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UNITED STATES BANKRUPTCY COURT Hearing Date: June 23, 2011 Hearing Time: 10:00 a.m.

SOUTHERN DISTRICT OF NEW YORK -------------------------------------------------------x


In re INNKEEPERS USA TRUST, et al., Debtors. Chapter 11 Case No. 10-13800 (SCC) (Jointly Administered)

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OBJECTION OF THE UNITED STATES TRUSTEE TO DEBTORS PLANS OF REORGANIZATION TO: THE HONORABLE SHELLEY C. CHAPMAN, UNITED STATES BANKRUPTCY JUDGE: Tracy Hope Davis, the United States Trustee for Region 2, in furtherance of the duties and responsibilities set forth in 28 U.S.C. Sections 586(a)(3) and (5), hereby files her objection to the Debtors Plans of Reorganization. ECF No. 1445. SUMMARY STATEMENT The United States Trustee objects to the confirmation of the Debtors plans pursuant to 11 U.S.C. 1129. Specifically, the plans contains improper non-debtor releases that render it unconfirmable. The releases enjoin direct causes of actions against non-debtors that have no impact on property of the estate, the administration of the Debtors cases or the consummation of the Debtors plans. For these reasons, including the fact that the releases concern non-debtors, this Court lacks subject matter jurisdiction to approve them. In addition, the releases do not comply with, or even address, In re Metromedia and its progeny for the approval of the non-debtor releases. The non-debtor release provisions, therefore, are not justified and should not be approved.

Finally, under the plans, distributions to certain preferred shareholders will result from the sale of certain hotels. These shareholders, however, will receive less under the plans and their non-debtor releases than if the Debtors cases were converted to Chapter 7 and a Chapter 7 Trustee pursued the sale. In such a scenario, the shareholders would receive the same sale distribution, but would be free to pursue any causes of action they may have. The plans, therefore, fail the best interest test set forth under 11 U.S.C. 1129(a)(7) and should not be confirmed. BACKGROUND General Background 1. On July 19, 2010 (the Petition Date), Innkeepers USA Trust (Innkeepers) and

certain of its affiliates (collectively, the Debtors) filed voluntary petitions for relief under the Bankruptcy Code. 2. The Debtors own and operate a portfolio of 72 hotels located in 20 states across

the United States. Declaration of Dennis Craven, Chief Financial Officer of Innkeepers USA Trust, in Support of First Day Pleadings (the Craven Declaration) at 6, ECF No. 2. 3. Since the Petition Date, the Debtors have operated their businesses and managed

their properties as debtors in possession pursuant to Bankruptcy Code Sections 1107 and 1108. By Order dated January 7, 2009, the Debtors cases are being jointly administered. ECF No. 51. 4. On July 28, 2010, the United States Trustee, pursuant to Section 1102(a)(1) of the

Bankruptcy Code, appointed the official committee of unsecured creditors (the Creditors Committee). ECF No. 82.

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The Debtors Pre-Petition Corporate and Capital Structure 5. Innkeepers is a self-administered real estate investment trust. Craven Declaration

at 17. Innkeepers indirect, wholly owned limited liability company subsidiaries, which are also the Debtors in these cases, hold title to, or ground leases in, the Debtors 72 hotel properties. Id. 6. In June 2007, Apollo Investment Corporation (Apollo) acquired all of

Innkeepers common shares. Id. at 23. Preferred holdings of Innkeepers known as Innkeepers $145 million 8% Series C Cumulative Preferred Shares, which were outstanding at the time of Apollos common-share acquisition of Innkeepers, remained outstanding after the acquisition.1 Id. In connection with Apollos acquisition, Apollos subsidiary, Grand Prix Holdings, LLC, a debtor in these cases, was issued all (except for a small amount issued to management) of Innkeepers (a) common shares and (b) 12% Series A Cumulative Preferred Shares (a different tranche of preferred holdings). Id. 7. Forty-five (45) of the Debtors hotels secure fixed rate mortgage loans in the

aggregate principal amount of $825 million. Id. at 26. The loans have been securitized and sold into the commercial mortgage-backed security market. Id. 8. Twenty (20) of the Debtors hotels secure floating rate mortgage loans in the

principal amount of $250 million. Id at 28. Grand Prix Mezz Borrower Gloating 2, LLC, the 100% owner of the Debtors that own these twenty (20) hotels, has also used its equity interest in those Debtors as collateral for a $118 million floating rate junior mezzanine loan. Id.

An ad hoc committee of Series C Cumulative Preferred Shares has been formed in these cases. See ECF No. 205. -3-

9.

The Debtors remaining seven (7) hotels (the Seven Sisters) secure an aggregate

of $230 million in funded pre-petition debt. Id. at 29 - 37. The Plans 10. The Debtors seek confirmation of four (4) plans of reorganization (the Plans).

