr. Boyer or Mr.18

Flamholtz or Mr. Krieger aren't important to that process. 19

Nothing could be further from the truth. With respect to the20

buyers' acquisition of inventory, trade relationships and the21

like are critical to a sale here.22

A buyer is not going to buy this company if we don't23

have trade support. That's the business. Our business is24

acquiring inventory and selling it to the public. If we don't25

70


have inventory there is no business to sell. With respect to1

Mr. Boyer, it was -- there was testimony of the fact that he2

was critical to the GOB process, which has allowed us to get to3

this point.4

We have to -- you know -- from a to b there are5

several steps. There are several moving parts, as Mr. Hughes6

indicated. Mr. Boyer was critical to get us the GOB process. 7

They got us the DIP and is giving us the availability to8

acquire inventory.9

Now, I realize that's in the past, but I don't think10

we can completely forget that, but there is a future. We've11

got 39 stores. That is effectively what a buyer is buying12

here. A buyer is buying here. A buyer is buying trade13

relationships and store locations.14

We've already talked about the trade relationships. 15

The store locations are critical. A buyer has to look at all16

of them, has to look at the leases, has to go out and do17

inspections, has to get a feel as to whether the store platform18

makes sense.19

You know, a store in any location doesn't do as well20

as a store in other locations. So Mr. Boyer will be21

responsible for that. We've got, I don't know, 30-60 days and22

39 stores. I have a feeling Mr. Boyer will be incredibly busy23

over the next several weeks.24

We also make the point that the percentages in our25

71


plan reflect the relative involvement. Mr. Hughes' bonus is1

100 percent. He is the most important party to this process. 2

That is the reason he gets the higher bonus or the highest3

bonus. The CEO gets a lower bonus.4

The CEO is heavily involved, but he also obviously5

has to run the company day to day, so he's not spending all of6

his time, 100 percent of his time on a sale, although he's7

spending a lot of time. But his bonus then reflects the fact8

that he is the second most important person in that process.9

Mr. Krieger and Mr. Deam and Mr. Flamholtz get I10

think 30 percent -- I don't have the numbers in front of me --11

and Mr. Boyer who, you know, we might all look at this and say12

he's maybe the least important in that process, but he is13

important, but his percentage is 20 percent.14

So the plan was logical. The plan percentages15

reflect the relative parties' involvement and value added to16

the process. There was testimony that this is not a lay-up. 17

This transaction, we think the facts of it speak for18

themselves. We do not today have a plan.19

We don't have a sale. We've testified that we have20

expressions of interest. We've got a clock. It's not a long21

period of time. We're not talking about getting a deal done22

by, you know, July of next year. We're talking about getting a23

deal done by the end of this year, effectively, on sale and to24

confirm a plan by February, which, you know, of course, if you25

72


do the math, Your Honor, to confirm a plan by February,1

presumably, we're going to have to file that plan in the2

exclusivity period.3

So we think that is extraordinary efforts, given the4

difficulties in the marketplace that Mr. Hughes testified. As5

to the liquidation bonus, I don't we need to spend a lot of6

time on it. I think the -- sort of the testimony speaks for7

itself. We wouldn't mention that the Advance Marketing case,8

which is not your case, it's Judge Sontchi's case, is a case9

that supports exactly the type of bonus we're talking about, a10

bonus in the event of liquidation.11

There's no dollar threshold there either, and matter12

of fact, it was not a total liquidation in that case. There13

were specific responsibilities that the party who would be14

getting the bonus had to fulfill, things like collection of15

receivables, return of inventories to sellers and the like.16

And so we think that the liquidation bonus, again,17

fits the standards and would be important to maximize value. 18

We can't make a sale occur here. We want to have a sale occur. 19

We think the committee will support a sale if it makes sense,20

but there has to be a buyer.21

And as a result, if, despite our best efforts, things22

don't quite happen the way we want, there still is a lot to do23

with it. There's still a lot of value maximized. We've got24

hundreds of millions of dollars in value of assets, and25

73


hundreds of millions of dollars of creditors to satisfy it.1

And it's not an easy task just to make sure that2

those two things happen, especially in today's environment. 3

And again, the bonus is lower to reflect the fact that the4

value would be lower, again, subject to committee support. So5

for all those reasons and the reasons indicated through6

