No. 02 B 02474 (Jointly Administered)United States Bankruptcy Court, N.D. Illinois, Eastern Division
November 19, 2002
John Wm. Butler, Jr. (ARDC. NO. 06209373) J. Eric Ivester (ARDC No. 0615581) Mark A. McDermott (ARDC No. 06209460) SKADDEN, ARPS, SLATE, MEAGHER FLOM (ILLINOIS) Chicago, Illinois, for the Debtors and Debtors in Possession.
ORDER UNDER 11 U.S.C. § 553 AND FED. R. BANKR. P. 9019 AUTHORIZING COMPROMISE WITH THE INTERNAL REVENUE SERVICE
SUSAN PIERSON SONDERBY, United States Bankruptcy Judge
Upon the motion dated November 5, 2002 (the “Motion”), wherein Kmart Corporation (“Kmart”) and certain of its domestic subsidiaries and affiliates, debtors and debtors in possession in the above, captioned cases (collectively, the “Debtors”), moved this Coat for entry of an order under FED. K. BANKR. P. 9019 approving that certain compromise (the “Compromise”) between Kmart and the Internal Revenue Service (the “IRS”) set forth in the two letters from the IRS attached as Exhibits 1 and 2;
it appearing to the Court that (i) it has jurisdiction over the matters raised in the Motion pursuant to 28 U.S.C. § 157 and 1334; (ii) this is a core proceeding pursuant to 28 U.S.C. § 157 (b)(2); (iii) the relief requested in the Motion is in the best interests of the Debtors, their estates, and their creditors; (iv) proper and adequate notice of the Motion and the hearing thereon has been given and that no other or further notice is necessary; (v) the IRS might be entitled to relief from stay to exercise the rights of setoff addressed by the Compromise and any objection to that relief might be overruled; and (vi) upon the record herein after due deliberation thereon, that the Motion should be granted as set forth below,
1. The Debtors’ decision to enter into the Compromise is reasonable under the circumstances and the Compromise is hereby approved.
2. The automatic stay is modified to permit the IRS to exercise the setoff rights subject to the Compromise.
3. The rights of all parties in interest with respect to the proper allocation, if any, among Kmart and its affiliates of amounts paid by the IRS under the Compromise are expressly reserved.
4. The Court shall retain exclusive jurisdiction to resolve any dispute rising from or relating to the Compromise.
MOTION FOR AN ORDER UNDER 11 U.S.C § 553 AND FED. R. BANKR. P. 9019 FOR AUTHORITY TO ENTER INTO A COMPROMISE WITH THE INTERNAL REVENUE SERVICE
Kmart Corporation (“Kmart”) and certain of its subsidiaries and affiliates (the “Affiliate Debtors”), debtors and debtors in possession in the above-captioned cases (collectively, the “Debtors”), respectfully move (the “Motion”) the Court for an order in accordance with Rule 9019
of the Federal Rules of Bankruptcy Procedure, approving the compromise (the “Compromise”) reached by Kmart and the Internal Revenue Service (the “IRS”) whereby, subject to the terms set forth below, (a) the IRS agrees to pay Kmart a tax refund amount plus applicable interest and reconciling amounts of at least $6.5 million (subject to increase as described in ¶ 9 below) (the “Net Tax Refund”) and (b) the IRS is entitled to implement the calculation and payment of the Net Tax Refund by performing certain setoffs under 11 U.S.C. § 553, as described in this Motion. In support of Motion, the Debtors respectfully represent as follows:
BACKGROUND
A. Overview of Chapter 11
1. On January 22, 2002 (the “Petition Date”), Kmart and each of its Affiliate Debtors filed a voluntary petition in this Court for reorganization relief under Chapter 11 of Title 11 of the United States Code, 11 U.S.C. § 101 et seq., as amended (the “Bankruptcy Code”). The Debtors continue to operate their businesses and manage their properties as debtors in possession pursuant to Sections 1107(a) and 1108 of the Bankruptcy Code.