ECF No. 1445. One plan concerns the hotels encumbered by the fixed rate and floating rate mortgage loans, id., one plan concerns the Anaheim Hilton Suits, one of the Seven Sisters, id, one plan concerns the Ontario Hilton, another of the Seven Sisters, id., and one plan (the Remaining Debtors Plan) concerns the five (5) remaining Seven Sister hotels (the Remaining Debtors). Id. 11. Pursuant to the Remaining Debtors Plan, the Remaining Debtors will be sold for

no less than $195 million. Disclosure Statement at 10, ECF No. 1444. The proceeds of the sale will allow for a distribution to holders of Series A and C Cumulative Preferred Shares. Id. at 16 and 17. 12. The Remaining Debtors Plan also contains non-debtor releases. Remaining

Debtors Plan at 69-70. Specifically, Article VIII.H of the Remaining Debtors Plan releases, among others, Apollo from all claims related to, among other things, the Debtors and their chapter 11 cases that arose prior to the effective date of the Remaining Debtors Plan. Id. In fact, actions resulting from acts or omissions that were grossly negligent, the result of willful misconduct or criminal conduct are also released. Id.

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13.

Other than a boiler plat discussion stating that the non-debtor releases are

intended to be part of a 9019 settlement, no justification for the non-debtor releases is provided by the Debtors. Disclosure Statement at 98. In fact, although the Disclosure Statement goes into great detail regarding Apollos participation and contribution to the Debtors fixed rate and floating rate plan, it is completely void of any discussion regarding why Apollo should receive a release under the Remaining Debtors Plan. Id. at 50-51. DISCUSSION 1. The Court Lacks Subject Matter Jurisdiction To Grant the Non-Debtor Releases

The non-debtor releases in the Remaining Debtors Plan cover claims and causes of action that creditors and equity holders (and not the Debtors) may hold against non-debtors, including Apollo, that do not impact property of the Debtors estates, the administration of the Debtors cases or the consummation of the Remaining Debtors Plan. For example, Series C Cumulative Preferred Shareholders may hold direct claims against Apollo. Such claims would not impact the res of the Remaining Debtors estates. Before a Bankruptcy Court may approve a non-debtor release, it must first determine that it has the subject matter jurisdiction as set forth in In re Johns-Manville Corporation, 517 F.3d 52 (2nd Cir. 2008), vacated & remanded on other grounds, 129 S.Ct. 2195 (2009), afffg in part & revg in part, 600 F.3d 135 (2nd Cir. 2010)(Manville); see also In re Dreier, 429 B.R. 112, 132 (Bankr. S.D.N.Y. 2010); In re Metcalfe & Mansfield Alternative Investments, 421 B.R. 685, 695 (Bankr. S.D.N.Y. 2010). In Manville, the Court held that a bankruptcy court only has jurisdiction to enjoin third-party non-debtor claims that directly affect the res of the bankruptcy -5-

estate. Manville at 66, see also Dreier 429 B.R. at 133 (because court lacks jurisdiction to enjoin claims that do not affect property of the estate or the administration of the estate, nondebtor releases must be limited to claims derivative of the debtors). The Remaining Debtors Plan offers blanket releases and injunctions that enjoin claims that do not affect the Debtors property or the administration of their estates. The Court does not have jurisdiction to grant such releases. Dreier 429 B.R. at 133. To the extent the Court determines to confirm the Remaining Debtors Plan, a qualifying section must be added that limits the non-debtor releases to causes of action that (a) the Remaining Debtors would have been entitled to assert in their own right, and (b) directly affect property of the Remaining Debtors estates. 2. The Debtors Do Not Satisfy The Metromedia Standards

In order to be valid, the non-debtor release must meet the standard set forth under Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F. 3d 136, 141 (2d Cir. 2005)(Metromedia). In Metromedia, the Second Circuit has held that non-debtor releases do not pass muster because they are contemplated by debtors in the plan; the Debtors must demonstrate that the facts justify the release being sought - a rare circumstance. See Id. at 141-43. Specifically, as noted above, [i]n bankruptcy cases, a Court may enjoin a creditor from suing a third party, provided the injunction plays an important part in the Debtors reorganization plan. Metromedia, 416 F. 3d at 141 (quoting Drexel Burnham Lambert Group, Inc., 960 F.2d at 292 (2d Cir. 1992)). In Metromedia, the Second Circuit expressed its dissatisfaction with the frequency with which non-debtor releases are included in plans. These releases were identified -6-

by the Court as a bankruptcy discharge arranged without a filing and without the safeguards of the Code. Id. at 142. Therefore, non-debtor releases are appropriate only in rare cases, and a non-debtor release in a plan of reorganization should not be approved absent the finding that truly unusual circumstances render the release terms important to the success of the plan. See id.. at 141-143. The Second Circuit has approved of non-debtor releases in unique circumstances, i.e., where 1) the estate received substantial consideration, see Drexel Burnham Lambert Group, Inc., 960 F.2d at 292 (2d Cir. 1992) (multi-billion dollar settlement including a payment of over a billion dollars into fund by Michael Milken and other co-liable Drexel personnel); 2) enjoined claims were channeled to a settlement fund rather than extinguished, see MacArthur Co. v. Johns-Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89, 93-94 (2d Cir. 1988); 3) where the enjoined claims would indirectly impact the debtors reorganization by way of indemnity or contribution, and the plan otherwise provided for the full payment of the enjoined claims, see Menard-Sanford v. Mabey (In re A.H. Robins Co.), 880 F.2d 694, 701 (4th Cir. 1989); and 4) the affected creditors consented. See In re Specialty Equip. Cos., 3 F.3d 1043, 1047 (7th Cir. 1993); see also Metromedia at 142. Subsequent cases further clarify the Metromedia requirements. In In re Karta Corp., 342 B.R. 45 (S.D.N.Y. 2006), the Court, with an eye on Metromedia and following the Second Circuits narrow standard, found that the case before it was the rare case involving unusual facts that justified the release of certain non-debtor parties, including the Plan funders and an affiliated company. Id. at 55.