testimony, and originally, we think the plan can be approved,7

is in the best interest of the estate, satisfies the debtors'8

business judgment, and again, should be approved. Thank you.9

THE COURT: Thank you, Mr. Erens. Mr. Kanowitz, if10

you would like to speak you're welcome to.11

MR. KANOWITZ: Briefly, Your Honor. The record is12

clear, and overwhelmingly supports the motion. I just rise to13

give you the input from the committee's perspective. What we14

did, you know, clearly, we looked at what these executives15

received pre-petition, looked at their employment contracts.16

We are experienced counsel from the Cooley, Godward,17

Kronish firm, and are familiar with other cases, RICO cases in18

particular, and understand what other plans are. We discussed19

this all with the committee. They voted. They reviewed the20

plan. They are fully informed and as indicated in the motion21

and on the record, they support it.22

I'm almost troubled, though, by the U.S. Trustee and23

his concern -- or her concern -- through the -- you know -- the24

acting trustee about the committee's role in this. I would25

74


think that they would be happy that we would be the stopgap, if1

you will, for the debtor just doing what it wants and getting2

the executives paid.3

That is sometimes the case where the debtors just do4

what they want. Then they string out cases and people collect5

salaries and get bonuses at the end. Anyway, I mean, the6

results aren't there. This is completely the opposite case,7

and as the testimony indicated, there are letters of intent out8

there that are being negotiated and the committee is actively9

involved.10

Mr. Gottlieb, the chair of our department, is11

actively involved in those negotiations directly with the12

debtors, as well as with the potential buyers. And I think13

it's just a little too simplistic to start saying there has to14

be a number in a plan for there to be success or for a metric15

to be reached.16

It's just too fluid and I don't want to chill the17

offers that we're receiving by speaking out of turn in court,18

but I would just say this. The committee is looking at short-19

term, as well as long-term strategic options. Numbers matter. 20

So do the overall scheme of how things work out, and I'll leave21

it at that.22

And that's what we're doing and we're working hand in23

hand with the debtor and the professionals, as well as the24

management to make sure that the best result comes out through25

75


this case. And that would be a plan of reorganization or sale1

supported by the committee that the debtors then get approved2

by the Court. That's it, Your Honor, unless you have any3

questions.4

THE COURT: I don't, Mr. Kanowitz. Thank you, sir.5

MR. KANOWITZ: Thank you.6

THE COURT: I appreciate it. Mr. Harrington,7

whenever you're ready, sir. Take your time8

MR. HARRINGTON: Thank you, Your Honor. For the9

record, William Harrington, again, from the Office of the10

United States Trustee. A couple of points, Your Honor. I11

guess we did lay out a lot of our position in opening argument12

and I'll try not to repeat it. Based on the testimony I don't13

think our position has changed.14

THE COURT: Okay.15

MR. HARRINGTON: Your Honor, I want to address the16

committee's point first. We certainly appreciate the efforts17

of the committee and the committee being involved in the18

process, end we certainly think that it's very important that19

the committee be involved in the process here.20

But the statute says, Your Honor, that you're the21

stopgap, not the committee, that you need to make the22

determination, and that you need all the facts available at the23

time you make the determination. The problem is, Your Honor,24

this is a proposed plan of things that are going to happen in25

76


the future.1

We don't have a sale -- we don't have numbers on the2

table, projections that these individuals have to be3

incentivized to raise the price to a certain level. We don't4

even have a plan, or kind of a plan framework currently in5

effect.6

So all's we have is the requirement of time and the7

requirement that the plan be supported by the committee under8

the circumstances. And that's all Your Honor has to go on. 9

That's all this plan is about. Your Honor, the testimony,10

which I think was uncontroverted, was the primary importance of11

these individuals to the process is that they stay in place and12

complete their current job functions.13

We're not arguing that these are key employees to the14

company, that they perform essential services for the company. 15

Certainly, in a retail case merchandise and inventory is very16

important to a company to survive, in and out of bankruptcy. 17

These are key employees, and the problem is, Your Honor, they18

are not -- there's no incentive for them to raise the price19

here.20

It's just to get a sale done to maximize value for21

the estate, and to get a plan confirmed, which under their22

current obligations as fiduciaries of the estate, they were23