2. On January 31, 2002, the United States Trustee appointed an Official Unsecured Creditors’ Committee and an Official Financial Institutions’ Committee. On June 14, 2002, the United States Trustee appointed an Official Committee of Equityholders. No trustee or examiner has been appointed.
3. This Court has jurisdiction over this Motion pursuant to 28 U.S.C. § 157 and 1334. Venue is proper pursuant to 28 U.S.C. § 1408 and 1409. This matter is a core proceeding pursuant to 28 U.S.C. § 157 (b)(2).
4. The statutory predicates for the relief sought herein are Section 553 of the Bankruptcy Code and Rule 9019 of the Federal Rules of Bankruptcy Procedure.
B. Overview of Kmart
5. Kmart is ranked number 36 on Fortune’s list of 500 companies and is a member of the Fortune Global 100. Kmart is the nation’s second largest discount retailer and the third largest general merchandise retailer.
6. As of the Petition Date, Kmart had approximately 240,000 associates worldwide and currently is one of the top twelve employers in the United States with approximately $5.2 bilhon in annual payroll and benefits. Kmart has relationships with more than 4,000 vendors worldwide and is one of the country’s largest purchasers of products.
7. As of the Petition Date, Kmart operated approximately 2,110 stores, primarily under the Big Kmart or Kmart Supercenter format, in all 50 United States, Puerto Rico, the U.S. Virgin Islands and Guam. As of the fiscal year ended January 30, 2002, Kmart had revenues of $36 bilhon, administered approximately $14.3 billon of assets at book value and reported total liabilities of $10 billon.
RELIEF REQUESTED
8. By this Motion, the Debtors seek entry of an order approving the Compromise under which: (i) the IRS agrees to pay to Kmart, in immediately available funds by wire transfer to an account designated by Kmart in writing, an amount equal to the Net Tax Refund; (ii) the IRS is entitled to offset certain corporate income tax deficiencies owed by the Kmart Group (defined below) for the taxable years ending 1/1986, 1/1988, 1/1992, and 1/1999 against corporate income tax refunds owed to the Kmart Group for the taxable years ending 1/1993 through 1/1995 and 1/1997 in implementation of the Net Tax Refund; and (iii) the IRS is further entitled to offset certain excise tax deficiencies or underpayment interest for the taxable periods ending 12/31/1997, 12/31/1998, and 12/31/01 against excise tax refunds or overpayment interest owed to the Kmart Group for the taxable periods ending 3/31/1997, 6/30/1997, 9/30/1997, 3/31/1998, 6/30/1998 and 9/30/1998, and, to the extent of the excess deficiency of $98,841.19, against the corporate income tax refunds owed to Kmart. The IRS will make payment of the Net Tax Refund promptly but in no event later than Nov. 27, 2002.
9. The parties are still trying to reach agreement on the interest computations for each of the income tax overpayments and underpayments at issue for taxable years ending 1/1986 through 1/1999 and to resolve any outstanding issues related thereto, including the proper application of the interest netting provisions of Section 6621(d) of the Internal Revenue Code of 1986, as amended (the “I.R.C.”). The parties agree, however) that the Net Tax Refund due to Kmart is at least $6.5 million and may be increased increase by up to an additional $1.5 million pursuant to the interest computation as finally agreed to by the parties. The parties expect that the amount of the Net Tax Refund will be finalized on or before the hearing date.
10. The Debtors and the IRS do not intend the Compromise to limit or otherwise affect any rights that the Debtors may have under the IRC, including without limitation any rights with respect to applicable statutes of limitations relating to taxes and interest. In addition, the parties agree that this Compromise resolves any and all government claims against the Debtors for (i) corporate income taxes for taxable years ending on or before 1/1999 and (ii) excise taxes for taxable periods ending on or before 12/31/1998.