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The Court in Karta determined that the non-debtor release provisions were important to the Debtors plan of reorganization for the following reasons: the released parties agreed to make a substantial financial contribution to fund the plan only if they would be released from Creditors claims. Id. If the releases were not approved, the released parties would not fund the plan. Without funding, the proposed plan would fail, therefore the releases could not be excised from the plan. Id. The Court, however, noted that it would be an abuse of process simply to allow the release of a non-debtor in return for its financial contribution. Something else was therefore needed in order to make a case unique. Id. The Court framed the issue as follows: whether a significant non-debtor financial contribution plus other unusual factors render a situation so unique that non-debtor releases are appropriate.2 Id. In the instant case, the Disclosure Statement for the Remaining Debtors Plan fails to provide justification for the non-debtor releases, especially as they apply to Apollo. Moreover, the non-debtor releases are too broad because the proposed releases are not restricted to

See also In re Adelphia, 368 B.R. 140 (Bankr. S.D.N.Y. 2007 (three categories of third party releases are acceptable under Metromedia: (1) persons indemnified by the estate under bylaws, employment contracts, or loan agreements; (2) persons involved in unique transactions, such as a party who makes a substantial financial contribution to the estate; and (3) persons who consent to the releases); In re Oneida Ltd., 351 B.R. 79 (Bankr. S.D.N.Y. 2006) (the Equity Committee had raised, but then abandoned, an objection to the validity of the Non-Debtor releases. In dicta, the Court stated that the releases were acceptable because all of the affected creditors had consented: they affirmatively checked a box on the Plan solicitation ballots indicating their willingness to grant releases); In re Spiegel Inc., 2006 WL 2577825, *7 (Bankr. S.D.N.Y. Aug. 16, 2006) (No. 03-11540 BRL) (Plans third-party releases and injunctions were critical components of the Settlement that played a vital part in the plan and were necessary to the proposed reorganization of the Debtors and the successful administration of their estates); In re XO Communications, Inc., 330 B.R. 394, 440 (Bankr. S.D.N.Y. 2005) (third-party releases permissible where non-Debtors provided significant consideration, non-Debtor releases were integral to the Plan, and non-Debtors interests aligned with those of the Debtors with regard to claims.) -8-

business-related claims. Specifically, the releases include all claims in any manner, including gross negligence, willful misconduct and criminal activity. Plan at 69-70. Thus, under Karta and Metromedia, absent adequate explanation from the Remaining Debtors as to their justification, the proposed releases should be disallowed. 3. The Plan Does Not Satisfy The Best Interest Test

A plan may be confirmed only if every non-assenting creditor receives at least as much value as if a Chapter 7 liquidation had taken place. 11 U.S.C. 1129(a)(7); see also In re U.S. Wireless Data, Inc., 547 F.3d 484, 495 (2nd Cir. 2008)(plan may not be confirmed unless each holder of an impaired claim accepts the plan or receives not less than it would receive in Chapter 7). In the instant case, under the Remaining Debtors Plan, distributions to Preferred C Cumulative Shareholders may result from the sale of the Remaining Debtors hotels. Disclosure Statement at 10. These shareholders, however, will receive less under the Remaining Debtors Plan and its non-debtor releases than if the Remaining Debtors cases were converted to Chapter 7 and a Chapter 7 Trustee pursued the sale.3 In such a scenario, the preferred shareholders would receive the same sale distribution, but would be free to pursue any causes of action they may have. The Remaining Debtors Plan, therefore, fails the best interest test set forth under 11 U.S.C. 1129(a)(7) and should not be confirmed.

An agreement with the purchaser has already been signed by the Debtors. Disclosure Statement at 10. A Chapter 7 trustee would step into the shoes of the Debtors and consummate the sale. -9-

CONCLUSION Wherefore, for the reasons set forth above, in the event the Court is inclined to confirm the Plan, it should deny approval of the non-debtor releases set forth in the Remaining Debtors Plan. Dated: New York, New York May 23, 2011

TRACY HOPE DAVIS UNITED STATES TRUSTEE By: /s/ Paul K. Schwartzberg Trial Attorney 33 Whitehall Street, 21st Floor New York, New York 10004 Tel. No. (212) 510-0500 Fax. No. (212) 668-2255

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