obligated to do. There are no additional duties. Certainly,24

the overlay of a bankruptcy always makes work more difficult.25

77


It always requires new responsibilities for1

management of a company in bankruptcy. That's every bankruptcy2

case, Your Honor. And Congress was well aware of that when3

they established these new limitations for payment of bonuses4

to executives.5

And Congress was very concerned about the payment of6

-- payments -- bonus payments to executives based on key7

employees getting retention bonuses going forward. And really,8

Your Honor, I think all the cases have addressed the retention9

issue, including yourself.10

When the primary issue is retention of the employees,11

that's evaluated under 503(c)(1). And the testimony's pretty12

clear that no one else is here and no evidence was presented13

that the debtor can satisfy their requirements under 503(c)(1)14

here. They may be able to satisfy some other requirements,15

Your Honor.16

I don't think there's a dispute that the services17

provided by these people are essential to the survival of the18

business, but I think that's what's -- that's the fundamental19

factor here. I think the testimony was the primary importance20

of these individuals is to stay in place, to continue to be21

retained by the debtors and to perform their ordinary job22

functions in an extraordinary environment, being the Chapter23

11.24

But that's every Chapter 11 case, Your Honor. There25

78


is no evidence, other than Mr. Hughes, that there is another1

bona fide job offer on the table, and there was no evidence and2

no analysis done of the third factor, and all three factors are3

required. You can't just have one factor under 503(c)(1).4

THE COURT: Correct.5

MR. HARRINGTON: That there was any analysis done or6

any calculation of the two final components in 503(c)(1)(C). 7

So Your Honor, the debtors haven't met their burden und8

503(c)(1), and when the testimony is that the primary9

importance of these individuals is that they stay retained and10

complete their ordinary job functions through the plan process11

and through the closing, so we could maximize value for the12

estate, that's governed by 503(c)(1).13

And if that's not governed by 503(c)(1), nothing is14

governed by 503(c)(1), Your Honor, and that provision of the15

Code was put in by Congress for no purpose. So I think Your16

Honor has to look at it from that framework, and Your Honor17

also has to be the stopgap.18

It's -- the Code and Congress require Your Honor to19

be the stopgap, and not to delegate that to the committee. And20

while we appreciate the efforts of the committee and the21

importance of the committee in being involved in the process,22

you're the final arbiter.23

You don't have enough yet to make that decision, Your24

Honor. We know these are key employees. We didn't argue that25

79


the amounts here were unreasonable. We didn't take a position1

with respect to that, Your Honor, but we do think you have to2

meet your requirements of the Code.3

Your Honor, with respect to timing, and I think very4

recently Your Honor has commented several times upon the timing5

of sales in Chapter 11 cases, the timing proposed here for a6

sale process is not extraordinary by any measure of the current7

cases I think Your Honor has before you.8

I mean, Your Honor has before you many cases where9

sales are completed in a far shorter time than is envisioned10

here. So I think it's not fair to say that this will be an11

extraordinary process to get the sale completed in the time12

frames that are established here.13

With respect to a plan, certainly, in a typical case14

you see extensions of the exclusivity period. So -- but15

meeting the exclusivity period, that's the first requirement in16

the Code and not getting that extended, Congress certainly17

thought people could do that or they wouldn't have set that18

exclusivity period.19

So while maybe in the current world that might be,20

you know, different from the ordinary case, Congress certainly21

didn't deem it to be extraordinary to get it done within the22

statutory exclusivity period. So Your Honor, I don't think we23

have an extraordinary time constraint here.24

And I think when the primary importance of the25

80


individuals is to stay retained and complete their ordinary job1

functions, which are critical job functions to this company, I2

don't argue that it's critical that the CFO be able to gather3

and collate documents for document review, that the4

merchandising director stay on top of merchandise and manage5

merchandise correctly, that the inventory in a retail case has6

to be manager.7

But because you're a key employee and you stay8

retained, if you're an insider that's governed under 503(c)(1),9

and we have a stipulation here that they're insiders and this10

is a non -- with respect to this plan -- and this is a non-11

ordinary course transaction, and it's governed by 503(c)(1). 12

And again, if this is not, there's no purpose to 503(c)(1),13