BASIS FOR RELIEF
11. Kmart is the common parent of an affiliated group of corporations (the “Kmart Group”) within the meaning of IRC § 1504 that files a consolidated federal income tax return. The IRS has audited the Kmart Group’s consolidated federal income tax returns for the taxable years ending 1/1986 through 1/1999. As a result of the audit, the IRS determined and Kmart agrees that forte taxable years listed below the Kmart Group made the following underpayments or overpayments (as the case may be) of corporate income tax, resulting in a net refund of $14,476,701.00 plus applicable interest owing to Kmart as of January 22, 2002:
12. The parties further agree that on September 29, 2000, Kmart received a payment from the IRS of $7,581,163 with, related interest and that this amount will be a payment against any taxes and interest due to Kmart as of that date.
13. The IRS has further determined and Kmart agrees that for the taxable periods listed below the Kmart Group made the following underpayments or overpayments (as the case may be) of excise tax or interest, resulting in a net tax deficiency plus interest of $98,841.19 owed by the Kmart Group as of January 22, 2002:
14. The Debtors believe that the Compromise is in the best interests of their estates.
APPLICABLE AUTHORITY
15. Section 553(a) of the Bankruptcy Code preserves common law rights of setoff that exist outside of bankruptcy. See United States v.Maxwell, 157 F.3d 1099, 1102 (7th Cir. 1998). The doctrine of setoff “allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding `the absurdity of making A pay B when B owes A.'” Anes v. Dehart, 195 F.3d 177, 182 (3d Cir. 1999) (quoting Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 18, 116 S.Ct. 286, 289, 133 L.Ed.2d 258 (1995)); see also Solow v. AmericanAirlines, Inc. (In re Midway Airlines, Inc, 221 B.R. 411, 453 (Bankr. N.D. Ill. 1998).
16. “Section 553(a) recognizes and preserves rights of setoff where four conditions exist: (1) the creditor holds a `claim’ against the debtor that arose before the commencement of the case; (2) the creditor owes a `debt’ to the debtor that also arose before the commencement of the case; (3) the claim and the debt are `mutual;’ and (4) the claim and debt are each valid and enforceable.” Midway Airlines, 221 B.R. at 453
(citing St. Francis Physician Network, Inc. v. Rush Prudential HMO, Inc.(In re St. Francis Physician Network, Inc.), 213 B.R. 710, 715 (Bankr. N.D. Ill. 1997)).
17. In this case, all of the prerequisites for setoff under nonbankruptcy law are present. First, the IRS has claims against Kmart for certain income tax deficiencies attributable to taxable periods ending before the Petition Date. Second, the IRS owes Kmart debts for income tax overpayments that Kmart made for taxable periods ending before the Petition Date. Third, mutuality exists where the IRS is attempting to offset its liability to the taxpayer by the amount the taxpayer owes the IRS and both of the debts are prepetition. See Pettibone Corp. v. UnitedStates(In re Pettibone Corp.), 161 B.R. 960, 963 (N.D. Ill. 1993), aff’don other grounds, 34 F.3d 536 (7th Cir. 1994). Finally, the IRS’ claims to be offset are valid and enforceable under applicable nonbaakruptcy law. IRC §§ 6213, 6301.
18. To the extent that Section 553 preserves nonbankruptcy setoff rights, however, their exercise during bankruptcy is permissive, not mandatory. United States v. Arkison (In re Cascade Roads, Inc.),34 F.3d 756, 763 (9th Cir. 1994); United States v. Norton, 717 F.2d 767, 772 (3d Cir. 1983). The decision as to whether to authorize the exercise of setoff rights “rests in the sound discretion of the bankruptcy court.”Illinois v. Lakeside Cmty. Hosp., Inc. (In re Lakeside Cmty. Hosp.,Inc., 151 B.R. 887, 890 (N.D. Ill. 1993) (“even if setoff is authorized) it is a matter within the bankruptcy judge’s discretion”). Accordingly, even assuming otherwise valid setoff rights exist, a bankruptcy court has the power to refuse permission for their exercise on any equitable ground.
19. The Debtors, however, believe that the setoff to be exercised under the Compromise is in the best interests of the estates. Thus, the Debtors and the IRS request that the Court authorize the Compromise described above.