Your Honor.14

THE COURT: Let me ask you a -- just a -- it's a15

somewhat philosophical, but I think it's a very pertinent16

question. Let's assume that this plan had specific EBITDA17

targets as incentives. Now, I've always thought that the18

management of any company has as its ordinary job, as its19

ordinary obligation, the duty to maximize the financial20

benefits, if you will, for the company. That's their ordinary21

job. If you're correct, then no incentive program would be22

acceptable.23

MR. HARRINGTON: Not so, Your Honor. I think most24

incentive programs that are employed by companies, and I think25

81


Your Honor can somewhat -- there has been no competition1

consultant here. So there is no evidence of industry standard2

with respect to compensation programs.3

But generally, they set a robust target, and target4

that is incentivizing to employees. And they usually stagger5

it so there are multiple tiers, so if you meet the lowest tier6

and you've put forth a good effort that's a little bit more7

than just showing up for work, you get the lowest tier.8

But if you put in the extra effort to increase the9

EBITDA target you get more. And if you exceed what the company10

had envisioned as its target you then can get even more. And11

that's how normal incentive plans are structured, that there is12

a target to shoot for.13

Here, you have no evidence of a target other than14

that's going to be delegated to the committee to, in its15

judgment at the time, to make a decision as to whether that's16

an acceptable target. So there's no incentive to reach a17

target that's been predetermined, and all companies set targets18

based on their projections.19

That's not atypical. Most of the sale incentive20

plans I think that have been approved in this district and21

other districts have had incentivizing targets. And when they22

haven't, when they've been first dollar plans, such as a -- you23

know -- you get one percent of the proceeds of any sale,24

generally, they've been denied as not having incentivizing25

82


targets, because they're first dollar payouts.1

Here, there's no target. It just has to be2

completed, and if there is target, Your Honor is being asked to3

delegate your analysis of that target to the committee, and the4

committee's going to make that determination. Under the Code,5

even if we're not in 503(c)(1), under 503(c)(3) Your Honor has6

to make a determination that it's justified by the facts and7

circumstances. How can you make that determination, Your8

Honor, without a target to evaluate?9

THE COURT: Well, but would we be in agreement that10

your office appointed a committee of -- whose membership11

consists of creditors who in the United States Trustee's12

judgment will best represent the interests of the creditors of13

this debtor?14

MR. HARRINGTON: Absolutely, Your Honor. We think15

they are -- we applaud their efforts to be involved in the16

process, and we do not dispute that it's essential that a17

committee is involved in the process. But Congress said Your18

Honor needed to be the final arbiter, not the committee when it19

comes to retention plans, and Your Honor had to make the20

judgment as to whether or not it's justified by the facts and21

circumstances.22

If they're -- I mean, I think the other factors at23

503(c)(3), I don't think there's any argument we are dealing24

with officers or managers, and we have a non-ordinary course25

83


plan. So I think we're outside of the framework, and there's1

always the underlying framework of 363, but we have the higher2

standard of 503(c), which has the overlay of 503(b), that it3

has to be an actual and necessary expense.4

THE COURT: Right.5

MR. HARRINGTON: So I think to get over the standard6

of 503(c)(3) we have all the factors there, and that Your Honor7

would have to make a determination that it's justified by the8

fact and circumstances and actual and necessary expense of the9

estate. But Your Honor doesn't have sufficient evidence before10

you today to make that determination.11

And I'm not saying, Your Honor, that when we got to12

the plan process if these bonuses were put in the plan, and in13

fact, they're not payable until after the plan process is14

completed, all creditors would have a chance to look at it,15

Your Honor would have a chance to look at it and I don't think16

we'd be standing here today with respect to that.17

If we had specific stale metrics that were18

incentivizing and evidence could be put forth today for Your19

Honor that these were incentivizing because, you know, we had20

received letters of intent at this level and that if we do x21

amount of work involved in the sale process and reach this22

level, that will be maximizing value and incentivizing to the23

various employees, you could make that determination.24

And that's what's happened in other cases. Here,25

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Your Honor, we have a naked plan that requires further due1

diligence by the committee as to whether these are appropriate2

factors, but no further due diligence by Your Honor as to3

whether appropriate factors have been established or met. And4

Your Honor has been tasked by Congress with making that5

determination. Thank you, Your Honor.6

THE COURT: Thank you, Mr. Harrington. Well, you7

know, I'm obviously very well aware of the extreme difficulties8

that are facing the retail businesses such as the debtor, given9

our current economic situation, and with the competitive forces10

that Boscov's is facing in the marketplace, given the larger11

mega stores that it's fighting for a market share with, and it12

seems to me that at some point in the future we're all going to13

regret that we didn't -- don't have a lot of Boscov's just if14

for no other reason than for the competition that is certainly15

important to the retail business and enures to the benefit of16

its customers.17

But given the environment the debtors are proposing18

with the support of the committee, what the Court finds is an19

incentive notice program for certain members of management. 20

And the -- I think the testimony was clear and it's very21

significant that this is a team effort by the group of22

management who will benefit from the incentive program.23

And each participant is playing a major role. Much24

like on a football team, you know, each player the offensive25

85


tackle may not be scoring touchdowns, but he is certainly1

contributing to the scoring of that touchdown, and very2

significantly, the plan takes into account, if you will, the3

relative roles that are being played by the plan beneficiaries4

in achieving what is really the target, the incentive target.5

And I'm not going to reiterate the plan in its6

specifics. It's already in the motion and has been described7

on the record here. The targets, though, which require8

creditor and court approval are either sales of assets or a9

plan confirmation, both on very, very tight time frames, and10

either of which would be subject to this Court's best interest11

analysis.12

And although in a first instance the committee may be13

serving, if you will, as I suppose sort of a test, it's really,14

ultimately going to be the -- for the Court to determine15

whether or not these are in the estate's best interest, and16

sufficient and important for the estate.17

And it may be that at these hearings, given this18

bonus program, the Court may want to go a little bit more19

factually as to what proposals were made and what proposals20

were rejected and that sort of thing. But to require that now21

I think would really be harmful to the process that the debtors22

are seeking, and that is to get as much as they can in for the23

committee, which is charged on a fiduciary basis with24

protecting the interests of all of the creditors is testing25

86


itself, I think is more than sufficient and is not a delegation1

by the Court of the Court's responsibility.2

It is a recognition by the Court that the committee3

is serving the best interest of the creditors and is an4

appropriate body to be making at least approval types of5

determinations based upon a lot more information than the Court6

would have, and to simply be using numbers today when the7

process is still developing I think would be rather8

inappropriate.9

The incentive targets are assuredly not guaranteed. 10

They are short-term marks so that in the Court's mind, by their11

very nature, they are not retention vehicles. It's not merely12

a stay and be paid type of process. So under these13

circumstances 503(c)(1), which governs certain retention14

bonuses, if you will, is not applicable.15

As an aside, section 503(c)(1) was promulgated, at16

least reading the legislative history, to address bad cases17

such as Enron and WorldCom, and clearly, Boscov's does not fall18

into that category of cases. And the fact that the creditors'19

committee again -- and I keep emphasizing this, I know, but it20

is so important -- the fact that the creditors' committee is21

involved in the process and is approved -- and is in agreement22

with the program being proposed is I think a very significant23

factor in the Court's decision that this is not simply a24

retention bonus arrangement.25

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Accordingly, the standard for review of the plan is1