20. Bankruptcy Rule 9019 provides, in part, that “[o]n motion by the [debtor in possession] and after notice and a hearing, the court may approve a compromise or settlement.” FED. R. BANKR. P. 9019(a). Compromises are tools for expediting the administration of the case and reducing administrative costs and are favored in bankruptcy. See Fogelv. Zell, 221 F.3d 955, 960 (7th Cir. 2000); In re Martin, 91 F.3d 389, 393 (3d Cir. 1996) (“To minimize litigation and expedite the administration of a bankruptcy case, `[c]ompromises are favored in bankruptcy'”) (quoting 9 COLLIER ON BANKRUPTCY ¶ 9019.03[1] (15th ed. 1993); Fishell v. Soltow (In re Fishell), No. 94-1109, 1995 WL 66622, at *2 (6th Cir. Feb. 16, 1995)). Further, numerous courts have endorsed the use of Bankruptcy Rule 9019 as a basis to approve a compromise or settlement. See, e.g., Patel v. Patel (In re Patel),43 B.R. 500, 504-05 (N.D. Ill. 1982); Bartel v. Bar Harbour Airways,Inc., 196 B.R. 268, 271 (S.D.N.Y. 1996); In re Foundation for New Era Philanthropy, Case No. 95-13729B, 1996 Bankr. LEXIS 1892 (Bankr. E.D. Pa. Aug 21, 1996); Grochocinski v. Kennedy (In re Miller), 148 B.R. 510, 516 (Bankr. N.D. Ill. 1992); Boyd v. North End Auto Sales, Inc. (In reCheck Reporting Servs., Inc.), 137 B.R. 653, 656-57 (Bankr. W.D. Mich. 1992).
21. The standards by which a court should evaluate a settlement are well established. In addition to considering the proposed terms of the settlement, the Court should consider the following factors: (a) the probability of success in litigation; (b) the difficulty in collecting any judgment that may be obtained; (c) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attendant to it; and (d) the interest of creditors and stockholders and a proper deference to their reasonable views of the settlement. See ProtectiveComm. for Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson,390 U.S. 414, 424-245, 88 S.Ct. 1157, 1163-64, 20 L.Ed.2d 1 (1968);Patel, 43 B.R. at 504-05; Fishell, 1995 WL 66622, at *3; OfficialUnsecured Creditors’ Comm. v. Pennsylvania Truck Lines, Inc. (In rePennsylvania Truck Lines, Inc.), 150 B.R. 595, 598 (E.D. Pa. 1992), aff’dmem., 8 F.3d 812 (3d Cir. 1993); In re Grant Broad., Inc., 71 B.R. 390, 395 (Bankr. E.D. Pa. 1987); In re Neshaminy Office Bldg. Assocs.,62 B.R. 798, 803 (E.D. Pa. 1986).
22. The decision to approve a settlement or compromise is within the discretion of the court and is warranted where the settlement is found to be reasonable and fair in light of the particular circumstances of the case. See IMT Trailer Ferry, 390 U.S. at 424-25, 88 S.Ct. at 1163-64. The settlement need not be the best that the debtor could have achieved, but need only fall “within the reasonable range of litigation possibilities.”In re Telesphere Communications, Inc., 179 B.R. 544, 553 (Bankr. N.D. Ill. 1994). In making its determination, a court should not substitute its own judgment for that of the debtor, Neshaminy Office,62 B.R. at 803.
23. As outlined above, there is sufficient business justification for the Debtors to enter into the Compromise, Furthermore, the Compromise is fair and reasonable and in the best interests of the Debtors’ estates and their creditors. Therefore, the Compromise should be approved.
WHEREFORE, the Debtors respectfully request the Court enter an order, substantially in the form attached hereto as Exhibit A, (i) approving the Compromise and authorizing the Debtors to comply with the terms thereof, and (ii) granting such other relief as the Court deems just and proper in the circumstances.
Mark A. McDermott ___________________ MARK A. MCDERMOTT
EXHIBIT 1