basically the business judgment test, has the debtor exercised2

its sound business judgment. And the factors which the Court3

is to review was delineated in a number of cases, including the4

Dana Corporation decision by Judge Lifland.5

And in determining whether the debtor has satisfied6

the sound business judgment test courts look to a number of7

factors which we have discussed here today and the evidence8

presented through the proffer, uncontroverted, essentially, and9

subject to cross-examination, compels the finding that the10

debtor has exercised its sound business judgment.11

All of the participants are not only working harder,12

but they are now working against a very, very incentivizing13

achievement-related deadline, which is going to benefit this14

estate markedly. Another very important, persuasive fact, and15

indeed yet another incentive, is that the plan requires the16

management to work with its creditors through the committee,17

and that to me is an incentive which also justifies the plan.18

And as I've already indicated and I'll reiterate it,19

the Court is not delegating its responsibility to the committee20

or anyone else for that matter, because any sale and plan21

remains subject to this Court's approval. So the Court22

concludes that the debtors have presented the Court with23

uncontroverted evidence.24

I know that the United States Trustee has presented25

88


and elicited alternative testimony, but I think as far as the1

Court is concerned under the statute the evidence is2

uncontroverted that the enactment of the incentive program is3

well within the debtors' business judgment, that 503(c)(1) does4

not apply, and accordingly, the Court will approve the motion5

and enter an order approving the plan. Yes.6

MR. HARRINGTON: I just have one clarification.7

THE COURT: Please.8

MR. HARRINGTON: Your Honor, you indicated that the9

plan is being approved under the business judgment test.10

THE COURT: At --11

MR. HARRINGTON: Does that mean the plan is not being12

approved under 503(c)(3), and is not an actual and necessary13

expense or justified by the fact --14

THE COURT: It is an actual and necessary. I --15

forgive me. I do find -- I do make that finding, and I think16

the finding is implicit, but the tests are very close, I17

recognize, and I appreciate the clarification. It is a18

necessary expense for the estate here and is appropriate under19

those circumstances as an incentive to achieve a successful20

conclusion to the case, either a sale or a plan.21

MR. ERENS: Thank you very much, Your Honor. We have22

an order to hand up.23

THE COURT: Okay. I think the order contains the24

reference. Yes.25

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MR. ERENS: We did only -- I didn't hand up a black-1

line because it's easy enough to point to the one change you2

made in the order.3

THE COURT: Yes.4

MR. ERENS: Which is a new paragraph 4, that the5

debtor-in-possession financing lenders effectively have asked6

that bonuses not be paid unless they're paid in full. The7

changes of that -- the chances of us doing a deal here where8

they're paying in full are zero. So we were fine with that.9

THE COURT: All right. With that being the only10

change and having reviewed -- come, Mr. Harrington.11

MR. HARRINGTON: I had one further --12

THE COURT: Of course. No. No. Don't be -- don't13

be hesitant.14

MR. HARRINGTON: And I apologize because I know I'm15

pushing my luck here.16

THE COURT: No. No. You're --17

MR. HARRINGTON: But with respect to paragraph --18

THE COURT: I haven't shot anybody yet.19

(Laughter)20

MR. HARRINGTON: With respect to paragraph 2 where it21

says, "The incentive is hereby approved pursuant to 363(b) and22

503," can we add language, "503(c) as it is justified by the23

facts and circumstances of the case and an actual and necessary24

under 503(b)"?25

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THE COURT: I would be pleased to do that. Is1

that --2

MR. ERENS: That's fine.3

THE COURT: I think that's a helpful suggestion. 4

I'll be happy to do it -- I'll be happy to either interlineate5

it or you may, whichever you would prefer.6

MR. ERENS: Whatever Your Judge [sic] wants to write7

in --8

THE COURT: Okay.9

MR. ERENS: -- is fine with us. I will write that10

in.11

MR. HARRINGTON: Thank you, Your Honor.12

THE COURT: Anything else?13

MR. ERENS: That's it on this order, and also for the14

agenda, unless Your Honor had any questions.15

THE COURT: I have no further questions. Mr.16

Kanowitz, anything further?17

MR. KANOWITZ: Nothing substantive, Your Honor. I18

would like to introduce one of my colleagues. Michael Klein,19

who has helped us throughout this case and may be appearing in20

this case before Your Honor.21

THE COURT: All right. Mr. Klein, welcome to you. 22

It's a pleasure to meet you and you'll be welcome in court23

here.24

MR. KLEIN: Thank you, Your Honor.25

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THE COURT: You know it.1

MR. KLEIN: May we be excused, Your Honor?2

THE COURT: Everyone may be excused. We'll stand in3

recess and a good weekend to all.4

ALL COUNSEL: Thank you, Your Honor.5

THE COURT: Thank you, counsel.6

(Whereupon, at 11:56 a.m., the hearing in the above-7

entitled matter was adjourned.)8

--oOo--9

CERTIFICATE10

I, ELIZABETH REID-GRIGSBY, a certified electronic11

transcriber, certify that the foregoing is a correct12

transcript, to the best of the transcriber's ability, from the13

official electronic sound recording of the proceedings in the14

above-entitled matter.15

16

/s/ Elizabeth Reid September 16, 200817

Elizabeth Reid - AAERT CET**0014518

J&J COURT TRANSCRIBERS, INC.19

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Documents

UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE