The Guitar Center Bankruptcy: Getting the Band Back Together

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Chapter 11 Bankruptcy Case Studies Student Work

2022

The Guitar Center Bankruptcy: Getting the Band Back Together The Guitar Center Bankruptcy: Getting the Band Back Together

Jonathan Jemison

Jacob Moses

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Jemison, Jonathan and Moses, Jacob, "The Guitar Center Bankruptcy: Getting the Band Back Together"

(2022).

Chapter 11 Bankruptcy Case Studies

. 70.

https://ir.law.utk.edu/utk_studlawbankruptcy/70

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THE GUITAR CENTER

BANKRUPTCY

Getting the Band Back Together

 
1 
Table of Contents 
CAST OF CHARACTERS ............................................................................................................................................... 3 
FOUNDING ................................................................................................................................................................. 5 
EXPANSION ................................................................................................................................................................ 5 
A BUYING SPREE FUNDED BY AN IPO ............................................................................................................... 5 
A SHIFT TO PRIVATE .............................................................................................................................................. 6 
WHAT LED TO CHAPTER 11 ....................................................................................................................................... 8 
SALES CHALLENGES .............................................................................................................................................. 8 
DEBT ............................................................................................................................................................................ 8 
COVID-19: PUSHES A HIGHLY LEVERAGED GUITAR CENTER INTO CHAPTER 11 .......................... 11 
THE RESTRUCTURING SUPPORT AGREEMENT .......................................................................................................... 13 
MILESTONES ........................................................................................................................................................... 14 
TERM DIP COMMITMENT LETTER MILESTONE ......................................................................................... 14 
NEW COMMON EQUITY INVESTMENT ........................................................................................................... 15 
OTHER TERMS OF THE RESTRUCTURING .................................................................................................... 18 
Critical Vendors .................................................................................................................................................. 18 
The ABL (Asset Based Loan) DIP Facility ......................................................................................................... 18 
New First Lien Debt ............................................................................................................................................ 19 
New Preferred Equity ......................................................................................................................................... 19 
New Junior Preferred Equity .............................................................................................................................. 19 
The Management Incentive Plan ......................................................................................................................... 20 
Director and Officer Insurance (“D&O Insurance”) ......................................................................................... 20 
Unexpired Leases and Executory Contracts ....................................................................................................... 20 
SUMMARY OF THE RESTRUCTURING TRANSACTIONS ............................................................................ 20 
PRE-PETITION SOLICITATION AND VOTING .............................................................................................................. 21 
THE INITIAL PLAN .................................................................................................................................................... 23 
CLASSIFICATION OF CLAIMS AND INTERESTS........................................................................................... 24 
Secured Notes Claims  ........................................................................................................................................ 25 
Unsecured Note Claims ...................................................................................................................................... 26 
Intercompany Claims (and Interests) .................................................................................................................. 27 
Existing Common Equity ..................................................................................................................................... 28 
MEANS OF IMPLEMENTATION ......................................................................................................................... 29 
TREATMENT OF CONTRACTS AND UNEXPIRED LEASES ......................................................................... 30 
CONDITIONS PRECEDENT TO PLAN CONFIRMATION .............................................................................. 32 
CONDITIONS PRECEDENT TO THE EFFECTIVE DATE .............................................................................. 32 
The Restructuring Support Agreement Effective ................................................................................................. 32 
Definitive Documents Effective ........................................................................................................................... 32 
Plan Confirmation Order .................................................................................................................................... 33 
New Common Equity Investment and Equity Commitment Letters ..................................................................... 33 
No DIP Default ................................................................................................................................................... 34 

 
2 
New Common Equity and Warrants Issued. ....................................................................................................... 34 
New First Lien Debt Issued ................................................................................................................................. 35 
ABL Facility Effective ......................................................................................................................................... 35 
Professional Fee Reserve .................................................................................................................................... 35 
WITHDRAWAL AND MODIFICATION OF THE PLAN .................................................................................. 36 
FIRST DAY MOTIONS ............................................................................................................................................... 37 
ORDERS FACILITATING ADMINISTRATION OF THE ESTATE ...................................................................................... 37 
MOTION FOR JOINT ADMINISTRATION OF THE ESTATE ........................................................................ 37 
MOTION TO EMPLOY PRIME CLERK AS CLAIMS AGENT........................................................................ 38 
MOTION TO CONTINUE USING EXISTING CASH MANAGEMENT SYSTEM ......................................... 38 
ORDERS TO SMOOTH DAY-TO-DAY OPERATIONS .................................................................................................... 39 
UTILITIES ................................................................................................................................................................. 39 
SUBSTANTIVE ORDERS............................................................................................................................................. 40 
DIP FINANCING ...................................................................................................................................................... 40 
DIP Marketing Process....................................................................................................................................... 40 
DIP Financing Proposal ..................................................................................................................................... 41 
ABL Adequate Protection Liens .......................................................................................................................... 42 
Superpriority Notes Adequate Protection Liens.................................................................................................. 42 
Senior Secured Notes Adequate Protection Liens ............................................................................................... 42 
ABL Superpriority Claim .................................................................................................................................... 43 
Superpriority Notes Superpriority Claim ............................................................................................................ 43 
Senior Secured Notes Superpriority Claim ......................................................................................................... 43 
The net effect of this lien structure was to ensure that the prepetition secured debt remained secured until it 
was retired and paid off by the DIP Facilities. After the prepetition debt was retired, the DIP Facility would 
enjoy the protection of senior lien status, junior only to certain government tax liens. ..................................... 44 
Objections to DIP Financing .............................................................................................................................. 44 
The Final Order on DIP Facilities ..................................................................................................................... 45 
MOTION TO CONTINUE CUSTOMER PROGRAMS ....................................................................................... 45 
INSURANCE ............................................................................................................................................................. 47 
TAXES ........................................................................................................................................................................ 48 
WAGES ...................................................................................................................................................................... 49 
THE NET OPERATING LOSS PRESERVATION MOTION ............................................................................. 50 
OBJECTIONS TO THE INITIAL PLAN ........................................................................................................................... 51 
LANDLORDS ............................................................................................................................................................ 51 
UNITED STATES TRUSTEE OBJECTION ......................................................................................................... 53 
TAXING AGENCIES ............................................................................................................................................... 55 
THE AMENDED PLAN ............................................................................................................................................... 56 
THE FINAL ORDER ................................................................................................................................................... 59 
SOLICITATION ....................................................................................................................................................... 59 
COURT ADDRESSES THE ISSUES RAISED IN THE UST’S OBJECTION ................................................... 60 
PROFESSIONAL FEES ........................................................................................................................................... 63 

THE FINAL DECREE .............................................................................................................................................. 64

EPILOGUE ................................................................................................................................................................. 64

Cast of Characters

The Debtor- Guitar Center

Guitar Center Holdings Inc.- Guitar Center Holdings Inc., a Delaware corporation, was the

parent company of Guitar Center Inc, and the primary holder of Guitar Center Inc. stock.

Guitar Center, Inc.- Guitar Center Inc. a Delaware corporation, was the primary debtor in the

jointly administrated bankruptcy.

Guitar Center Stores, Inc.- Guitar Center Stores, Inc. a Delaware Corporation, was a subsidiary

of Guitar Center, Inc. and oversaw much of the company’s brick and mortar leases.

Guitar Center Gift Card Company, LLC- Guitar Center Gift Card Company, a Virginia limited

liability company, was a subsidiary of Guitar Center Stores, Inc. and oversaw the company’s gift

card program.

Music and Arts Instructor Services, LLC- Music and Arts Instructor Services, a Maryland limited

liability company, was a subsidiary of Guitar Center Stores and oversaw the music instruction

side of Guitar Center’s business.

AVDG LLC- AVDG LLC, a Delaware limited liability company, was a subsidiary of GC

Business Solutions and specialized in the design and installation of audiovisual and automation

systems.

Prepetition Creditors

Ares Management Company (“Ares”)- Ares is an American global alternative investment

manager operating in the credit, private equity and real estate markets. Ares owned all of the

outstanding Guitar Center stock at time Guitar Center filed for bankruptcy

Wells Fargo Bank (“Wells Fargo”)- Wells Fargo is an American multinational financial services

company. Wells Fargo was Guitar Center’s primary revolving door creditor

The Bank of New York Mellon Corporation (“Mellon”)- Mellon is an American investment

banking services holding company. Mellon owned all of the prepetition superpriority secured

notes, the prepetition secured notes, and some of the prepetition unsecured notes

Wilmington Savings Fund Society (“Wilmington”)- Wilmington is an American financial

services company. Wilmington owned the rest of the prepetition unsecured notes that Mellon did

not own.

Creditors involved in Reorganization

Ares- Ares helped to provide financing to Guitar Center while Guitar Center was in chapter 11

bankruptcy.

The Carlyle Group (“Carlyle”)- Carlyle is an American multinational private equity, alternative

asset management and financial services corporation with $325 billion of assets under

management. Carlyle provided financing to Guitar Center while Guitar Center was in chapter 11

bankruptcy and provided exit financing once Guitar Center emerged from bankruptcy.

Brigade Capital Management (“Brigade”)- Brigade is a global alternative investment manager

specializing in credit investment strategies. Brigade provided financing to Guitar Center while

Guitar Center was in chapter 11 bankruptcy and provided exit financing once Guitar Center

emerged from bankruptcy.

Terminology

“Sponsor Support Party” means Ares Management Company.

“Brigade Co Investor” means Brigade Capital Management.

“Carlyle Co Investor” means The Carlyle Group.

“Co Investors” means Brigade Capital Management and The Carlyle Group.

“Investor Support Parties” means Ares Management Company, Brigade Capital Management,

and The Carlyle Group.

“Creditor Support Parties” means The Bank of New York Mellon Corporation.

The Bankruptcy Players

The Honorable Kevin R. Huennekens- Judge Hunnekens was the United States bankruptcy judge

for the Eastern District of Virginia who presided of the Guitar Center bankruptcy.

John P. Fitzgerald III- Mr. Fitzgerald was the United States Trustee for region 4 at the time of

Guitar Center’s bankruptcy.

Founding

The story of Guitar Center began in 1959 when Wayne Mitchell opened a small appliance

and organ store in Hollywood, California. As rock and roll music began to gain popularity across

the country in the early 1960s, Mitchell realized that Americans were more interested in electric

guitars than dusty old organs.

In 1964, Mitchell took a huge risk and bought several guitars and

amplifiers to create the first Guitar Center.

Mitchell sought to overhaul the traditional customer

understanding of music stores and give customers the “Guitar Center experience.”

Instead of

looking at the instrument before purchasing it, customers were encouraged to feel, touch, and

play the instruments on the wall for an immersive experience.

Furthermore, Mitchell

encouraged musicians to sell Guitar Center equipment and merchandise to grow the brand

organically.

The success of this first store would propel Guitar Center to become the leader in

the music retail industry.

Expansion

In 1972, Guitar Center began expanding its locations into other American markets such

as San Francisco, Dallas, and Houston.

In 1984, Guitar Center purchased its iconic corporate

headquarters on Sunset Boulevard, which remains one of the nation’s largest and most famous

retail stores.

The opening of the new corporate headquarters also inaugurated the world-famous

“Rockwall”, a sidewalk gallery, where hundreds of famous musicians have pressed their prints

into the sidewalk.

A Buying Spree Funded by an IPO

Throughout the 1990s, Guitar Center continued to expand its locations around the nation.

In March of 1997, Guitar Center conducted an initial public offering to become the first publicly

traded music retail company.

With an infusion of public capital and an eye towards aggressive

Our History, GUITAR CENTER, https://perma.cc/EPQ8-85YT.

Id.

Disclosure Statement for Joint Pre-Packaged Chapter 11 Plan of Reorganization of Guitar Center, Inc. Et Al. Case

20-34656 (KRH). (“Initial Disclosure Statement”) 15 at 18.

Id.

Our History, supra note 1, https://perma.cc/EPQ8-85YT.

Id.

expansion, Guitar Center began to purchase several smaller music retail companies. In 1999,

Guitar Center acquired Musician’s Friend—then the world’s largest mail-order and e-commerce

retailer of musical instruments—to expand its e-commerce presence with the dawn of the

internet.

Continuing their expansion in the early 2000’s, Guitar Center acquired American

Music Group, an instrument retailer who specialized in providing instruments to educators, band

directors, and students.

Looking to further increase its influence on the music industry, Guitar

Center bought Music and Arts, a music products retailer that supplied education and equipment

to new musicians.

In 2007, Guitar Center acquired substantially all of the assets of two musical

instruments retailers: The Woodwind & The Brasswind and Music 123.

Lastly, between 2017

and 2020, Guitar Center acquired the majority of the assets of three residential and commercial

audio visual design and integration businesses to form its AVDG business.

After its acquisition spree, Guitar Center was positioned in the music industry primarily

through two business lines. Guitar Center’s core business offered a multitude of exclusive

products and services including new, used and vintage guitars, amplifiers, percussion,

instruments, keyboards and much more.

The “Music & Arts” business of Guitar Center was a

band and orchestral provider of products and services.

The “Music & Arts” business appealed

primarily to a younger demographic beginning their journey into organized music.

A Shift to Private

Guitar Center operated as a public company until October 2007 when Bain Capital

Partners, LLC (“Bain Capital) and a co-investor acquired ownership of Guitar Center for $1.9

billion and assumed debt.

Under the terms of the deal, Guitar Center stockholders received $63

for each of their shares, which was a 26 percent premium over the stock’s closing price.

Id.

Id. AVDG stands for audio visual design group.

Declaration of Tim Martin of Guitar Center, Inc., in Support of Chapter 11 Petitions and First Day Motions. Case

20-34656 (KRH). (“Declaration of Tim Martin”). 254 at 6.

Id.

Reuters, Equity Firm Is Acquiring Guitar Center, N.Y. TIMES Jun. 28, 2007, https://perma.cc/J6RN-JHG9.

Id.

Several credit analysts believed the leveraged buyout was a prudent move by Bain Capital.

Guitar Center had a dominant retail position in a high-service business, yet significantly

underearned as compared to other high-service-oriented retail segments.

Unfortunately for Bain

Capital and its investors, Guitar Center had stumbled upon hard times and an influx of debt only

hastened their problems.

Id.

Initial Disclosure Statement, 15 at 349.

What Led to Chapter 11

The primary issues that faced Guitar Center before their Chapter 11 case were the sales

challenges presented by an expanding e-commerce market, their mounting debt, and the COVID-

19 “whammy”.

Sales Challenges

There can be no doubt that the music industry has been an integral part of American

culture. As Guitar Center grew into a music giant, it connected itself to the culture of American

music. However, this did not prevent Guitar Center from struggling in the harsh economic

environment of the early 2000’s. Moreover, e-commerce retailers, such as Sweetwater Sound,

made their way onto the scene during the 1990’s and presented serious challenge to the existing

business model that Guitar Center operated under.

Further, discount retailers, such as Walmart

Stores, Inc., began to undercut Guitar Center’s prices by selling cheaper versions of Guitar

Center’s key products.

The effect of the widespread economic downturn paired with challenges

to its business model placed Guitar Center under significant strain. It was clear that e-commerce

had become paramount to the success of a music retailer in the modern era. As a primarily brick

and mortar retailer with a marginal e-commerce presence, Guitar Center looked to embrace this

new reality by hiring new marketing and e-commerce executives in 2018.

However, the

existing and emerging market difficulties were not the sole culprit to blame for Guitar Center’s

journey towards chapter 11.

Debt

By its own admission, the main reason Guitar Center filed for Chapter 11 was their “long

dated debt load.”

Since 2007, the company was unable to exit the private equity merry-go-

round. In that year, the economic downturn that plauged the United States hit retailers hard, and

Guitar Center was not immune. Guitar Center hired Goldman Sachs to find a potential buyer for

Staff Author, Can Guitar Center Find New Rhythm?, THE LOS ANGELES BUSINESS JOURNAL (Dec. 28, 2017),

https://perma.cc/K8P5-E5XU.

Id.

Daphne Howland & Ben Unglesbee, Guitar Center Adds 2 Executives Amid Online Push, RETAIL DIVE (May. 29,

2018), https://perma.cc/5SY6-CD4N.

Initial Disclosure Statement, 15 at 22.

the company.

Ultimately, affiliates of Bain Capital Partners bought out the company for $1.9

billion, while also assuming $200 million of Guitar Center’s debt for a total transaction value of

$2.1 billion.

In April 2014, Guitar Center entered into a deal with private equity group Ares

Management. The goal of the deal was to reduce Guitar Center’s debt and improve Guitar

Center’s financial position, allowing it to allocate cash towards areas such as personnel, store

bases, and brands.

The 2014 deal with Ares Management was a debt-to-equity exchange that

reduced Guitar Center’s total debt load by about $500 million and its cash interest expense by

$70 million.

Here, Ares Management exchanged a portion of Guitar Center’s debt that it held

for preferred stock in order to assume a controlling interest in the company.

Bain Capital would

retain partial ownership of the company, as well as representation on the Board of Directors.

Along with these moves, Guitar Center refinanced its remaining debt through issuing new senior

secured notes, senior unsecured notes, and obtained a new revolving credit facility.

In 2017, Guitar Center carried an enormous long term debt load and its revenues had

remained stagnant since 2012.

In November 2017, Guitar Center had approximately $615

million in senior secured first lien notes, due in 18 months.

Because the company’s cash flow

was unlikely to materially reduce debt and improve leverage within this time frame, rumblings

emanated from financial services companies that the company’s outlook was negative.

With

maturity dates fast approaching, refinancing the company’s debt was necessary. As a result, in

The Associated Press, Guitar Center to Be Acquired by Bain Capital for $1.9 Billion, CNBC (June. 27, 2007),

https://perma.cc/SE3C-KCMG.

Id.

Chris Witkowsky, Ares Management Takes Controlling Stake Through Debt of Bain-backed Guitar Center, PE

Hub (Apr. 4, 2014), https://perma.cc/AZ9R-N7FE.

Id.

Declaration of Tim Martin, 254 at 17.

Id.

Initial Disclosure Statement, 15 at 19.

Staff Author, Can Guitar Center Find New Rhythm?, THE LOS ANGELES BUSINESS JOURNAL (Dec. 28, 2017),

https://perma.cc/K8P5-E5XU.

Id.

Moody's Downgrades Guitar Center Inc. to Caa1; Outlook Negative, MOODY’S INVESTORS SERVICE (Nov. 28,

2017), https://perma.cc/S2YF-3FTF.

December 2017, Ares increased its ownership in Guitar Center by purchasing all of the

outstanding voting shares in Guitar Center’s parent entity, Guitar Center Holdings, Inc.

Around the same time,

the company entered into refinancing transactions aimed at

addressing the $615 million in debt that was nearing its maturity date.

Guitar Center’s total

debt load at this point was more than $1 billion, and about sixty-five percent of this amount

matured in April 2019.

The company had to buy itself some time or risk default. Ultimately,

Guitar Center: (i) completed a bond exchange that added three years to the maturity date of $325

million in senior unsecured bonds due in 2020; (ii) issued $635 million in new senior secured

notes at a higher interest rate with a new maturity date in 2021; and (iii) extended the due date

for its existing $375 million Asset Based Lending Facility

from 2019 to 2022.

The company

used cash and proceeds from the newly issued bonds to pay off the maturing $615 million in

existing senior secured notes.

The 2018 refinancing transactions allowed Guitar Center some breathing room in the

form of short term liquidity, but various financial reporting services still viewed the company’s

status as dubious.

The refinancing was heralded as a “distressed exchange” by financial

analysts, primarily because Guitar Center added $50 million to its already gigantic debt burden

while having limited opportunity for growth.

Guitar Center would pay a high price for the short

term financial flexibility it found from the 2018 transactions: it saw its interest expenses grow in

the amount of $56.6 million by the end of the 2019 fiscal year.

Ultimately, Guitar Center would

be stuck with net losses of $42.8 million and $61.9 million for the 2018 and 2019 fiscal years,

Guitar Center Holdings was created to serve as the parent company of the different entities that comprised Guitar

Center. Initial Disclosure Statement, 15 at 22.

Id.

Moody’s Downgrades Guitar Center’s Ratings, MusicIncMag.com, Nov. 30, 2017, https://perma.cc/UM96-7KT2.

An asset based loan is an agreement to loan money secured by assets of the borrower. The loan is secured by the

assets of the company which may be the inventory, accounts receivables, equipment or other property owned by the

borrower. INVESTOPEDIA.COM, https://perma.cc/DN6S-JLX7.

Initial Disclosure Statement, 15 at 14.

Id.

Guitar Center’s interest expenses increased by49.6% from $84.8 million to $126.8 million in the 2018 fiscal year

and further increased by another 11.5% to $141.4 million in the 2019 fiscal year. Initial Disclosure Statement, 15 at

23.

respectively.

Despite these losses, management felt that positive trends underlying Guitar

Center’s business rendered these recent pitfalls sustainable in predictable circumstances.

Unfortunately for the company, ‘predictable circumstances’ were not on the horizon.

COVID-19 Pushes a highly leveraged Guitar Center into chapter 11

Guitar Center’s 2018 refinancing gave the company short term liquidity and breathing

room. The company saw sustained growth for ten consecutive quarters after the refinancing.

However, the arrival of the COVID-19 pandemic served to upset the “delicate balance” the

company had struck between servicing its longstanding debt burden and financing its

operations.

In March 2020, the pandemic forced the music giant to shut the doors of nearly all

of its 500 locations and furlough approximately 9,000 of its estimated 13,000 employees.

The

resulting loss of sales revenue obliterated any positive momentum accrued over the past 10

quarters and put the company in serious jeopardy of defaulting on upcoming principal and

interest payments due in April 2020.

In total, Guitar Center faced an interest payment on the

$325 million in unsecured notes from 2018 and an interest payment on the $635 million in

secured notes from 2018. Furthermore, Guitar Center was required to pay the full amount owed

on outstanding senior unsecured notes.

A global pandemic could not have come at a worse time

for an overleveraged non-essential retailer.

After reports surfaced that Guitar Center was late on its payments, the company was able

to negotiate with its lenders and come up with another refinancing transaction for near term

liquidity.

The 2020 refinancing transactions resulted in Guitar Center: (a) exchanging a

substantial majority of the 2018 unsecured cash/PIK

notes in order to defer a significant portion

of the cash interest payment due on the 2018 notes in April 2020; (b) issuing Superpriority

Id.

Id. at 14.

Id. at 15. See also Howland & Unglesbee supra note 26 (as of February 2020, Guitar Center held 1.2 billion in

debt and 3 million in cash, was working with investment banks to negotiate with its lenders).

Declaration of Tim Martin, 254 at 3,7.

Moody’s Downgrades Guitar Center, supra note 37; see also Initial Disclosure Statement, 15 at 15.

Initial Disclosure Statement, 15 at 15.

Id.

Payment-in-kind (PIK) refers to a financial instrument that pays the interest or dividends on a note with additional

securities or equity instead of cash.

Secured Notes

to certain Secured Noteholders; (c) exchanging a majority of the remaining

then-outstanding senior unsecured notes that matured in April 2020 for additional secured notes

and repaying the remaining un-exchanged senior unsecured notes due 2020 in cash.

The 2020 refinancing transaction helped Guitar Center in the short term, but the impacts

of the COVID-19 pandemic would continue to affect its business. The company’s net sales

during the first half of the fiscal year of 2020 would decrease by 20%.

Because of the COVID-

19 pandemic, Guitar Center was forced to shut down its second largest revenue source–

instrument lessons.

Even as retail locations began to commence limited operations later in the

year, they were still faced with challenges from intermittent closures and expenditures targeted at

addressing health and safety costs. An extremely overleveraged and reeling Guitar Center would

outright default on a $45 million interest payment in October 2020.

This default spurred the

company and its creditors towards negotiations for a potential reorganization. For approximately

three months, Guitar Center and its creditors worked out the terms of several restructuring

transactions with an eye towards filing for chapter 11.

These transactions served as the

foundations of Guitar Center’s eventual initial plan in its chapter 11 case.

Ultimately, the

company would file a petition to enter Chapter 11 on November 22, 2021.

On the petition date,

Guitar Center’s existing Pre-Petition debt totaled in the amount of $1,329.8 million under five

financing arrangements described below.

The net proceeds of Superpriority notes were used to fund the April 2020 cash interest payment due on the

secured notes, as well as related fees and expenses of the 2020 refinancing transactions. Initial Disclosure Statement,

15 at 23.

Id. at 23–24.

Tim Martin Declaration, 254 at 29.

Id. at 12, 17, 28.

Jem Aswad, Guitar Center, Laden with Debt, Considers Restructuring Options, Including Bankruptcy, VARIETY

(Oct. 27, 2020) https://perma.cc/K2YF-UUK6.

Tim Martin Declaration, 254 at 29–35.

Id. at 34.

Id.

Initial Disclosure Statement, 15 at 20–22.

Creditor

Type

Amount

Wells Fargo

ABL Facility &

Letters of Credit

$276.6 Million

NY Mellon

Superpriority Secured

Notes

$35.7 Million

NY Mellon

Secured Notes

$640 Million

NY Mellon

PIK/Cash

$5.8 Million

Wilmington

Unsecured Notes

$379.3 Million

The Restructuring Support Agreement

Before Guitar Center filed for bankruptcy, it negotiated a restructuring support agreement

with its key credit holders. The restructuring support agreement contemplated and discussed

certain restructuring and recapitalization transactions to be taken place while Guitar Center

entered bankruptcy.

The parties to the restructuring support agreement were Guitar Center, the

Sponsor Support Party, the Brigade Co-investors, the Carlyle Co-investor, and the creditor

support parties

each of whom would be closely involved in the reorganization. The

restructuring support agreement acted as map for Guitar Center and its key secured credit holders

and equity holders because it stated how Guitar Center was to acquire financing during its

bankruptcy, how Guitar Center’s new equity structure was to be set up and implemented as it

would exit Chapter 11 under a confirmed plan of reorganization.

Id. See also Declaration of Tim Martin, 254 at 20–22.

Initial Disclosure Statement, 15 at 172.

The preamble to the RSA describes the “creditor support parties” as the holders of unsecured notes claims, the

holders of secured notes support parties and the superpriority secured notes support parties.

Milestones

There were several “milestones” included in the restructuring support agreement that set

up a timeline for the reorganization process.

These milestones obligated Guitar Center and

other parties to meet certain deadlines along the way to the plan’s effective date.

The first milestone in the restructuring support agreement provided that Guitar Center

would pay the reasonable professional fees and expenses of the other parties to the agreement by

November 18, 2020.

Term DIP Commitment Letter Milestone

Another milestone included in the restructuring support agreement obligated Guitar

Center to pay the reasonable fees and expenses that were documented under the Term DIP

Commitment Letter (included in the restructuring support agreement) by no later than November

18, 2020.

Guitar Center and the creditor support parties who participated in restructuring

support agreement planned to have Guitar Center serve as a “debtor in possession”

(“DIP”) for

the duration of the upcoming chapter 11 case.

It was necessary for Guitar Center to obtain DIP

financing to avoid immediate and irreparable harm to its business, their estates, the creditors and

other parties-in-interest.

Furthermore, the DIP financing would enable Guitar Center to

continue business operations.

Guitar Center entered Chapter 11 with limited cash on hand, and

the Prepetition Secured Lenders’ consent to use their cash collateral was conditioned upon the

transactions outlined in the restructuring support agreement, including Guitar Center’s access to

Initial Disclosure Statement, 15 at 183.

Id. at 183–84.

Id. at 183.

Id.

In the majority of chapter 11 cases, a debtor will remain in possession of its assets, while assuming the fiduciary

and other responsibilities that a trustee would normally have in a bankruptcy case. Such responsibilities include

investigation and oversight of a chapter 11 case. MICHAEL L. BERNSTEIN, GEORGE W. KUNEY, BANKRUPTCY IN

PRACTICE 17 (6th ed. 2022).

Declaration of Eric Winthrop in Support of Debtors’ Motion for Entry of Interim and Final Orders: (I)

Authorizing the Debtors to Obtain Senior Secured Priming Superpriority Postpetition Financing; (II) Authorizing

Use of Cash Collateral; (III) Granting Liens and Providing Claims with Superpriority Administrative Expense

Status; (IV) Granting Adequate Protection; (V) Modifying the Automatic Stay; (VI) Scheduling a Final Hearing; and

Granting Related Relief. Case 20-34656 (KRH). (“Declaration of Eric Winthrop”). 31 at 6.

Debtors’ Motion for Entry of Interim and Final Orders Pursuant to 11 U.S.C. §§ 105, 361, 362, 363, 364, 503,

506, and 507: (I) Authorizing Debtors to Obtain Senior Secured Priming Superpriority Postpetition Financing; (II)

Granting Liens and Providing Claims with Superpriority Administrative Expense Status; (IV) Granting Adequate

Protection; (V) Modifying the Automatic Stay; (VI) Scheduling a Final Hearing; and (VII) Granting Related Relief.

Case -2034657 (KRH) (“Debtors’ Motion for DIP Financing”). 30 at 41.

Id. at 13.

DIP financing. Most importantly, Guitar Center commenced their bankruptcy case during the

most critical time for retailers, the holiday season.

Guitar Center had to pay their employees,

vendors, and other crucial entities to keep inventory stocked and cash flow up. The Term DIP

Commitment Letter referenced in this milestone was written between Guitar Center and its

creditors who held superpriority secured notes pre-petition.

Under the restructuring support

agreement, Guitar Center was to obtain, pursuant to Section 364(c)

and 364(d)

of the

Bankruptcy Code, a Term DIP Facility that would provide Guitar Center with $325 million in

senior secured superpriority funding. This facility would be used to refinance the pre-petition

ABL credit facility and provided Guitar Center with general working capital for the duration of

its chapter 11 case.

This funding source would play a large role in Guitar Center’s restructuring

endeavors.

New Common Equity Investment

The restructuring support agreement further provided that by November 18, 2020, Guitar

Center and the Investor Support Party

would have executed and delivered counterparty

signature pages to the New Common Equity Investment Agreement and New Common Equity

Commitment Letters.

This “New Common Equity Investment” referred to a substantial equity

transaction between Guitar Center and the Investor Support Party.

Under the terms of the New

Common Equity Investment Agreement and Commitment Letters, Guitar Center would issue

new common equity as part of its chapter 11 plan of reorganization, pro rata, to each of the

Declaration of Eric Winthrop, 31 at 7.

Initial Disclosure Statement, 15 269, 281.

Under section 364(c)(3) of the Bankruptcy Code if the trustee is unable to obtain unsecured credit, the court after

notice and hearing, may authorize the obtaining of credit or the incurring of debt secured by a junior lien on property

of the estate that is subject to a lien. 11 U.S.C. §§ 364(c)(3).

Under section 364(d) of the Bankruptcy Code, the Court after notice and a hearing, may authorize the obtaining of

credit or the incurring of debt secured by a senior or equal lien on property of the estate that is subject to a lien only

if the trustee is unable to obtain such credit otherwise and there is adequate protection of the interest of the holder of

the lien on the property of the estate on which such senior or equal lien is proposed to be granted. 11 U.S.C. §§

364(d).

Initial Disclosure Statement, 15 at 224.

There were further milestones included in the term dip commitment letter which imposed deadlines on guitar

center for filing motions relating to the term dip facility and obtaining the court’s approval throughout the case. Id.

at 224.

The Investor Support Party was defined in the Restructuring Support Agreement as Ares Management, Carlyle

Group and Brigade Management. Id. at 181.

Id. at 183.

Id. at 177.

investors inside the Investor Support Party at a rate of 33.3% each.

One party inside the

Investor Support Party, Brigade Management, would also receive warrants

under the New

Common Equity Investment Agreement.

In consideration for the new common equity, each

investor would commit an amount not exceeding $55 million, for a total amount of $165

million.

This restructuring transaction was a centerpiece of Guitar Center’s reorganization

efforts. The restructuring transactions allowed Guitar Center to access a necessary source of

funding and afforded the investor support parties with equity and governance rights upon the

Effective Date of the to-be-confirmed chapter 11 plan.

Because of the role that this transaction

would play in Guitar Center’s reorganization, the restructuring support agreement sought to

ensure that the New Common Equity Investment documents had been fully executed before

moving forward in the chapter 11 process.

The next milestone that was included in the restructuring support agreement required

Guitar Center to commence prepetition solicitation of the chapter 11 plan in accordance with

Bankruptcy Code Section 1126(b), no later than November 19, 2020.

Bankruptcy Code

Section 1126(b)(1)-(2) provides that a holder of a claim or interest that has accepted or rejected

the plan before the commencement of a chapter 11 case is deemed to have accepted or rejected

the plan if the solicitation of such acceptance or rejection was in compliance with any applicable

non-bankruptcy law, or if there is no such law, acceptance or rejection was solicited after

disclosure of adequate information.

This milestone was included in the restructuring support

agreement to prompt Guitar Center to solicit votes on a plan for reorganization from key parties

that would be entitled to vote on its plan before the chapter 11 proceedings began. In order for

the pre-petition votes to “count” for purposes of confirmation of the plan, Guitar Center had to

Id. at 314.

Id. See also James Chen, What is a Warrant?, INVESTOPEDIA (Oct. 6, 2021), https://perma.cc/LXS7-Y9BG.

Initial Disclosure Statement, 15 at 314.

Id.

Ares Management was to nominate 3 members to the Guitar Center board, Brigade Capital was to nominate 3

members to the Guitar Center board, and CSP IV Acquisitions was to nominate 3 members to the Guitar Center

board. The proceeds from the New Common Equity Investment Agreement would be used to pay off the Term DIP

Facility. Id. at 211.

Initial Disclosure Statement, 15 at 183.

11 U.S.C. §§ 1126. See also S. REP. NO. 95-989, https://perma.cc/2NRH-QREV; BERNSTEIN & KUNEY, supra

note 78, at 570.

meet the adequate disclosure requirements of Section 1126(b).

Essentially, this required voting

parties receive: (i) a disclosure statement, with all exhibits, (ii) the proposed plan, and (iii) an

applicable ballot to cast a vote on the plan.

These documents had to be distributed to

substantially all members of each voting class that Guitar Center solicited pre-petition.

The restructuring support agreement included a milestone that imposed a November 22,

2020 deadline for Guitar Center to commence the chapter 11 case and file its first day motions.

Within one day after filing the voluntary petition for chapter 11 and the first day motions, the

restructuring support agreement called for Guitar Center to file a DIP Financing Motion, the pre-

packaged plan, the disclosure statement, and a motion seeking approval of the disclosure

statement and confirmation of the plan in a combined hearing.

Because Guitar Center and its

creditors had negotiated the terms and timing of this chapter 11 case before it was filed, the

restructuring support agreement called for the first day motions to be filed quickly and to push

the proceedings forward.

This was a boon to Guitar Center, as court approval of the DIP

Motion would afford it essential funding to continue with the chapter 11 case as planned in the

restructuring support agreement.

The restructuring support agreement contemplated that the court would grant Guitar

Center’s DIP Motion and enter an Interim DIP order 2 days after Guitar Center filed its voluntary

petition for chapter 11.

100

The fact that the parties to the restructuring support agreement

expected such a short timeframe demonstrates the efficiency and speed that can accompany the

use of prepetition out of court restructuring agreements in a chapter 11 case. Since the plan was

negotiated outside of court and had been approved by Guitar Center’s key creditors, the

The adequate disclosure requirements of Bankruptcy Code Section 1126 are spelled out in Bankruptcy Code

Section 1125. The kind and form of information that meets the adequate disclosure confirmation requirement is left

to judicial discretion, and will be governed by the circumstances of the case. 11 U.S.C. §§ 1125.

Christina Pullo, Undertaking a Prepackaged Plan Solicitation, PRIME CLERK LLC, at 8, Practice Note w-016-

7091.

11 U.S.C. §§ 1126(b); FED. R. BANK. P. 3018 (this rule allows a court to invalidate a pre-petition vote on a plan if

distribution of solicitation was not distributed to substantially all members of a voting class).

Initial Disclosure Statement, 15 at 184.

Id.

Id. at 183.

Id. See also The Prepackaged Bankruptcy Strategy, THOMPSON REUTERS, Practical Law Practice Note 9-503-

4934.

100

Initial Disclosure Statement, 15 at 184.

expectation was that the proposed DIP motion would be granted by the court without issue in this

case.

The restructuring support agreement set milestones 45 days after the petition date for the

court to enter a Final DIP Financing order, an order approving Guitar Center’s disclosure

statement, and an order confirming the plan.

101

The final milestone included in the restructuring

support agreement stipulated that the Effective Date

102

of the plan would be no later than

February 1, 2021.

103

Other Terms of the Restructuring

In addition to the milestones leading to the DIP Financing and plan confirmation, the

restructuring support agreement also addressed other matters.

Critical Vendors

The restructuring support agreement called for Guitar Center to file a motion with the

court, seeking permission to pay its critical vendors prepetition claims under the administrative

expense priority in Bankruptcy Code Section 503(b).

104

Critical vendors are vendors whose

goods and/or services are required by the debtor and who will not supply them absent payment of

their pre-petition claims.

105

Guitar Center and its key credit holders desired to deem certain

vendors as “critical vendors” because the vendors were unlikely to continue supplying Guitar

Center with inventory without payment of their prepetition claims.

The ABL (Asset Based Loan) DIP Facility

Guitar Center’s lenders under the prepetition ABL credit agreement intended to provide

Guitar Center with financing under the ABL DIP Facility.

106

Obtaining an ABL facility during

101

Each of these were necessary for the Effective Date of the plan to occur. Initial Disclosure Statement, 15 at 184.

Guitar Center included its initial disclosure statement in the prepetition plan and solicitation, so the major players in

this case likely did not expect a lot of pushback to getting the disclosure statement approved.

102

Once the plan had been confirmed by the court, the “Effective Date” was the date contemplated in the

Restructuring Support Agreement on which the restructuring transactions and distributions included in the plan

would take place. Id. at 52–54.

103

Id. at 184.

104

Id. at 216.

105

BERNSTEIN & KUNEY, supra note 73, at 288.

106

An asset based loan is an agreement to loan money secured by assets of the borrower. The loan is secured by the

assets of the company which may be the inventory, accounts receivables, equipment or other property owned by the

borrower. Asset-Based Lending, INVESTOPEDIA.COM, https://perma.cc/DN6S-JLX7.

the chapter 11 proceedings allowed Guitar Center to continue paying payroll expenses, purchase

inventory from critical vendors, and pay rent due under its leases.

New First Lien Debt

On the Effective Date of the confirmed plan, the New First Lien Debt

107

was to be issued

in the amount of $335 million to Guitar Center on prevailing market terms.

108

Guitar Center and

its key credit holders knew the New First Lien Debt was necessary so Guitar Center could have

working capital after emerging from chapter 11.

New Preferred Equity

On the Effective Date of the confirmed plan, the New Preferred Equity was to be issued

to each holder of a Prepetition Secured Notes, on a pro rata basis.

109

Essentially, Guitar Center

desired to do a debt/equity swap with the holders of the Prepetition Secured Notes claims.

110

The

restructuring support agreement required Guitar Center to create a whole new class of stock to

satisfy the Prepetition Secured Notes claims.

111

New Junior Preferred Equity

On the plan Effective Date, Guitar Center was mandated to issue the New Junior

Preferred Equity to each holder of the Prepetition Unsecured Notes Claim on a pro rata basis.

112

Guitar Center could call

113

in the New Junior Preferred Equity at any time after it had called and

redeemed the New Preferred Equity, but not before then. Furthermore, the New Junior Preferred

Equity did not have any rights to dividends or voting.

114

107

First lien debt is a form of senior secured debt where the first lien debt is secured by having the first claim on

collateral. First Lien/Second Lien Debt, FINANCIAL EDGE.COM, https://perma.cc/JH4W-BBVE.

108

Initial Disclosure Statement, 15 at 216.

109

Id.

110

A debt/equity swap is a refinancing deal in which a debt holder gets an equity position in exchange for the

cancellation of the debt. The logic behind this is an insolvent company cannot pay its debts or improve its equity

standing. Debt/Equity Swap, INVESTOPEDIA.COM, https://perma.cc/6P8E-MDC5.

111

Initial Disclosure Statement, 15 at 216.

112

The New Junior Preferred Equity was created with a liquidation preference totaling $2 million.

113

Guitar Center could call in the New Junior Preferred Equity at a total price of $2 million.

114

Essentially, the New Junior Preferred Equity is a $2,000,000 lottery ticket. If Guitar Center was successful and

retired its New Preferred Equity, which it could only do if it has paid off all its current debt, then it can call the New

Junior Preferred Equity and give the holders $2,000,000.

The Management Incentive Plan

On or after the Plan Effective Date, Guitar Center planned to adopt and implement a

management incentive plan.

115

The management incentive plan was designed to keep Guitar

Center’s high-level executives on board while Guitar Center went through Chapter 11 by

providing management with a small percentage of the New Common Equity that would be issued

as part of the restructuring transactions.

116

Guitar Center and its key credit holders found it

desirable to keep the most senior executives because they knew the most about Guitar Center’s

business.

Director and Officer Insurance (“D&O Insurance”)

After the plan’s Effective Date, Guitar Center could not terminate or otherwise reduce the

coverage under any directors’ and officers’ insurance policies in effect or purchased as of the

petition date.

117

It has become common for trustees, creditors’ committees, and individual

creditors or groups of creditors to assert breach of fiduciary duty and other claims against

officers and directors of a bankrupt corporation.

118

When this occurs, the defendant directors and

officers will need to make use of the D&O Insurance policy to fund their defense and pay any

resulting settlement or judgement.

119

Unexpired Leases and Executory Contracts

On the Plan Effective date, all contracts and unexpired leases to which Guitar Center was

a party were to be assumed or deemed assumed, unless Guitar Center previously rejected the

lease.

120

Guitar Center and its key credit holders knew they needed a plan for Guitar Center’s

leases because Guitar Center had over 300 leased properties when they entered bankruptcy.

Summary of the Restructuring Transactions

Below is a chart that outlines the key restructuring transactions included in the restructuring

support agreement that served as the foundation for Guitar Center’s prepetition plan for

reorganization.

115

Initial Disclosure Statement, 15 at 218.

116

Id.

117

Id.

118

BERNSTEIN & KUNEY, supra note 78, at 205.

119

Id.

120

Id. at 219.

Pre-Petition Solicitation and Voting

After the restructuring support agreement was executed, prepetition, Guitar Center

proceeded to solicit approval of its plan of reorganization before filing for relief under chapter

11. Although Guitar Center characterized this as a pre-packaged plan in the disclosure statement,

it would be more accurate to label the pre-petition plan as pre-negotiated, as Guitar Center

solicited approval from only their key creditors and interest holder, not all creditors.

121

The Bankruptcy Code contains certain requirements regarding the treatment of classes of

claims

122

and interests

123

that exist against the bankruptcy estate. To satisfy these requirements, a

plan must group creditors into similarly situated “classes” and then requires a determination of

whether or not the class is “impaired” by the plan.

124

Pursuant to Bankruptcy Code Section 1124,

in order to leave a class of claims or interests unimpaired, a plan must either: (i) leave unaltered

the legal, equitable, and contractual rights to which such claim or interest entitles the holder of

such claim or interest; or (ii) decelerate and reinstate the prepetition contract, and cure any

default.

125

If a class is impaired by a plan, it must vote to accept the plan under Bankruptcy Code

Section 1126(c), which provides that a plan is binding on a class if it is approved by a majority in

number and two thirds in amount of voting creditors.

126

Here, some advantages of pre-packaged and pre-negotiated plans can be seen. When done

properly, a debtor can obtain the approvals needed to satisfy the disclosure and solicitation

requirements of Bankruptcy Code Section 1125(a), as well as the confirmation requirements of

1129(a). When the requirements of these sections are met, a chapter 11 case can progress much

quicker, since the essential requirements for plan confirmation have presumptively been met.

127

Pursuant to Bankruptcy Code Section 1126(f), holders of claims and interests that are not

impaired are conclusively presumed to have accepted the plan.

128

Therefore, Guitar Center had

no need to solicit votes from these classes during its pre-petition activities. There were only two

classes of claims under Guitar Center’s plan which the plan treated as impaired: Secured Notes

121

A pre-packaged plan complies with the requirements set out in Bankruptcy Code Section1129(a)(8), because all

Guitar Center’s creditors were not involved in the prepetition solicitation process, this one did not.

122

Bankruptcy Code Section 101(5)(A) defines a “claim” as “a right to payment” whether or not such a right is

reduced to a judgment, liquidated, unliquidated, fixed, contingent, matured, unmeasured, disputed, undisputed, legal,

equitable, secured, or unsecured. 11 U.S.C. §§ 101(5)(A). See also BERNSTEIN & KUNEY, supra note 78, at 346.

123

While not defined expressly in the Bankruptcy Code, Section 1126 informs that a working definition of

“interests” essentially means equity securities. BERNSTEIN & KUNEY, supra note 78, at 347.

124

BERNSTEIN & KUNEY, supra note 78, at 540.

125

11 U.S.C. §§ 1124. See also BERNSTEIN & KUNEY, supra note 78, at 540.

126

11 U.S.C. §§ 1126. See also BERNSTEIN & KUNEY, supra note 78, at 540.

127

Of course, there is a risk that the pre-packaged plan may have failed to satisfy a requirement and the court will

reject the plan. Dennis J. Connolly, Current Issues Involving Prepackaged and Prenegotiated Plans, NORTON

ANNUAL SURVEY OF BANKRUPTCY LAW, Sep. 2004.

128

Initial Disclosure Statement, 15 at 14.

Claims and Unsecured Notes Claims.

129

These were the only claim holders who were able to

vote to approve the plan during pre-petition solicitation. In order to meet the confirmation

requirements laid out in Bankruptcy Code Section 1129(a)(10), at least one of these two classes

had to vote to accept

130

the plan.

131

The window to vote began on November 17, 2020 and ran

through December 10, 2020. The classes were sent ballots to vote with as well as a disclosure

statement to satisfy the requirements of 1125(a).

132

Ultimately, the holders of the Secured Notes

Claims and the Unsecured Notes Claims each voted to approve the plan.

133

This gave Guitar

Center a great deal of creditor support as it approached the time for filing for relief under chapter

11.

134

The Initial Plan

On November 22, 2021, Guitar Center filed its voluntary petition for chapter 11. On the

same day that Guitar Center filed its case, Guitar Center submitted the pre-negotiated plan that

had been approved prepetition. The company also filed the prepetition disclosure statement,

which included the restructuring support agreement, agreements outlining the restructuring

transactions, a liquidation analysis, and financial projections relating to the plan. Furthermore,

Guitar Center filed various administrative motions on the same day. The plan was filed with the

Court immediately after Guitar Center filed for bankruptcy in accordance with the restructuring

support agreement. The goals of the initial plan were to carry out the transactions and

agreements outlined within the milestone of the restructuring support agreement and mirrored the

terms that were voted on during the pre-petition solicitation process.

135

129

Id.

130

A class of Claims accepts the Plan where: the holders of (i) at least two-thirds in dollar amount of the Claims

voting in such Class vote to accept the Plan; and (ii) more than one-half in number of the Claims voting in such

Class vote to accept the Plan. 11 U.S.C. §§ 1126(c)–(d).

131

11 U.S.C. §§ 1129(a)(10). See also BERNSTEIN & KUNEY, supra note 78, at 540.

132

Initial Disclosure Statement, 15 at 2–5.

133

100% of superpriority note claimholders, 71% of secured notes claimholders, 84% of unsecured notes

claimholders voted to approve the plan. Id. at 5.

134

At the same time, it is important to note that Guitar Center did not involve trade creditors, landlords, insurance

providers, and so on during the pre-petition solicitation process. This created the potential for roadblocks and

objections during the case. See also Connolly, supra note 132, at 7 (explaining that some disadvantages of

prepetition solicitation include adverse effects on debtors and their suppliers).

135

Joint Pre-packaged Chapter 11 Plan of Reorganization of Guitar Center, Inc. Et Al Case 20-34656 (KRH).

(hereinafter “Initial Plan”). 16 at 1.

Classification of Claims and Interests

When Guitar Center filed its initial plan with the Court, it had already solicited approval

of the plan during the pre-petition process from the classes of claim holders that were “impaired”

by the plan.

136

However, along with the two impaired classes, Guitar Center provided for the

treatment of 10 total classes of claim and interests, shown below.

137

136

Initial Disclosure Statement, 15 at 14.

137

Initial Plan, 16 at 25.

Secured Notes Claims

Class 4 of claims as outlined in Guitar Center’s chapter 11 plan consisted of all Secured

Notes Claims against the bankruptcy estate.

138

Class 4 was one of the two classes impaired by

the initial plan.

139

They were impaired because the initial plan altered the legal, equitable, and

contractual rights owed to the secured notes holders.

140

Consequently, the holders of Secured

Notes Claims were required to approve Guitar Center’s initial plan for reorganization in order for

the court to confirm it.

141

Since this class had already voted to approve the initial plan during the

pre-petition solicitation process, there was no need to solicit approval of the initial plan during

the case. This removed a major obstacle to confirmation of the initial plan.

142

Additionally, Guitar Center sought to confirm the initial plan under Bankruptcy Code

Section 1129(b), therefore the initial plan’s treatment of this class of claims had to comply with

the 1129(b) “fair and equitable” requirement.

143

With respect to classes of secured claims, one

manner in which a plan can satisfy the confirmation requirements of 1129(b happens when the

plan provides that “the proponent ‘rewrites the contract’ to provide for payments over time, with

a present value at least equal to the value of the collateral.”

144

Here, the plan stated that such claims were allowed in the principal amount of

$640,000,000, plus all accrued and unpaid interest and expenses related to the secured notes

during the chapter 11 cases.

145

Pursuant to the plan, as of the Effective Date, Guitar Center

would make pro rata distributions (the Secured Notes Claims Distribution) to holders of this

138

Id. at 27.

139

Id. at 25.

140

11 U.S.C. §§ 1124(2)(E).

141

11 U.S.C. §§ 1129(a). However, a court can still confirm a plan that does not have the requisite votes for

approval under Bankruptcy Code Section 1129(b). 11 U.S.C. §§ 1129(b); see also BERNSTEIN & KUNEY, supra note

78, at 542.

142

So long as the court found that Guitar Center had complied with the applicable Bankruptcy Code requirements.

See generally Connolly, supra note 132.

143

11 U.S.C. §§1129(b). This rule is known as the “cramdown rule”, and allows the proponent of a plan to impose a

plan on dissenting classes where one class of impaired creditors has voted to accept the plan. BERNSTEIN & KUNEY,

supra note 78, at 542.

144

The absolute priority rule in 1129(b) requires the claims of a dissenting class of creditors to be paid in full before

any junior class of creditors may receive or retain any property in satisfaction of their claims. 11 U.S.C. §§

1129(b)(2)(A)(i). See also BERNSTEIN & KUNEY, supra note 73, at 547 (explaining that “a class may not receive or

retain value under a plan unless all classes that enjoy higher priority are paid in full, unless they agree otherwise.”)

145

Initial Plan, 16 at 30.

class of claims in exchange for full and final satisfaction of the claims against the estate.

146

This

distribution provided holders of the Secured Notes Claims with a pro rata share of cash in the

aggregate amount of $450 million and 100% of the New Preferred Equity.

147

By providing this

class of claims with a distribution of cash, shares of the New Preferred Equity, and paying

interest and expenses that accrued during the chapter 11 cases, the plan’s treatment of the class

satisfied the “fair and equitable” requirements of Bankruptcy Code Section 1129(b).

148

Further,

the initial plan’s treatment of the Secured Notes Claims did not violate the “absolute priority

rule,” as this distribution would satisfy the secured claims against the bankruptcy estate which

allowed for the initial plan to afford distributions to unsecured creditors.

149

Unsecured Note Claims

Class 6 of claims as outlined in Guitar Center’s chapter 11 plan consisted of all

Unsecured Note Claims against the bankruptcy estate.

150

This was the only other class left

impaired by the initial plan. As such, Class 6 had been involved in pre-petition solicitation,

ultimately voting to approve the plan.

151

Because Guitar Center sought to confirm the plan under Section 1129(b), the plan’s

treatment of this class of claims had to conform to 1129(b)’s confirmation requirements.

152

With

respect to unsecured claims, a plan can meet confirmation standards under 1129(b) if it pays

creditors in full upfront or over time with interest at a rate calculated to provide the creditor with

the present value of the claim amount; or it pays nothing to junior classes of creditors.

153

Here, Guitar Center’s initial plan stated that this class of claims shall be allowed in the

amount of $385,088,767 in unsecured notes relating to the 2018 Cash/PIK Notes.

154

Further, it

also included an amount of $5,782,295 relating to the 2020 Cash/PIK unsecured notes for a total

146

Id. at 32.

147

Id. at 32, 51.

148

See supra text accompanying note 149.

149

The plan afforded distributions to the secured notes claims, provided the unsecured notes claims with pro rata

shares of New Junior Preferred Equity, and no other class received or retained value under the plan. Initial Plan, 16

at 30, 51.

150

Id. at 30.

151

Initial Disclosure Statement, 15 at 14.

152

11 U.S.C. §§ 1129(b).

153

11 U.S.C. §§ 1129(b)(2)(B)(i); see also BERNSTEIN & KUNEY, supra note 78, at 550.

154

Initial Plan, 16 at 32.

aggregate principal amount of $379,406,472 of allowed claims within this class.

155

Per the initial

plan, each holder of a claim in this class would receive its pro rata share of the Unsecured Notes

Claims Distribution

156

on the initial plan’s Effective Date or as soon as practicable thereafter.

157

The distribution would give the class of claims pro rata shares of 100% of New Junior Preferred

Equity

158

in exchange for full and final satisfaction and release of claims against Guitar

Center.

159

The New Junior Preferred Equity would only total in the amount of $2 million, meaning

that the plan’s treatment of this class of claims did not pay this class of creditors the full value of

pre-petition claims.

160

Creditors in this class voted to accept the initial plan during the pre-

petition solicitation phase.

161

This is likely due to the fact unsecured note holders lacked priority,

and would receive nothing under a traditional chapter 7 liquidation analysis.

162

Because the

initial plan did not provide for full satisfaction of this class of claims, in order to satisfy the

requirements of Section 1129(b), no class junior to the Unsecured Notes Claims could receive

distributions under the initial plan.

163

Intercompany Claims (and Interests)

Class 8 of claims in Guitar Center’s initial plan consisted of Intercompany Claims.

164

These claims consisted of claims that Guitar Center held against itself, by way of intercompany

accounts receivable, payables, and other intercompany transactions.

165

The initial plan

155

Id.

156

The Unsecured Notes Claims Distribution would give the class of claims pro rata distributions of 100% of New

junior preferred equity. Id.at 33.

157

Id.

158

Id. See also Initial Disclosure Statement, 15 at 212.

159

Initial Plan, 16 at 33.

160

Id.

161

Initial Disclosure Statement, 15 at 14.

162

Id. at 361.

163

See supra text accompanying note 149.

164

Intercompany Transactions result in the daily creation of intercompany receivables and payables (collectively,

the “Intercompany Claims”). Intercompany Claims exist at any given time, resulting in the existence of prepetition

Intercompany Claims. The Debtors’ treasury department oversees the cash collections and disbursements and

maintains records of any transfers among the Debtors. Debtors’ Motion for Entry of Interim and Final Orders: (I)

Authorizing the Debtors to (A) Continue to Operate their Cash Management System and Maintain Existing Bank

Accounts and Business Forms, (B) Continue Using Credit Cards, and (C) Engage in Intercompany Transactions; (II)

Providing Administrative Expense Priority for Postpetition Intercompany Claims; (III) Granting an Extension with

Respect to Compliance with Requirements of Section 345(b) of the Bankruptcy Code; and (IV) Granting Related

Relief. Case 20-34656 (KRH). (hereinafter “Cash Management Motion”). 11 at 27.

165

Id.

contemplated the reinstatement of these prepetition claims, with the consent of the Investor

Support Parties.

166

With respect to this class of claims, Guitar Center moved the court to apply

administrative expense priority for any postpetition Intercompany Claim, so as to allow each

subsidiary to continue to bear repayment responsibility for the underlying obligation.

167

Existing Common Equity

In the initial plan, Class 10 was comprised of interests in Existing Common Equity in

Guitar Center. Pursuant to the initial plan, all prepetition Guitar Center common equity would be

cancelled on the Effective Date of the initial plan.

168

No holder of any existing common equity

was to receive a distribution or retain property or other value on account of its prepetition equity

interests.

169

These claims were fully impaired.

170

It might seem alarming that this initial plan could be confirmed despite all existing

common equity being impaired, without having the right to vote on the initial plan.

171

However,

the application of Bankruptcy Code Section 1129(b) provides clarity on this issue. The

confirmation requirements of Section 1129(b) allow a court to confirm a plan that meets the

standards of the “fair and equitable requirement” and absolute priority rule.

172

Here, it is important to remember that this plan was pre-negotiated between Guitar Center

and its key creditors. Some of these key creditors were the also members of the prepetition

existing common equity class.

173

Therefore, these members, in particular, had to agree to the

treatment of class 10 under initial plan before it was filed. An integral function of the initial plan

was incorporating a new equity structure upon the Effective Date of the initial plan.

174

Because

the initial plan’s treatment of class 6 opted not to pay unsecured note holders in full, any class

166

Initial Plan, 16 at 34.

167

Cash Management Motion, 11 at 19.

168

Initial Plan, 16 at 34.

169

Id.

170

Id.

171

Initial Plan, 16 at 30.

172

See supra text accompanying note 149.

173

Ares Management held substantially all prepetition common equity in Guitar Center Holdings, Inc. and was

involved in the prepetition negotiations in this case.

174

This proposition is evidenced by the fact that the Effective Date could not occur without the completion of the

New Common Equity Investment, as this source of funding was needed for multiple restructuring transactions. See

supra text accompanying note 101.

junior to class 6 was unable to receive payment in order for the initial plan to meet confirmation

requirements of 1129(b).

175

Means of Implementation

After discussing the classification of claims and interest, Guitar Center’s initial plan

provided for the means of implementation of the initial plan. The initial plan provided for a New

Board of Directors of Guitar Center and the issuance of new equity.

176

The New Corporate

Governance Documents outlined the management structures and governance of Guitar Center

upon reorganization

177

The New Board was designed primarily to allow the new equity holders

to direct and control the Reorganized Guitar Center.

Furthermore, the initial plan provided the procedures for disputed claims. Since the

restructuring support agreement was negotiated between Guitar Center and its key creditors,

Guitar Center knew some interested parties were likely to be upset regarding their distributions

under the initial plan. As such, Guitar Center had to implement a disputed claims process so

interested parties could dispute their distributions. Initially, Guitar Center desired to pay all

claims in the ordinary course of business.

178

If Guitar Center disputed any claim, the dispute

would be resolved as if the chapter 11 cases had not commenced, and would survive the

Effective Date.

179

Moreover, Guitar Center or an interested party could object to the any of the

claims filed. The objections had to be filed ninety days before the Effective Date or the date that

a proof of claim was filed.

180

Without such a process, the interested parties could have subjected

Guitar Center voluminous litigation.

175

See supra text accompanying note 149.

176

Initial plan, 16 at 37–38.

177

The New Corporate Governance Documents stated: i. there would be a New Board of directors consisting of ten

persons; ii. the Sponsor Support party, the Carlyle Co-Investor and the Brigade Co-Investor each had the right to

designate three persons to the New Board, and in the case of the Sponsor Support Party, one of such three persons

planned to serve as the Chairman of the New Board; (iii) the Sponsor Support Party, the Carlyle Co-Investor and the

Brigade Co-Investor were entitled to designate one director to each committee of the New Board; and (iv) the chief

executive officer of Reorganized Guitar Center was appointed by the New Board. Id. at 39.

178

Id. at 43.

179

Id. If Guitar Center initiated any claims while in bankruptcy, they wanted to litigate them in the proper forum and

venue without disruption from the bankruptcy court. Moreover, Guitar Center wanted the claims to survive the

effective date in case they desired to pursue them further.

180

Id.

Furthermore, the initial plan provided for a management incentive program.

181

Under the

management incentive program, Guitar Center was required to reserve, exclusively for directors

and management employees, a pool of shares of new common stock representing 10-12% of the

New Common Equity.

182

The final amount of the pool had to be reasonably acceptable to Guitar

Center and each of the Investor Support Parties.

183

Guitar Center desired to keep its high level

executives after they emerged from bankruptcy because these executives had substantial

knowledge of Guitar Center’s business and large turnover could be costly. Therefore, it was

likely these executives wanted to be compensated for the work they had already done for Guitar

Center and the work they did to negotiate the restructuring support agreement.

Finally, the initial plan discussed a cash out election process as part of the Secured Notes

claims distribution.

184

Each holder of an allowed secured notes claims was to be granted a piece

of the New Preferred Equity to satisfy their claim against Guitar Center. If an allowed Secured

Note holder did not want a part of the New Preferred Equity, then they could elect to receive

cash at a dollar to dollar basis.

185

However, the initial plan also instituted a cash out election cap,

which capped the aggregate amount of dollars that were allocated to the cash out election.

186

the amount the cash out elections exceeded the cash election cap, then holders of allowed

Secured Notes claims making a cash out election had their election automatically reduced on a

pro rata basis.

187

The cash out election process was used as an incentive to entice certain credit

holders to go along with the restructuring support agreement and initial plan.

Treatment of Contracts and Unexpired Leases

Additionally, the initial plan addressed the milestone in the restructuring support

agreement regarding the assumption or rejection of contracts and unexpired leases. Under

Bankruptcy Code Section 365(a) “the trustee, subject to the court’s approval, may assume or

reject any executory contract or unexpired lease of the debtor.”

188

Furthermore, under

Bankruptcy Code Section 1123(b)(2) “a plan may provide for the assumption, rejection, or

181

Id. at 44.

182

Id.

183

Id.

184

Id. at 41.

185

Id.

186

Id.

187

Id.

188

11 U.S.C. §365(a).

assignment of any executory contract or unexpired lease of the debtor not previously rejected

under such section.”

189

Here, Guitar Center planned to assume all executory contracts

(“contracts”) and unexpired leases (“leases”) unless a contract or a lease was otherwise assumed

or rejected, was the subject of a motion disputing the assumption/rejection of the lease or

contract, or was listed on the schedule of rejected contracts.

190

Moreover, the initial plan provided a cure of defaults for assumed contracts and leases.

191

Guitar Center had to pay cash to satisfy the monetary defaults for each contract and lease that

was being assumed under the initial plan.

192

If Guitar Center and a counterparty had a dispute

regarding the amount necessary to cure a default and they could not resolve the dispute

consensually, then no cure was to be paid until entry of a final order resolving the dispute.

193

Next, the initial plan developed a process for claims arising out of the rejection of certain

contracts and leases. Claims arising from the rejection of contracts and leases had to be filed

thirty days after the entry of the confirmation order with respect to the contracts and leases.

Additionally, claims could be filed on the date on which Guitar Center informed the applicable

counterparty of their determination to reject its contract or lease.

194

Finally, the treatment of contracts and unexpired leases section of the initial plan

considered the assumption of Guitar Center’s insurance policies. Similarly to the management

incentive program, Guitar Center desired to assume all D&O (“directors and officers”) liability

insurance policies primarily for the benefit of their high level executives. Many of the executives

would only participate in the negotiations of the restructuring support agreement and the initial

plan if Guitar Center’s insurance policies remained effective throughout the bankruptcy. Keeping

the insurance policies in place was important, so executives could protect themselves from

liability for their actions during the bankruptcy. All of Guitar Center’s insurance policies and any

agreements, documents, or instruments relating thereto, were treated as executory contracts.

195

Guitar Center preferred to treat the insurance policies as executory contracts because then they

189

11 U.S.C §1123(b)(2).

190

Initial Plan, 16 at 47.

191

Id. at 48.

192

Id.

193

Id.

194

Id. at 48-49.

195

Id.

could treat the insurance policies as an administrative claim and cure the claim in full. On the

Effective Date, pursuant to Bankruptcy Code section 365(a), Guitar Center assumed all insurance

policies and any agreements, documents, and instruments related thereto.

196

Maintaining Guitar

Center’s insurance policies were crucial to sustaining their ongoing business to ensure no gaps in

liability emerged while Guitar Center was in bankruptcy.

Conditions Precedent to Plan Confirmation

Next, the initial plan discussed the conditions precedent to confirmation. Here, the only

condition to confirmation was the restructuring support agreement could not terminate due to a

default by Guitar Center.

197

As discussed above, the restructuring support agreement was the

map intended to guide Guitar Center through its chapter 11 case. Guitar Center’s key creditors

wanted to hold the power to direct Guitar Center throughout its bankruptcy. Therefore, this

condition was designed so the initial plan could not be confirmed if the DIP lenders

198

declared

a default based upon an event of default in the restructuring support agreement.

199

However, if an

event of default in the restructuring support agreement did occur, then the DIP lenders could

waive the term and give Guitar Center more time to comply with the applicable term.

Conditions Precedent to the Effective Date

Furthermore, the initial plan provided for conditions that needed to be satisfied before the

Effective Date and consummation of the plan could occur.

200

The Restructuring Support Agreement Effective

The restructuring support agreement needed be in full force and effect, and there could

not be a default under the restructuring support agreement or termination event after the

expiration of the applicable grace period.

201

Definitive Documents Effective

The plan had to be confirmed, the disclosure statement needed to be approved, and any

other definitive documents

202

had to be in full force and effect. Furthermore, the plan, the

196

Id.

197

Id.

198

The DIP Lenders were the Term DIP Commitment parties and Wells Fargo.

199

Some examples of events of default in the restructuring support agreement were if Guitar Center withdrew the

plan or if Guitar Center publicly announced their intention not to support the restructuring transactions

200

Id. at 55.

201

Id.

disclosure statement, and any other definitive documents had to be consistent in all aspects with

the restructuring support agreement and reasonably acceptable to all parties.

203

Here, Guitar

Center and its key creditors desired to predicate the Effective Date on plan confirmation,

approval of the disclosure statement and the definitive documents being in full force and effect

because the restructuring transactions contained within the initial plan were to occur on the

Effective Date and were cross conditioned on the performance of other transactions. Ensuring

that the initial plan, disclosure statement, and other definitive documents were in effect before

the occurrence of the Effective Date would guarantee the availability of funding sources

necessary on the Effective Date.

Plan Confirmation Order

The Bankruptcy Court would have entered the Final Confirmation Order, which had to be

consistent in form with all material aspects of the restructuring support agreement and also

reasonably acceptable to the ABL DIP agent, Guitar Center, and the Investor Support Party.

204

When a court enters a confirmation order, it acknowledges the plan satisfies the statutory

requirements found in Bankruptcy Code Section 1129 and will constitute a binding collective

contract between and among all parties in interest after the effective date.

205

Furthermore, if the

court denies confirmation, the court may grant the debtor leave to amend, allowing the debtor to

come back and ask for confirmation of a new plan.

206

New Common Equity Investment and Equity Commitment Letters

Once the plan had been confirmed by the court, the restructuring support agreement and

initial plan provided that on the morning of the Effective Date, the New Common Equity

Investment Agreement would be executed.

207

The New Common Equity Investment represented

one of the restructuring transactions that Guitar Center and its creditors considered essential to

202

Essentially, the definitive documents were all the documents that governed the restructuring transactions. These

documents included the New Corporate Governance documents, the New Common Equity documents, and the New

Preferred Equity documents. Initial Plan, 16 at 57.

203

These documents included the disclosure statement, plan, first day motions, new common equity documents,

corporate governance, and management incentive plan.

204

Initial Plan, 16 at 56.

205

11 U.S.C. §1129(a).

206

BERNSTEIN & KUNEY, supra note 78, at 539.

207

Initial Disclosure Statement, 15 at 329.

the reorganization as a whole.

208

The funding that Guitar Center would receive from the New

Common Equity Investment would be used to satisfy the Term DIP Facility on the Effective

Date.

209

Consequently, without the execution of this agreement and the subsequent delivery of

the investment funds, the entire reorganization would be in jeopardy. In contemplation of this,

the initial plan included a condition that required this agreement to be executed and funding

delivered to Guitar Center before the Effective Date of the reorganization could occur.

210

No DIP Default

No event of default under and as defined in the applicable DIP Facility could have

occurred under the DIP Facilities or the DIP Order.

211

Some of the events of default were: (i) a

failure to make payment when due, (ii) noncompliance with covenants or breaches in any

material respect of representations and warranties, in either case, (iii) change of ownership, (iv)

termination of exclusivity, etc.

212

New Common Equity and Warrants Issued.

The initial plan contained a condition precedent to the Effective Date, that required the

New Common Equity and Warrants to have been delivered in accordance with the terms set forth

in the New Common Equity Investment Documents.

213

Guitar Center and the parties involved in

the pre-petition solicitation process predicated the occurrence of the Effective Date on this

condition because this transaction was integral to the overall reorganization efforts.

214

Here, occurrence of the Effective Date was cross-conditioned on the execution of the New

Common Equity Investment Agreement.

215

The New Common Equity Investment Agreement

was set to close on the morning of the Effective Date.

216

Upon closing, Guitar Center would

provide evidence that it allocated the securities (and with respect to Brigade, the warrants) in

book entry form for the respective Investor Parties.

217

Once Guitar Center delivered such

208

Id. at 172. See supra text accompanying note 101.

209

Initial Disclosure Statement, 15 at 10

210

Id. at 220.

211

Initial Plan, 16 at 56.

212

Id.

213

Initial Disclosure Statement, 15 at 184.

214

See supra text accompanying note 101.

215

Initial Plan, 16 at 56.

216

Initial Disclosure Statement, 15 at 329.

217

Id.

evidence, the Investor Support Parties would irrevocably release a wire transfer for the funds in

the amount of the agreed upon purchase price for the securities.

218

This condition precedent to

the occurrence of the Effective Date was important because per the terms of the initial plan, the

Effective Date also represented the maturity date for the Term DIP Facility, and other significant

financial obligations.

219

Without the funding from the New Common Equity Investment, Guitar

Center would not be able to make the required payments upon the Effective Date.

New First Lien Debt Issued

The New First Lien debt needed to be issued and the New First Lien documents had to be

in full force and effect, and consistent in all aspects with the restructuring support agreement.

220

Here, The New First Lien Debt was necessary for Guitar Center to have working capital after it

emerged from bankruptcy. Guitar Center was concerned that if the New First Lien Debt was not

issued before the Effective Date, then they would have a cash flow problem the first day out of

bankruptcy.

ABL Facility Effective

The New ABL Facility had to be in full force and effect.

221

Furthermore, the New ABL

Facility documents had to be consistent in all material aspects with the restructuring support

agreement and reasonably acceptable to the Support Parties and Guitar Center.

222

The New ABL

facility was necessary so Guitar Center could continue to purchase inventory and pay payroll

expenses. Guitar Center funded many of its operations through a revolving ABL, therefore it was

likely Guitar Center needed to continue using an ABL after they emerged from bankruptcy.

Professional Fee Reserve

The professional fee reserve had to be established and fully funded.

223

The professional

fee reserve was a reserve of cash to pay all the professionals associated with Guitar Center and

its key creditors during the chapter 11 proceeding.

218

Id.

219

See supra text accompanying note 101.

220

Initial Plan, 16 at 56.

221

Id.

222

Id.

223

Id.

Moreover, the initial plan provided Guitar Center a course of action to waive the

conditions discussed above. The conditions to the Effective Date could only be waived by Guitar

Center with the written consent of the Support Parties.

224

The required parties had the ability to

withhold their consent in whole or in part.

225

Here, the Support Parties provided for a safety

valve in case Guitar Center could not accomplish one of the conditions precedent. They could in

their sole discretion waive a condition if Guitar Center asked or failed to satisfy a condition.

Furthermore, the conditions relating to the ABL DIP Claims could only be waived with the

consent of the ABL DIP Agent.

226

Finally, the initial plan contemplated the effect of a failure of a condition. If the

conditions of the plan discussed above were not satisfied or improperly waived before the

termination of the restructuring support agreement, then the plan became null and void in all

respects.

227

Withdrawal and Modification of the Plan

Lastly, Guitar Center’s initial plan discussed the procedures for withdrawal or

modification of the plan during the chapter 11 process. Drawing again from the restructuring

support agreement, Guitar Center sought to introduce certain safeguards if the initial plan did not

work out in their favor. Bankruptcy Code Section 1127 states “the proponent of a plan may

modify such plan at any time before confirmation.”

228

Bankruptcy Code Section 1127 allowed

Guitar Center, with the reasonable consent of its key creditors, to amend or modify the plan

before the Effective Date.

229

Here, Guitar Center reserved the right to seek to withdraw the plan

at any point prior to the Effective Date.

230

If the plan were withdrawn, then the plan and the

confirmation order would be null and void in all aspects.

231

Holders of claims that have accepted

the plan would be deemed to accept the modified plan if the modification did not materially and

adversely change the treatment of their claims.

232

After the initial plan was filed, Guitar Center’s

224

Id.

225

Id.

226

Id.

227

Id.

228

11 U.S.C. §1127(a).

229

Id.

230

Initial Plan, 16 at 58.

231

Id.

232

Id.

bankruptcy truly began because all of the creditors Guitar Center left out of the negotiations

regarding the restructuring support agreement and the initial plan now had the opportunity to

interject their claims.

First Day Motions

After Guitar Center filed their initial plan, the milestones in the restructuring support

agreement called for Guitar Center to file critical administrative motions that would help

expedite the proceedings.

233

First day motions and orders are governed by Federal Rules of

Bankruptcy Procedure Sections 6003 and 4001.

234

Rule 6003 governs the notice requirements

regarding first day motions.

235

Rule 4001 governs first-day financing motions.

236

The ability to

plan and prepare salient first day motions is another way that Guitar Center benefitted from

structuring its reorganization before filing for chapter 11. In chapter 11 cases, filing first day

motions is often a chaotic process that can leave debtor’s counsel scrambling.

237

However,

Guitar Center’s initial plan was pre-negotiated, and filing first day motions was considered in the

restructuring support agreement.

238

This allowed Guitar Center to enter chapter 11 with a battle

plan for its first day motions. These motions generally involve facilitating the administration of

an estate, smoothing day to day operations, and substantive matters in a chapter 11 case

239

Orders Facilitating Administration of the Estate

Motion for Joint Administration of the Estate

One of the first motions the Court addressed was Guitar Center’s motion for joint

administration. Because Guitar Center Holdings, Inc. and its wholly owned subsidiaries entered

chapter 11 in separate cases, moving the court to administer the cases together would afford

Guitar Center and the Court significant administrative convenience.

240

Guitar Center and its

233

Id. at 184.

234

BERNSTEIN & KUNEY, supra note 76 at 289.

235

Rule 6003 requires 21 days’ notice before the court may grant certain relief, except to the extent that relief is

necessary to avoid “immediate and irreparable harm. FED. R. BANKR. P. 6003.

236

Rule 4001 states that a final hearing on cash collateral motion or on a motion to obtain financing may commence

“no earlier than fourteen days after service of the motion.” Rule 4001 further provides that relief can be granted at a

preliminary hearing before the end of the 14 day period, but only to the extent “necessary to avoid immediate and

irreparable harm to the estate pending a final. FED. R. BANKR. P. 4001.

237

BERNSTEIN & KUNEY, supra note 78, at 287.

238

Initial Plan, 16 at 184.

239

Id. at 290–91. BERNSTEIN & KUNEY, supra note 78, at 310.

240

Debtors’ Motion for Entry of an Order: (I) Directing Joint Administration of Chapter 11 Cases; and (II) Granting

Related Relief. (“Joint Administration Motion”). Case 20-34656 (KH). 3 at 9.

subsidiaries moved for joint administration of their cases under Rule 1015(b) of the Federal

Rules of Bankruptcy and Bankruptcy Code Section 105(a).

241

Bankruptcy Rule 1015(b) permits

that “the court may order a joint administration of the estates” if “two or more petitions are

pending in the same court by or against a debtor and an affiliates.”

242

Furthermore Bankruptcy

Code Section 105(a) authorizes the court to issue “any order, process, or judgement that is

necessary or appropriate to carry out the provisions of this title.”

243

The Court granted the motion

for joint administration of the cases.

244

Motion To Employ Prime Clerk As Claims Agent

Next, the Court considered Guitar Center’s application to employ Prime Clerk as notice

and claims agent. Prime Clerk employed leading industry professionals with significant

experience in both the legal and administrative aspects of chapter 11 cases.

245

In the capacity of

claims agent Prime Clerk transmitted, received, docketed, and maintained proofs of claims filed

in connection with the cases.

246

The Court approved Guitar Center’s application.

247

Motion To Continue Using Existing Cash Management System

Guitar Center also filed a cash management system motion.

248

Here, Bankruptcy Code

Section 345(b) required Guitar Center to keep all estate funds in an FDIC or other government

insured depository.

249

Moreover, the United States Trustee overseeing the chapter 11 case had

its own guidelines regarding Guitar Center’s cash management system. These guidelines stated

Guitar Center had to establish three brand new bank accounts at the time they filed their

bankruptcy case.

250

241

Id. at 8–9.

242

FED. R. BANKR. P. 1015(B).

243

11 U.S.C. §§105(a)

244

Order: (I) Directing Joint Administration of Chapter 11 Cases; and (II) Granting Related Relief. Case 20-34656

(KRH). 63 at 4.

245

Debtors’ Application for Entry of an Order Authorizing Retention and Appointment of Prime Clerk LLC as

Claims, Noticing, and Administrative Agent, Effective as of the Petition Date. Case 20-34656 (KH). 17 at 7.

246

Id. at 6

247

Order Authorizing Retention and Appointment of Prime Clerk, LLC as Claims, Noticing, and Administrative

Agent, Effective as of the Petition Date. Case 20-34656 (KH). 112 at 2.

248

Cash Management Motion, 11 at 16.

249

If Guitar Center declined to use an FDIC bank, then they would have to post a bond to secure repayment. 11

U.S.C. § 345(b).

250

The three new accounts had to be (1) a general expense account, (2) a payroll account, and (3) a taxes/special

escrow account. U.S. Trustee Guideline 2.1-2.3 2020. 4 https://perma.cc/ENN6-DT8U.

Guitar Center requested that the court continue to allow them to use their existing cash

management system, which included fifty-eight bank accounts at six different banks.

251

Furthermore, Guitar Center contended that their cash management system was an integral part of

their intercompany transactions, and any disruption to their cash management system would

severely disrupt their business operations to the detriment of the estate, creditors, and other

stakeholders.

252

Essentially, Guitar Center found it unnecessary and burdensome to remove all of

their money from their various accounts to comply with the requirements of Bankruptcy Code

Section 345(b) and the trustee guidelines. Guitar Center argued that if they were forced to adjust

the cash management system the estate would incur needless costs that would erode the value of

Guitar Center to the detriment of their creditors.

253

Finally, Guitar Center stated it is within the

Court’s discretion to modify the requirements of 345(b) and waive the US trustee guidelines. The

Court granted Guitar Center’s motion and authorized their banks to continue maintaining,

servicing, and administering Guitar Center’s accounts without interruption.

254

Orders to Smooth Day-to-Day Operations

Utilities

Pursuant to Bankruptcy Code Section 366, Guitar Center requested the court’s authority to pay

utilities in the ordinary course of business.

255

Bankruptcy Code Section 366 offers protection to a

debtor against utility service providers altering or terminating service postpetition if the debtor

provides “adequate assurance” of payment

256

within thirty days after filing for chapter 11.

257

Guitar Center maintained utilities for its 563 retail and service locations, distribution

centers, and corporate offices through two utility service providers—Engie Insight Services and

251

Cash Management Motion, 11 at 7.

252

Id. at 12.

253

Id. at 23.

254

Order: (I) Establishing Certain Notice, Case Management, and Administrative Procedures; and (II) Granting

Related Relief. Case 20-34656 (KRH). 78 at 3.

255

Debtors’ Motion for Entry of Interim and Final Orders: (I) Approving the Debtors’ Proposed Adequate

Assurance of Payment for Future Utility Services; (II) Prohibiting Utility Companies From Altering, Refusing, or

Discontinuing Services; (III) Approving Debtors’ Proposed Procedures for Resolving Additional Assurance

Requests; and (IV) Granting Related Relief. Case 20-34656 (KRH) (hereinafter “Utilities Motion”). 9 at 5.

256

11 U.S.C. §§ 366(c)(1)(a)

257

11 U.S.C. §§ 366(c)(2).

Cass Information Systems, Inc.

258

These providers would manage the payment of Guitar Center’s

utility bills, a total expense of around $1,324,368 each month.

259

The company paid these two

utility service providers approximately $11,600 per month.

260

At the time of filing its chapter 11

petition, Guitar Center owed the utility service providers an estimated $16,000.

261

To satisfy the

requirements of Bankruptcy Code Section 366, Guitar Center proposed making an “Adequate

Assurance Deposit” of $662,184 into a specified bank account.

262

This account would name

utility providers as the sole beneficiaries.

263

The court granted Guitar Center’s motion and issued an interim order before entering a

final order. Specifically, the court held that the Adequate Assurance Deposit in the amount of

$662, 184, together with Guitar Center’s ability to pay for future utilities services would

constitute adequate assurance of future payment as required by Bankruptcy Code Section 366.

264

Substantive Orders

DIP Financing

DIP Marketing Process

Guitar Center needed DIP funding to pay off their prepetition claims and the prepetition

obligations of the ABL. Guitar Center with the help of their advisors, engaged in a competitive

marketing process to obtain DIP financing on the best available terms.

265

Before they filed for

chapter 11, Guitar Center negotiated heavily with their key creditors and contacted 20 different

financial institutions to solicit offers for DIP financing.

266

Because the majority of Guitar

Center’s assets were encumbered by liens granted to the prepetition secured lenders, any

258

Utilities Motion, 9 at 6–7.

259

Id.

260

Id.

261

Id.

262

Id. at 8.

263

Id. at 9.

264

Final Order: (I) Approving the Debtors’ Proposed Adequate Assurance of Payment for Future Utility Services;

(II) Prohibiting Utility Companies From Altering, Refusing, or Discontinuing Services; (III) Approving Debtors’

Proposed Procedures for Resolving Additional Assurance Requests; and (IV) Granting Related Relief. Case 20-

34656 (KRH). 233

265

Declaration of Eric Winthrop, 31 at 10.

266

Id.

potential third party lender was hesitant to agree to provide DIP financing without priority over

the liens held by the prepetition secured lenders.

267

Ultimately, Guitar Center’s key creditors came together to propose a term sheet for a

Term DIP facility of $325 million.

268

Furthermore during the Term DIP facility negotiation

process, Guitar Center obtained a $50 million ABL DIP facility from their Prepetition ABL

Agent, Wells Fargo.

DIP Financing Proposal

The Term DIP Commitment Parties and Wells Fargo wanted to provide credit to Guitar

Center under Bankruptcy Code Section 364(c) and requested senior secured and superpriority

status for their DIP financing liens.

269

As such, the DIP financing would: receive priority over all

administrative expenses outlined in Bankruptcy Code Sections 503(b) and 507(b); would be

secured by a lien on property of the estate not otherwise subject to a lien; and would be secured

by a junior lien on property subject to a lien.

270

To obtain this priority, Guitar Center had to show

that “financing was not available otherwise” on an unsecured or administrative basis.

271

discussed above, Guitar Center spoke with 20 different financial institutions and none of them

were willing to provide DIP financing on a unsecured or junior secured basis.

Next, the Term DIP Commitment Parties and Wells Fargo wanted to lend pursuant to

Bankruptcy Code Section 364(d), which provides for a super priority priming liens over existing

liens. Since they were the existing lienholders, they implicitly consented to this treatment. The

DIP Lenders emphasized that their existing liens required adequate protection, under Bankruptcy

Code Sections 363 and 364, in the form of junior and senior liens on Guitar Center’s prepetition

property, which the court approved. The Lenders wanted these protections because Guitar

Center’s obligations under the ABL Credit Agreement, Superpriority Secured Notes, and

Secured Notes are secured by “crisscrossing” senior-and-junior- priority liens on almost all of

Guitar Center’s assets.

272

Some of the new judicially imposed liens would only last until the

267

Id. at 11.

268

Id. The key creditors were Ares, Brigade, Caryle, and New York Mellon.

269

Debtors’ Motion for DIP Financing, 30 at 30.

270

11 U.S.C. §364(c).

271

Id.

272

Declaration of Eric Winthrop, 31 at 6.

Prepetition ABL payoff date, when Guitar Center would use certain DIP funds to pay off its

Prepetition ABL loan. The new judicially imposed liens were divided into six different

categories:

ABL Adequate Protection Liens

The first category comprised the ABL Adequate Protection Liens. These liens were

created for the benefit of Prepetition ABL Agent and were effective until the Prepetition ABL

loan was paid in full, which would be immediately upon the funding of the ABL DIP Facility.

273

The ABL Adequate protection liens were secured by perfected postpetition liens on all DIP

collateral and were only junior to (i) the Carve Out

274

, (ii) Permitted prior Senior Liens, (iii) the

ABL DIP Liens, (iv) the Prepetition ABL liens and with respect to the Term DIP priority

Collateral, (A) the Term DIP liens, (B) the prepetition Notes liens, (C), the notes adequate

protection liens and (D) the ABL DIP Liens

275

Superpriority Notes Adequate Protection Liens

The second category comprised the Superpriority Notes Adequate Protection Liens.

These liens were created for the benefit of the Superpriority Noteholders.

276

Superpriority Notes

Adequate Protection Liens were secured by perfected postpetition liens on all DIP Collateral and

junior only to (i) the Carve out, (ii) Permitted Prior Senior Liens, (iii) the Term DIP Liens, and

with respect to the ABL DIP Priority Collateral, (A) the ABL DIP Liens and (B) the ABL

Adequate Protection Liens.

277

Senior Secured Notes Adequate Protection Liens

The third category comprised the Senior Secured Notes Adequate Protection Liens. These

liens were created for the benefit of the Senior Secured Noteholders and were secured by DIP

273

Final Order Pursuant to 11 U.S.C. §§105, 361, 362, 363, 364, 503, 506, and 507: (I) Authorizing Debtors to

Obtain Senior Secured Priming Superpriority Postpetition Financing; (II) Authorizing use of Cash Collateral; (III)

Granting Liens and Providing Claims with Superpriority Administrative Expense Status; (IV) Granting Adequate

Protection; (V) Modifying the Automatic Stay; (VI) Granting Related Relief. Case 20-34656 (KH). (“Final Order on

DIP Financing”). 315 at 31.

274

The Carve out was, an amount sufficient or a sum certain, for the payment of professional fees and expenses

“carved out” from liens granted by the court. These administrative fees are “carved out” of the DIP facilities and had

to be used by Guitar Center in a certain manner. Examples of Carve out fees include but are not limited to: (i) all

fees required to be paid to (A) the Clerk of the Court and (B) the U.S Trustee. So What Does a Bankruptcy Carve

Out Clause Really Mean?, NATIONALLAWREIVIEW.COM, https://perma.cc/G4ZE-YSHG.

275

Final Order on DIP Financing, 315 at 31.

276

Id. at 32.

277

Id.

Collateral and junior only (i) the Carve Out, (ii) Permitted Prior Senior Liens, (iii) the Term DIP

Liens, (iv) the Prepetition Superpriority Notes Liens, (v) the Superpriority Notes Adequate

Protection Liens and (vi) with respect to the ABL DIP Priority Collateral, (A) the ABL DIP

Liens and (B) the ABL adequate Protection Liens

ABL Superpriority Claim

The fourth category comprised the ABL Superprority Claim. Until the Prepetition ABL

obligations were paid in full, the Prepetition ABL Agent was granted a superpriority

administrative expense claim.

278

The Superpriority Claim was junior only to (i) the Superpriority

DIP Claims (except with respect to the ABL DIP Priority Collateral, in respect of which the ABL

Superpriority Claim will be senior to the Superpriority DIP Claim of the Term DIP Agent) , (ii)

the Carve Out, and (iii) the Notes Superpriority Claims (except with respect to the ABL DIP

Priority Collateral).

279

Superpriority Notes Superpriority Claim

The fifth category comprised the Superpriority Notes Superprority Claim. The

Superpriority Notes holders were granted a Superprioity administrative expense claim, which

was junior only to (i) the ABL Superpriroity Claim with respect to the Priority ABL Collateral,

(ii) the Superpriority DIP Claims (except with respect to the Term DIP Priority Collateral, in

respect of which the Superpriority Notes Superpriority Claim will be senior to the Superpriroity

DIP Claim of the ABL DIP Agent) and (iii) the Carve out.

280

Senior Secured Notes Superpriority Claim

The sixth and final category comprised the Senior Secured Notes Superpriority Claim.

The Senior Secured Notes Holder were granted an allowed superpriority administrative expense

claim, which was junior to (i) the ABL Superpriority Claims with respect to the Priority ABL

Collateral, (ii) the Superpriority DIP Claims (except with respect to the Term DIP Priority

Collateral, in respect of which the Senior Secured Notes Superpriority Claim will be senior to the

278

Id. at 34.

279

Id.

280

Id. at 36.

Superpriority DIP Claim of the ABL DIP Agent), (iii) the Superpriority Notes Superpriority

Claim, and (iv) the Carve Out.

281

The net effect of this lien structure was to ensure that the prepetition secured debt

remained secured until it was retired and paid off by the DIP Facilities. After the prepetition debt

was retired, the DIP Facility would enjoy the protection of senior lien status, junior only to

certain government tax liens.

Objections to DIP Financing

Certain Texas Taxing Entities and the Maricopa County Treasurer (“MTC”) filed

objections to Guitar Center’s Interim Order for DIP financing.

282

MTC objected to Guitar

Center’s Interim Order for DIP financing to the extent that Guitar Center sought to prime MTC’s

tax liens.

283

MTC held a secured tax lien on the property Guitar Center owned in Maricopa

County, Arizona.

284

According to Arizona law, the personal property tax liens attached on

January 1 of the respective tax year and the taxes could not be discharged until the taxes and

interest were paid in full or title to the property vests in a purchaser of the property for taxes.

285

Finally, the tax liens were superior to any other liens of every kind and description regardless of

when another lien attached.

286

Moreover, Certain Texas Taxing Entities also possessed tax liens on Guitar Center’s

property in Texas.

287

The Texas tax liens attached pre-petition and were secured by tax liens on

the real and tangible personal property of Guitar Center. Additionally, Guitar Center had failed to

provide adequate protection for the Certain Texas Taxing Entities’ senior liens.

288

The Certain

281

Id.

282

Maricopa County Treasurer’s Objection to Interim Order Pursuant to 11 U.S.C. §§105, 361, 362, 363, 364, 503,

506, and 507: (I) Authorizing Debtors to Obtain Senior Secured Priming Superpriority Postpetition Financing; (II)

Authorizing use of Cash Collateral; (III) Granting Liens and Providing Claims with Superpriority Administrative

Expense Status; (IV) Granting Adequate Protection; (V) Modifying the Automatic Stay; (VI) Granting Related

Relief. Case 20-34656 (KH) 230 at 1. (hereinafter “MTC Objection to DIP Financing”). Limited Objection of

Certain Texas Taxing Entities to Motion to Approve Use of Cash Collateral Debtors’ Motion for entry of Interim

and Final Orders (I) Authorizing the Debtors to use Cash Collateral; (II) Granting Liens and Providing Claims with

Superpriority Administrative Expense Status; (III) Granting Adequate Protection; (IV) Modifying the Automatic

Stay; (VI) Granting Related Relief. Case 20-34656 (KRH) 206. (“Certain Texas Tax Entities Objection to DIP

Financing”).

283

MTC Objection to DIP Financing, 230 at 1.

284

Id. at 3.

285

A.R.S. §42-17153; A.R.S. §42-19106.

286

A.R.S.§42-19106

287

Certain Texas Tax Entities Objection to DIP Financing, 206 at 2.

288

Id.

Texas Taxing Entities requested adequate protection in the DIP Final Order by not allowing post-

petition liens to prime their tax liens.

289

The Final Order on DIP Facilities

The Court filed and entered the Final Order on December 17, 2020 approving both the

ABL and Term DIP facilities.

290

The Court sustained the objection by MTC and Certain Texas

Taxing Entities and in the Final Order directed that no lien granted in the Final Order could

prime any of the tax liens imposed by MTC or Certain Texas Taxing Entities on Guitar Center’s

property.

291

Wells Fargo and the Term DIP Commitment parties were satisfied with the new

judicially imposed liens because they protected the DIP facilities post-petition, pursuant to

Bankruptcy Code Sections 364(c) and 364(d). Guitar Center was ordered to maintain all of the

DIP collateral until the obligations were paid in full.

292

Motion to Continue Customer Programs

Pursuant to Bankruptcy Code Sections 105(a) and 363(b) and 507(a)(7), rules 6003 and

6004 of the Federal Rules for Bankruptcy Procedure and local rule 9013-1 of the United States

Bankruptcy Court for the Eastern District of Virginia, Guitar Center filed a motion with the

Court for authority to continue administering certain customer programs.

293

The motion

requested the authority to pay certain prepetition unsecured claims relating to customer programs

which are generally prohibited without court approval until they are paid pursuant to a confirmed

plan of reorganization.

294

At the time of filing, Guitar Center had an estimated amount in excess

of $34 million outstanding customer programs claims.

295

Guitar Center’s customer programs

consisted of a refund and exchange program, a rewards program for the Musician’s Friend brand,

a private level credit card, and a gift card program.

296

Guitar Center also requested authority

from the court to continue operating its layaway program and payment processing agreements

289

Id.

290

Final Order on DIP Financing, 315 at 18.

291

Id. at 77.

292

Id. at 49

293

Debtors’ Motion for Entry of Interim and Final Orders: (I) Authorizing the Debtors to Maintain and Administer

Certain Customer Programs and to Honor Certain Related Prepetition Obligations; and (II) Granting Related Relief.

Case 20-34656 (KRH) (hereinafter “Customer Programs Motion”) 12.

294

Id. at 5–6.

295

Id. at 6–11.

296

Id.

for non-cash transactions.

297

Guitar Center primarily argued that it should be authorized to

maintain these consumer programs under Bankruptcy Code Section 363(b) and 363(c)(1)

because these sections authorized the company to maintain the customer programs in the

ordinary course of business.

298

Guitar Center also argued that under Bankruptcy Code Section

507(a)(7), certain obligations for up to $3,025 in claims under its gift card program, purchase

deposits, and layaway program could enjoy priority claim status.

299

After entering an interim

order granting the motion, the court entered a final order granting the motion.

300

Critical Vendors Motion

Pursuant to Bankruptcy Code Sections 363, 105(a), and 503, Guitar Center filed a motion

to pay prepetition trade creditor’s claims.

301

Guitar Center noted in this motion that many of the

existing trade claimants were vendors of specialty products, goods, and services that were

integral to its business.

302

These vendors were general unsecured creditors who supplied Guitar

Center with specialty merchandise that could not be replaced.

303

Guitar Center’s critical vendors

were not heavily involved in the pre-petition negotiations that resulted in the initial plans for

reorganization. As such, this motion was of particular importance, because it would allow Guitar

Center to ensure that its critical vendors continued to supply necessary goods and services

throughout its chapter 11 case. Guitar Center argued that it should be permitted to satisfy these

claims because they were entitled to priority under Bankruptcy Code Section 503(b)(9).

304

This

section provides for an administrative expense priority for the value of any goods a debtor

receives in the ordinary course of business within 20 days of the petition date.

305

Applying

Section 503(b)(9) to critical vendor claims would allow Guitar Center to satisfy these claims

297

Id.

298

Id. at 11.

299

Id. at 14.

300

Final Order: (I) Authorizing the Debtors to Maintain and Administer Certain Customer Programs and to Honor

Certain Related Prepetition Obligations; and (II) Granting Related Relief. Case 20-34656 (KRH) 235.

301

Debtors’ Motion for Entry of Interim and Final Orders: (I) Authorizing Payment of Prepetition Obligations Owed

to Trade Creditors in the Ordinary Course of Business; (II) Granting Administrative Expense Priority to All

Undisputed Obligations On Account of Outstanding Orders; and (III) Granting Related Relief. Case 20-34656

(KRH) (hereinafter “Critical Vendors Motion”). 6 at 8.

302

Id.

303

Id.

304

Id. at 12.

305

11 U.S.C. §§ 503(b)(9).

during the chapter 11 proceedings and prevent potential operations stoppages.

306

There were no

objections to the motion and the court granted a final order after issuing an interim order.

307

Insurance

Guitar Center filed a motion seeking the Court’s authority to pay all amounts that become

due relating to insurance policies, without regard to whether such obligations accrued or arose

before or after it filed for chapter 11.

308

In its motion, Guitar Center stated that it maintained 28

insurance policies with various third party insurance carriers, paying an annual premium amount

in the aggregate of $5,012,130.

309

Guitar Center first argued that pursuant to Bankruptcy Code

Section 363(b), courts have authorized debtors in possession, to pay certain prepetition

obligations, including insurance, when such payment was shown to be justified by the debtor’s

sound business judgment.

310

Additionally, Guitar Center made the point that under Bankruptcy

Code Sections 1107(a) and 1008, as a debtor in possession during a chapter 11 proceeding, it

owed a fiduciary duty to hold and operate the business for the benefit of its creditors, which

obligated Guitar Center to maintain its insurance policies therefore.

311

Further, it cited

Bankruptcy Code Section 1112(b)(4)(C) and the U.S. Trustee’s Operating Guideline to support

the proposition that a failure to maintain adequate insurance throughout the chapter 11 case

would require the case to be dismissed.

312

There were no objections and the court entered a final

order granting the motion.

313

306

In order to prevent a halt in operations, Guitar Center requested authority to satisfy all pre-petition trade claims

whether or not the initial plan providing for the full satisfaction of trade claims in the chapter 11 cases was

confirmed, arguing that this was permitted by 503(b)(9). Critical Vendors Motion, 6 at 12–15.

307

Final Order: (I) Authorizing Payment of Prepetition Obligations Owed to Trade Creditors in the Ordinary Course

of Business; (II) Granting Administrative Expense Priority to All Undisputed Obligations On Account of

Outstanding Orders; and (III) Granting Related Relief. Case 20-34656 (KRH) 237.

308

Debtors’ Motion for Entry of Interim and Final Orders: (I) Authorizing the Debtors to (A) Continue and Renew

Their Insurance Policies and Honor Obligations Thereunder, and (B) Continue Surety Bond Program; and (II)

Granting Related Relief. Case 20-34656 (KRH) (hereinafter “Insurance Motion”). 8 at 8.

309

Id. at 7.

310

Id. at 11.

311

Id.

312

Id. at 14–15.

313

Final Order: (I) Authorizing the Debtors to (A) Continue and Renew Their Insurance Policies and Honor

Obligations Thereunder, and (B) Continue Surety Bond Program; and (II) Granting Related Relief. Case 20-34656

(KRH) 234.

Taxes

Guitar Center filed a motion to authorize the payment of prepetition income taxes,

franchise taxes, property taxes and other regulatory fees.

314

At the time of filing, Guitar Center

owed $10.2 million in sales and use taxes, $1.15 million in income and franchise taxes, $8.32

million in property taxes, $5.7 million in import taxes, $700k of miscellaneous taxes and fees,

and $1.35 million in estimated pending audits.

315

In total, Guitar Center estimated its pre-petition

tax burden to be $27.42 million, approximately $8.547 million of which could become due

within 21 days after it filed this motion.

316

Guitar Center presented three main arguments in its motion. First, it argued that the court

was able to grant the requested relief and authorize it to pay certain pre-petition obligations

under Bankruptcy Code Section 363(b) if payment was shown to be justified by its sound

business judgment.

317

Here, Guitar Center claimed that paying the prepetition taxes was within

its ordinary course of business and also claimed that the failure to pay the existing taxes could

materially disrupt the administration of the bankruptcy cases in a number of ways. If the existing

taxes were not paid, the taxing authorities would likely take action against Guitar Center that

would interfere in its existing operations.

318

Guitar Center also argued that that under Bankruptcy

Code Section 541(d), certain taxes held in trust for the government were not property of the

bankruptcy estate, because the estate did not hold an equitable interest in those funds.

319

Guitar

Center also offered that under Bankruptcy Code Sections 507(a)(8) and 1129(a)(9)(C), certain

taxes and fees would have been entitled to priority status payment before general unsecured

claims, and that priority claims must be paid in full before any plan could be confirmed in

chapter 11 cases.

320

There were no objections and the Court entered a final order granting Guitar

Center’s motion.

321

314

Debtors’ Motion for Entry of Interim and Final Orders: (I) Authorizing the Payment of Certain Prepetition Taxes

and Fees; and (II) Granting Related Relief. Case 20-34656 (KRH) (hereinafter “Taxes Motion”) 10.

315

Id. at 7–11.

316

Id.

317

Id. at 11.

318

Id. at 10–11.

319

Id. at 13.

320

Id. at 14.

321

Final Order: (I) Authorizing the Payment of Certain Prepetition Taxes and Fees; and (II) Granting Related Relief.

Case 20-34656 (KRH) 237.

Wages

Guitar Center filed a motion to authorize the payment of prepetition wages, salaries, other

compensation, employee benefits and expenses relating to its 13,000 employees.

322

Guitar

Center’s primary argument in the motion was that continuing to compensate it’s employees was

critical to its uninterrupted operations and, as such, may be authorized by Bankruptcy Code

Sections 363, 105(a), 503, 507, and under the “doctrine of necessity.”

323

Guitar Center claimed

that unless the court authorized it to continue with existing compensation and related employee

programs, its business operations would be substantially impaired.

324

Further, Guitar Center

highlighted that without the requested relief, its employees would face significant financial

consequences and it could lose employees critical to preserving the value of the estates.

325

In the motion, Guitar Center estimated that no employee had an existing claim for an

amount that exceed the cap under Bankruptcy Code Section 507(a)(4).

326

This section provides

for an up-to $13,650 priority claim for unpaid prepetition wages owed to employees by a debtor

in bankruptcy.

327

Additionally, Guitar Center argued that it would be required by Bankruptcy

Code Section 1129(a)(9)(B) to pay priority claims, collectively, in full to confirm a chapter 11

plan.

328

There were no objections and the court entered a final order that authorized Guitar

Center to pay and honor all the claims described in the motion under the statutory priority cap in

Section 507(a)(4).

329

322

Debtors’ Motion for Entry of Interim and Final Orders: (I) Authorizing the Debtors to (A) Pay Prepetition

Wages, Salaries, Other Compensation, and Reimbursable Expenses, and (B) Continue Employee Benefits Programs;

and (II) Granting Related Relief. Case 20-34656 (KRH) (hereinafter “Wages Motion”). 7 at 6.

323

Wages Motion, 7 at 29. The Doctrine of Necessity is a principle used in bankruptcy law which permits the use of

certain provisions of the Code or common law ostensibly in contradiction to other law in order to accomplish a vital

objective in a bankruptcy case. The Doctrine exists simply because it works. The proper use of the Doctrine helps to

stabilize a debtor's business relationships without significantly hurting any party. Russell A. Eisenberg, Frances F.

Gecker, The Doctrine of Necessity and Its Parameters, 73 MARQLR 1.

324

Wages Motion, 7 at 8.

325

Id.

326

Id. at 9.

327

11 U.S.C. §§ 507(a)(4).

328

Wages Motion, 7 at 29.

329

Final Orders: (I) Authorizing the Debtors to (A) Pay Preppetition Wages, Salaries, Other Compensation, and

Reimbursable Expenses, and (B) Continue Employee Benefits Programs; and (II) Granting Related Relief. Case 20-

34656 (KRH) 249.

The Net Operating Loss Preservation Motion

On November 22, 2020, Guitar Center filed a motion with the court seeking approval of

notification and hearing procedures for certain transfers of and declarations of worthlessness

with respect to its common stock.

330

Guitar Center filed this motion to preserve existing

beneficial tax attributes.

331

Specifically, Guitar Center wanted to continue to capitalize on net

operating losses (“NOLs”) that it carried.

332

A taxpayer has an NOL

333

when its allowable tax

deductions exceed its gross operating income in a specific year.

334

These NOL’s can be carried

forward and are considered to be an asset as they offset future income and shield it from income

taxation.

335

Guitar Center estimated in its motion that its cumulative NOL carryforward totaled

approximately $213.38 million.

336

Guitar Center also estimated that it had other tax attributes

available to reduce future taxable income: tax credits of $1.98 million and interest expense

carryforwards in the amount of $136.78 million.

337

The key issue that Guitar Center’s motion focused on was the Internal Revenue Code’s

(“IRC”) treatment of its existing tax attributes.

338

Specifically, Guitar Center’s motion focused

on the rules regarding NOL and “ownership change” in Sections 382 and 383 of the IRC.

339

Pursuant to Bankruptcy Code Section 362(a)(3), any act by a holder of a debtor’s equity

securities that causes the termination or limits the use of the debtor’s valuable tax attributes

violates the automatic stay.

340

These IRC sections provide for limitations on tax attributes,

including NOLs, in the event of an “ownership change”.

341

In order to avoid impairing benefits

330

Debtors’ Motion for Entry of Interim and Final Orders: (I) Approving Notification and Hearing Procedures for

Certain Transfers and Declarations of Worthlessness With Respect to Common Stock’ and (II) Granting Related

Relief. Case 20-34656 (KRH) (hereinafter “NOL Motion”). 13 at 1.

331

Id. at 6.

332

Id. at 6–7.

333

I.R.C. § 172; see also Bankruptcy: Overview of the Chapter 11 Process, THOMPSON REUTERS, Practical Law

Practice Note.

334

Id.

335

Id.

336

NOL Motion, 13 at 6-7.

337

Id.

338

Id.

339

Sections 382 and 383 of IRC limit the amount of taxable income that can be offset by a corporation’s tax

attributes in taxable years following an ‘ownership change. The ‘ownership change’ rule can be triggered if a five

percent shareholder has increased its ownership to 50% or more, or if a holder of 50% of common stock takes a

worthless stock deduction in a new taxable year. I.R.C § 382; I.R.C. § 383; NOL Motion, 13 at 7.

340

11 U.S.C. §§ 362(a)(3); NOL Motion, 13 at 13.

341

See supra text accompanying note 339.

of its tax attributes, Guitar Center looked to have the court implement certain procedures and

guidelines for transfers and sale of its existing common stock that would have the stock declared

null and void if not followed.

342

A major concern here was that Ares Management, as primary

shareholder, might consider taking a worthless stock deduction in the future, which Guitar

Center sought to prevent.

There were no objections to the motion, and the court ultimately entered an interim, and a

final order that implemented the guidelines that would prevent any transfer of stock or deduction

that could put Guitar Center’s tax attributes at risk.

343

Objections to the Initial Plan

With the first day motions behind it, Guitar Center confronted the objections to its initial

plan of reorganization from creditors and counterparties that had not been part of the prepetition

negotiation of the restructuring support agreement and the prepetition solicitation of acceptances

of the plan.

Landlords

Guitar Center’s landlords were the first counterparty to object to Guitar Center’s initial

plan of reorganization. The landlords’ initial objections predominantly centered around a lack of

adequate information in the procedure order and rejection notice, a lack of cure information, and

a need for more time. Under Bankruptcy Code Section 365(b)(1)(A), debtors are responsible for

providing adequate assurance regarding their ability to perform under the lease.

344

Here, several

landlords were objecting to the initial plan to ensure that Guitar Centers complied with the

requirements of Bankruptcy Code Section 365(b)(1)(A), including but not limited to, paying all

amount due and owed under the lease through the Effective Date.

345

Many landlords were still

342

NOL Motion, 13 at 12–16.

343

Final Order: (I) Approving Notification and Hearing Procedures For Certain Transfers and Declarations of

Worthlessness With Respect to Common Stock’ and (II) Granting Related Relief. Case 20-34656 (KRH). 232.

344

U.S.C. §365(b)(1)(C)–(f)(2). Adequate assurance requires a foundation that is non-speculative and sufficiently

substantial so as to assure the non-debtor party that it will receive the amount of the default. Risa Lynn Wolf-Smith

& Erin L. Connor, The Meaning of “Prompt and Adequate”, 13 J. Bankruptcy Law and Prac. 95, 97 (2013)

https://perma.cc/8EHH-5ZWB.

345

Limited Objection of GRI-EQY (Presidential Markets), LLC to Notice of Assumption of Certain Executory

Contracts and Unexpired Leases in Connection with Confirmation of the Debtors’ Joint Pre-Packaged Chapter 11

Plan of Reorganization. Case 20-34656 (KRH). 210 at 2.

evaluating the appropriate cure amount and were worried that Guitar Center was not going to pay

back rent owed to them while Guitar Center was in chapter 11.

346

Additionally, other landlords were upset about the time given to file claims arising out of

the rejection of certain leases.

347

The procedures order and the rejection notice required that

claims arising from the rejection of Guitar Center’s leases would be due thirty days after the

entry of the confirmation order or the date on which Guitar Center informed the applicable

landlord that Guitar Center was rejecting the lease.

348

Many landlords found this procedure

objectionable because it did not allow them enough time to ascertain the state of the leased

premises or determine if they had any claims against Guitar Center.

349

The landlords, instead,

advocated for an order that would provide that claims arising from the rejection of leases should

be filed within thirty days of the Effective Date or the date when Guitar Center informed the

applicable landlord that they were rejecting their lease.

350

Moreover, the landlords noted that

neither the procedures orders or the rejection notice contained provisions regarding the

disposition of personal property remaining at the premises following the return of possession by

Guitar Center.

351

The landlords claimed that any final order regarding the premises provide that

any personal property remaining in the premises on the Effective Date be deemed abandoned.

352

Finally, some landlords objected to the initial plan because they claimed the initial plan

did not comply with Bankruptcy Code Section 365(d)(4), as Guitar Center sought to indefinitely

postpone their obligations to reconcile and object to unsecured claims.

353

Under Bankruptcy

Code Section 365(d)(4), a debtor must decide which commercial leases it wishes to assume or

346

Id.

347

Limited Objection of Greenway Plaza LLC to Debtors’ Notice of Assumption of Certain Executory Contracts

and Unexpired Leases in Connection with Confirmation of the Debtors’ Joint Pre-Packaged Chapter 11 Plan of

Reorganization. Case 20-34656 (KRH). 188 at 2–3.

348

Notice of Rejection of Certain Executory Contracts and Unexpired Leases in Connection with Confirmation of

the Debtors’ Joint Pre-Packaged Chapter 11 Plan of Reorganization. Case 20-34656 (KRH). 158 at 2-3.

349

Limited Objection of LBA Realty Fund III-Company XII, LLC to Notice of Rejection of Certain Executory

Contracts and Unexpired Leases in Connection with Confirmation of the Debtors’ Joint Pre-Packaged Chapter 11

Plan of Reorganization. Case 20-34656 (KRH). 248 at 4.

350

Id.

351

Id. at 5.

352

Id. at 6.

353

Limited Objection of Various Landlords to Confirmation of the Chapter 11 Plan. Case 20-34656 (KRH)

(“Limited Objection by Various Landlords”). 278 at 2.

reject no later than the entry of the Final Order confirming the plan.

354

Here, some landlords

claimed that Guitar Center’s initial plan allowed it to reject leases post-confirmation of the

plan.

355

Next, the landlords were concerned with Guitar Center’s ability to indefinitely postpone

their obligations to reconcile and object to unsecured claims. The landlords theorized that since

claims were to be paid in full under the initial plan, a prolonged delay of the claims

reconciliation process would deprive affected landlords of prompt distributions on potentially

significant claims.

356

To mitigate this issue, the landlords suggested that the Court limit Guitar

Center’s right to seek a ninety-day extension of the claim objection deadline for cause.

357

United States Trustee Objection

After Guitar Center filed its initial plan, the United States Trustee (“UST”) filed an

objection to the disclosure statement and the plan.

358

The objection focused on provisions for the

release and exculpation of creditors against other non-debtor parties that were included in the

initial plan.

359

According to the UST, Guitar Center’s disclosure statement and plan failed to

show that such releases were appropriate and therefore the court could not confirm the initial

plan in its current state.

360

First, the UST argued that Guitar Center’s initial plan contained release provisions,

injunction and exculpation provisions that deprived non-voting claim holders of their rights

against third parties on a non-consensual basis.

361

Consequently, the initial plan had the potential

to ‘impair’ certain non-voting claim holders, even though they would receive payment under the

plan.

362

The UST acknowledged that there was no per se prohibition on imposing third party

releases of non-debtors on other non-debtors, but claimed that such releases are not appropriate

354

U.S.C. §365(d)(4).

355

Limited Objection by Various Landlords, 278 at 2.

356

Id.

357

Id. at 7.

358

Objection of the United States Trustee to Confirmation of the Plan and Related Relief. Case 20-34656 (KRH)

(hereinafter “UST Objection”) 200.

359

Id. at 6.

360

Id. at 10.

361

Id.

362

Id. at 11.

in most cases.

363

The UST argued that the appropriateness of such provisions are determined by

the facts of each case, meaning Guitar Center needed to make an evidentiary showing to the

Court that these releases were essential to its reorganization efforts and overall plan.

364

The next key argument in this objection focused on the method of “opting out” of the

release provisions included in Guitar Center’s initial plan.

365

Not only would the third party

releases be effective against any creditor or interest holder that was deemed to accept the initial

plan, but also against those creditors and interest holders who abstained from voting or outright

rejected the plan, but failed to “opt out” of the releases.

366

Here, the UST’s objection focused on the notion that releases of non-debtors must be

accompanied by ‘unambiguous consent’.

367

As written, the UST was concerned that certain

creditors could be “caught asleep at the switch” in consenting to these releases unintentionally.

368

The UST also included a policy oriented argument directed at the court which claimed that if it

confirmed this plan, debtors in chapter 11 cases going forward would include similar provisions

in their own plans, under which at least a few creditors would inadvertently “consent” to

releases.

369

In order to remedy this issue, the UST requested that the third-party releases in the

plan be deemed consensual only by parties who have voted to accept the plan.

370

The UST’s objection also raised an issue with the Management Incentive Plan included

in the initial plan.

371

Because the initial plan required Guitar Center to adopt the Management

Incentive Plan, the UST argued that the intial plan violated Bankruptcy Code Section 503(c).

372

The UST requested that the court reject the initial plan unless Guitar Center made a showing that

the Management Incentive Plan complied with Section 503(c).

373

363

Id. at 13.

364

Id.

365

Id. at 14–17.

366

Id.

367

Id.

368

Id.

369

Id.

370

Id. at 17.

371

Id. at 21.

372

Id.

373

Id.

Finally, the UST objected to the plan’s confirmation in its current state because it did not

include a “carve out” for governmental claims

374

in the releases, exculpation and injunctions

provisions, and did not provide enough information regarding the management and control of

guitar center post-reorganization.

375

Taxing Agencies

The next group of creditors to object to Guitar Center’s initial reorganization plan were

the Texas Taxing Agencies and the Internal Revenue Service (“IRS”). The Texas Taxing

Agencies claimed the initial plan should not be confirmed unless and the plan provided that the

Texas Taxing Agencies’ pre- and post-petition liens remained on Guitar Center’s real and

tangible personal property until the taxes were paid in full.

376

Furthermore, the Texas Tax

Agencies objected to the initial plan to the extent it provided Guitar Center an option to pick and

choose which secured parties had rights on certain collateral over similarly situated secured

parties. This would result in preferential treatment of the claims to the detriment of junior

secured creditors.

377

The Texas Taxing Agencies wanted similar treatment for claims of similarly

situated creditors.

Additionally, the IRS objected the initial plan because the IRS asserted that the plan did

not purport to discharge, satisfy, or release priority taxes that were not paid in full as required by

the Bankruptcy Code

378

379

Moreover, the IRS could not estimate the amount of claims they had

against Guitar Center because Guitar Center had several unfiled tax returns, therefore the IRS

needed time to amend their proofs of claims.

380

To remedy this objection, the IRS proposed that

any IRS claim that were not paid in full on the Effective Date shall accrue (and be paid) interest

374

Id. at 20.

375

Id.

376

Limited Objection of Certain Texas Taxing Entities to the Joint Pre-Packaged Chapter 11 Plan of Reorganization

of Guitar Center. Case 20-34656 (KRH). 199 at 3.

377

Id.

378

With respect to [priority tax claims] the holder of such claim will receive on account of such claim regular

installment payments in cash of a total value, as of the effect date of the plan, equal to the allowed amount of such

claim. 11 U.S.C. §1129.

379

Objection to Confirmation of Chapter 11 Plan, Notice of Objection to Confirmation of Plan and Notice of

Scheduling Hearing on this Objection. Case 20-34656 (KRH). (“IRS Objection to Plan”) 214 at 4.

380

Id.

on the unpaid balance at the underpayment rate established by the Internal Revenue Code

381

382

The IRS declared their interest plan would satisfy their priority tax claims in full.

The Amended Plan

After the various objections filed against the initial plan, Guitar Center prepared and filed

the First Amended Plan of Reorganization in response.

383

The amended plan attempted to

address the issues raised in the objections to the initial plan.

First, the amended plan provided that there was no requirement to file a proof of clam (or

move the Bankruptcy Court for allowance of a claim) to have a claim allowed for the purposes of

the plan.

384

Furthermore, Guitar Center amended the process in which an interested party or

Guitar Center could dispute a claim. Under the amended plan the Bankruptcy Court would

resolve any claims dispute with a final order before the Effective Date.

385

By allowing the

Bankruptcy Court to issue a final order regarding the leases, contracts, and administrative claims

before the Effective Date, Guitar Center addressed the landlords concerns that Guitar Center

might later object to those claims and seek to reduce or eliminate them.

Moreover, the amended plan addressed a long-standing concern of the landlords that

Guitar Center was not going to pay back rent accrued during the chapter 11 proceedings.

386

Upon

the assumption of a lease, Guitar Center was required to pay or perform any unfulfilled

obligations under the lease in accordance with terms of the lease.

387

This made the plan explicitly

meet the mandates of Bankruptcy Code Section 365(b).

388

Under the amended plan, Guitar

381

If any provision of this title requires the payment of interest on a tax claim or an administrative expense tax, the

rate of interest shall be the rate determined under applicable nonbankruptcy law. 11 U.S.C.§ 511.

382

IRS Objection to Plan, 214 at 4.

383

Redline Version of Amended Joint Pre-Packaged Chapter 11 Plan of Reorganization of Guitar Center. Case 20-

34656 (KRH). (hereinafter “The Amended Plan”). 286 at 1.

384

Many landlords had filed limited objections to the initial plan under the theory that they needed to file an

objection just to get on Guitar Center’s radar of claims. However, many of the objecting landlords unexpired leases

had already been accepted by Guitar Center under the schedule of accepted leases. Id. at 50.

385

Id.

386

The amended plan stated that Guitar Center would pay cash to satisfy the monetary defaults on the Effective Date

unless otherwise agreed to and negotiated by the parties to the executory contracts or unexpired leases. Id.at 56.

387

Id. at 44

388

Limited Objection by Various Landlords, 278 at 2.

Center was required to pay the accrued obligations regardless of whether such obligations arose

before or after the Petition Date.

389

Additionally, there was very little detail regarding the disputed cure process in the initial

plan and many interested parties could not ascertain the proper steps that needed to be taken to

dispute a cure. To remedy this issue, the amended plan stated that if a counterparty to a contract

or lease disputed the amount of cure paid by the Guitar Center on the Effective Date, then the

counterparty had to raise the dispute no later than 30 days after the Effective Date.

390

If Guitar

Center and the counterparty could not resolve a dispute consensually, then the counterparty had

to file a proof of claim no later than 60 days after the Effective Date and no disputed portion of

the cure would be paid.

391

If a proof of claim was filed, then Guitar Center had 45 days to either

file an objection to the proof of claim or schedule a conference call with the Bankruptcy Court to

discuss the proof of claim.

392

Unless Guitar Center filed an objection or a requested a status

conference, the amount of cure asserted in the proof of claim would be allowed and Guitar

Center would pay the additional cure.

393

The new cure dispute process provided more clarity on

the steps necessary for an interested party to dispute the cure amount.

394

Furthermore, the amended plan addressed the concerns of the landlords that Guitar

Center had too much discretion to reject leases at any point after the Effective Date. The new

paragraph in the amended plan described exactly when Guitar Center was deemed to reject a

lease. In the amended plan, Guitar Center rejected all contracts and leases on the date stated on

the schedule of rejected contracts or leases, or on the date on which Guitar Center informed the

landlords that they had vacated the leases premises.

395

Moreover, many of the objections filed by

the landlords, complained that Guitar Center did not have a plan for left over personal property.

As a result of the landlord objections, the amended plan needed to provide some sort of remedy

for the left-over property. In response, in the amended plan any personal property (including

furniture, fixtures, equipment, and inventory) remaining, on the rejection date would be deemed

389

The Amended Plan, 286.

390

Id.

391

Id.

392

Id.

393

Id.

394

If no dispute was timely raised or no proof of claim was timely filed, then the cure paid by Guitar Center would

be binding on the applicable counterparty. Id. at 55.

395

Id. at 57.

abandoned without further order from the Court.

396

The landlords would be authorized to use or

dispose of any such property in their sole discretion, without liability to Guitar Center.

397

The amended plan addressed some of the concerns that were raised in the UST objection

to Guitar Center’s disclosure statement and the initial plan. First, Guitar Center modified its plan

to incorporate some changes the UST requested regarding the opt-out procedure for third party

releases.

398

Specifically, the changes provided that any holder of a claim or interest who objected

to the plan, either informally or formally, would not be considered to release its claims against

third parties under the provisions in Guitar Center’s plan.

399

These changes were minor

alterations to the language of the third party releases, but because Guitar Center and its creditors

agreed on the major terms and restructuring transactions provided for in the plan, it was

relatively simple to modify specific language in order to placate the issues raised in the

objection.

Further, Guitar Center and its creditors sought to take advantage of the efficiency and

quickness of reorganizing under a pre-packaged plan, while also operating within the parameters

set out in the restructuring support agreement milestones. Achieving a speedy confirmation of a

plan was paramount to all parties involved and making minor changes of this nature was likely

met with little resistance in order to prevent any confirmation delays. Guitar Center further

addressed the UST’s objection through modifications to the plan during the process of amending

its initial plan by filing a plan supplement which included the identity of the persons who were to

manage and control Guitar Center post-reorganization.

400

Finally, the amended plan changed the process in which claims could be filed based on

the rejection of contracts and leases. Initially, all proof of claims on account of the rejection of a

contract and lease had to be filed no later than 30 days after the entry of the confirmation order

or on the date Guitar Center gave notice to the countparty regarding the rejection of the lease. In

the amended plan, all proofs of claim for rejection damages had to be filed no later than 30 days

396

Id.

397

Id.

398

Amended Plan, 286 at 15.

399

UST Objection, 200 at 14–15; Amended Plan at 42.

400

Id. at 22–23.

after the rejection date.

401

Moreover, if a counterparty to a rejected contract or lease failed to

timely file a proof of claim, then they would be barred from pursuing that claim against anyone.

Notably, most of the new provisions and adjusted provisions in the amended plan were

geared towards Guitar Center’s landlords. While the landlords were not a secured creditor or a

DIP financer, they still had considerable influence because Guitar Center’s business involved

brick and mortar locations. If Guitar Center did not address many of the concerns raised in the

landlords objections they could hamper Guitar Center by filing extensive and expensive litigation

after Guitar Center emerged from chapter 11. Therefore, it made considerable sense for Guitar

Center to address the landlords concerns in the amended plan.

The Final Order

On December 17, 2020, the Court entered its final order: (I) Approving, on a final basis,

adequacy of the disclosure statement; (II) Confirming the amended plan. When it entered the

Final Order, the Court found that Guitar Center’s amended plan met the statutory requirements

of the Bankruptcy Code. The Final Order confirmed all the provisions within the amended plan

and explained how each provision should be carried out by Guitar Center.

First, the Court approved the disclosure statement. It was extremely important for Guitar

Center to have the disclosure statement approved because it contained all the background

information surrounding Guitar Center’s bankruptcy. The Final Order stated that the disclosure

statement contained “adequate information”

402

as defined in Bankruptcy Code Section

1125(a)(1).

403

Furthermore, the disclosure statement satisfied Bankruptcy Rule 3016(b)

404

Solicitation

After approving the disclosure statement, the Court found that the prepetition plan

solicitation and voting procedures satisfied the requirements of the Bankruptcy Code and all

401

The amended plan simplified the proof of claims process by having a 30-day cutoff date as opposed to different

dates based on when the Court ruled on the matter. The Amended Plan, 286 at 57.

402

Adequate information means information of a kind, and in sufficient detail, as far as is reasonable or practicable

in light of the nature and history of the debtor. 11 U.S.C. § 1125(a)(1)

403

Findings of Fact, Conclusions of Law, and Order: (I) Approving, on a Final Basis, Adequacy of the Disclosure

Statement; (II) Confirming the Amended Joint Pre-Packaged Chapter 11 Plan; and (III) Granting Related Relief.

Case 20-34656 (KRH). (“Final Order”). 320 at 6.

404

In chapter 9 or 11 cases, a disclosure statement under section 1125 of the code shall be filed with the plan or

within a time fixed by the court. 11 U.S.C. §1125.

applicable non-bankruptcy rules, laws, and regulations.

405

In so doing, the Court concluded that

the solicitation materials

406

provided adequate information to the holders of claims entitled to

vote on the plan of the procedures and deadline for completing and submitting the ballots.

Additionally, the solicitation materials adequately informed holders of Secured Notes Claims of

the cash out election process and the procedures and deadline for making such election.

407

Here, one can observe a key benefit of approaching a chapter 11 reorganization with a

pre-packaged plan in hand. Because creditors and classes of holders voted to approve the plan

during the pre-petition solicitation process, the court had a straightforward path to finding that

the solicitation and voting procedures satisfied the requirements of the Bankruptcy Code. When

Guitar Center filed for chapter 11, it brought with it the support of most of its secured creditors

who had already voted to approve the initial plan.

408

The restructuring transactions aimed at

satisfying the Secured Notes Claims, including the cash out election and Secured Notes Claims

Distribution, were vital aspects of Guitar Center’s plan. This was the largest class of pre-petition

claims in this case, and arguably no class had its rights affected as severely.

409

By establishing

that this class had notice of and voted to support the plan before the case had been filed, Guitar

Center was able to enjoy a much smoother route to confirmation. It’s likely that these facts

served as strong evidence to the court that the solicitation and voting procedures satisfied the

requirements necessary for confirmation of the plan.

Court Addresses The Issues Raised In The UST’s Objection

In the Final Order, the court approved of Guitar Center’s modifications in its amended

plan relating to the classification, indemnification, release, exculpation and injunction

provisions.

410

The UST had previously objected to the initial plan, citing concern with the opt-

out procedures for third party liability, the omission of a “carve out” for releases with respect to

governmental authorities, and a lack of information as to who would serve as officers and

405

The Court found that the solicitation and voting requirements satisfied Sections 1125(g) and 1126(b) of the

Bankruptcy Code, Bankruptcy Rules 3017 and 3018, and relevant Local Bankruptcy Rules. Final Order, 320 at 6.

406

Solicitation Materials, that is, the ballots and cash out election notice used to vote on the plan.

407

Final Order, 320 at 6.

408

Cash Management Motion, 11 at 2. Holders of 100% in aggregate principal amount of the Debtors’ senior

secured superpriority notes; and holders of over 71% in aggregate principal amount of the Debtors’ senior secured

notes voted to approve the plan during pre-petition solicitation.

409

The Secured Notes Claims were allowed in the amount of $640 MM, the largest claim amount that was included

in Guitar Center’s plan for reorganization. See supra note 137.

410

Final Order, 320 at 6.

directors of Guitar Center upon reorganization.

411

To address this objection, Guitar Center

modified the language of the release provisions to allow parties to opt-out by formally or

informally objecting to confirmation of the plan.

412

Guitar Center also filed a plan supplement

with its amended plan that identified the persons who were to serve as directors and officers of

Guitar Center once it reorganized.

413

Here, the Court held that Guitar Center’s classification of claims and interests in its plan

met the requirements for confirmation outlined in the Bankruptcy Code.

414

The Court found that

Guitar Center’s amendments to the initial plan with respect to the release provisions met the

requirements of Bankruptcy Code Section 1123(b)(3).

415

The Court held that these releases were

negotiated at arms-length, in good faith, were essential to the overall plan, and approved the new

language in the final order.

416

Further, the court was satisfied that Guitar Center had met the

requirements for confirmation under the relevant sections of the Bankruptcy Code in providing

the identities of the persons who would serve as its officers and directors upon reorganization.

417

While not expressly provided for in the amended plan, the final order included provisions that

imposed the “carve out” requested by the UST.

418

This provision exempted governmental

agencies from the plan’s provisions that released or discharged liability outside of claims.

419

Next, the Court addressed the contracts and leases section of the plan. The Court

emphasized that Guitar Center had the sole discretion to reject leases because the brick-and-

mortar leases were an integral part of their business and as such Guitar Center should be able to

determine which stores are profitable. Additionally, the Court found that Guitar Center’s

determinations regarding the assumption of contracts and leases were based on and within Guitar

Center’s sound business judgement

420

and were necessary to the implementation of the plan.

421

411

UST Objection, 200 at 12–17.

412

Amended Plan, 286 at 30, 57, 21.

413

Final Order, 320 at 7.

414

The court held that the plan satisfied all applicable requirements of the Bankruptcy Code, thereby satisfying the

requirements for confirmation in Section 1129(a)(1). Id. at 12.

415

Id. at 16.

416

Id.

417

Id. at 13.

418

Id. at 55–56.

419

Id.

420

Under section 363(c)(1) Unless the court orders otherwise, the debtor may enter into transactions, including the

sale or lease of property of the estate, in the ordinary course of business. 11 U.S.C. §363(c)(1).

As outlined in the amended plan and by the landlord objections discussed above, the

major concerns regarding the plan were the procedures for the disputed claims process and

whether Guitar Center would pay back rent on the accepted leases. The Final Order adopted all

the provisions from the initial plan and the amended plan with a few small changes. First, entry

of the Final Order constituted a determination by the Court that Guitar Center had provided

adequate assurance of future performance under the contracts and leases.

422

Next, the Court

confirmed Guitar’s Center plan to pay the cure amount to accepted leases but amended the plan

so that Guitar Center could only amend the schedule of rejected leases after the entry of the Final

order and with the consent of the landlords.

423

Moreover, if a lease was added to the schedule of

rejected leases after the Effective Date, then a landlord would have 10 days to object to the

proposed rejection date.

424

After, entry of the Final Order all of the objecting landlords withdrew

their claims.

Furthermore, the Final Order approved of the New ABL Facility and the New First Lien

Debt. The Court recognized that both the New ABL Facility and the New First Lien debt were

necessary for Guitar Center, so they could have working capital on the Effective Date. On the

Effective Date, Guitar Center was authorized, to enter the New ABL Facility and all liens from

the New ABL facility were granted first priority status on the “ABL Priority Collateral”

425

subject to certain tax liens.

426

In addition, on the Effective date, Guitar Center was authorized to

enter the New First Lien Debt and all liens from the New First Lien Debt were granted first

priority status on the “Notes Priority Collateral”

427

428

Finally, the Final Order addressed the objections of the various taxing agencies.

Specifically, the taxing agencies were worried that the New ABL Facility and the New First Lien

debt were going to prime their tax liens. To address this concern, the Court modified the plan so

that nothing in the plan or the Final Order discharged, released, precluded, or enjoined any

421

Final Order, 320 at 25.

422

Id. at 26.

423

Id.

424

Id. at 29

425

The ABL priority collateral included Guitar Center’s account receivables, cash, deposit accounts, inventory, and

the proceeds of each category just listed.

426

Final Order, 320.

427

The Notes Priority Collateral included Guitar Center’s intellectual property, the proceeds that flow from the

intellectual property and all other assets that are not in the ABL priority collateral.

428

Final Order, 320.

liability to any Government Unit.

429

Moreover, nothing in the plan or the Final Order could stop

a Government Unit from asserting or enforcing any liability.

430

Lastly, all priority tax claims and

allowed secured tax claims were to be paid in the ordinary course of business by Guitar

Center.

431

The Final Order was the last step to confirming Guitar Center’s plan for reorganization.

Once the Court entered the Final Order, Guitar Center was set to move towards the Effective

Date and emerge from chapter 11 with a clean slate.

Professional Fees

After the Court entered the Final Order, Guitar Center applied and the Court approved the

various professional fees associated with the chapter 11 proceedings. Pursuant to Bankruptcy

Code Section 327 Guitar Center was authorized to retain professionals to assist in their

bankruptcy.

432

Furthermore, section 328 explains that the fees associated with professionals must

be reasonable.

433

When the Court approved Guitar Centers fees it was essentially saying the fees

incurred were reasonable under the terms of the bankruptcy.

Professionals

Fee associated with professional service

A&G Realty Partners, LLC- the real estate

consultants that helped Guitar Center value their

different leases.

$1,071,548.80

Hunton Andrews Kurth LLP- the co counsel for

Guitar Center while there in bankruptcy

$282,707.40

KPMG- the accountants employed by Guitar

Center to ascertain the potential tax liabilities

associated with the reorganization of Guitar

Center

$570,272.70

Milibank LLP- counsel to Guitar Center during

their chapter 11 case

$3,696,194.93

429

Id. at 56.

430

Id.

431

Id.

432

The trustee, with the court’s approval, may employ one or more attorneys, accountants, appraisers, auctioneers,

or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested

persons, to represent or assist the trustee in carrying put the trustee’s duties under this title. 11 U.S.C. § 327.

433

The trustee, with the court’s approval, may employ or authorize the employment of a professional person, as the

case may be, on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis, on

a fixed or percentage fee basis, or on a contingent fee basis. 11 U.S.C § 328.

In total Guitar Center spent $5,620,723.83 on professionals during their Chapter 11 proceedings.

The Final Decree

After the Effective Date, Guitar Center filed a motion seeking a final decree and closing

the chapter 11 cases. The purpose of the Final Decree was to have the Bankruptcy Court state the

case was finished and to discharge Guitar Center as debtor in possession.

434

It would also mean

that no further quarterly fees would be due to the United States Trustee’s Office. Moreover,

Guitar Center desired to terminate Prime Clerk as the claims, noticing and administrative agent.

The Court granted the motion and allowed Guitar Center to end its chapter 11 case.

435

Epilogue

During their bankruptcy, Guitar Center was able to deleverage its balance sheet by

approximately $500 million. This allowed Guitar Center to emerge from bankruptcy with a clean

slate and new battle plan to reassert themselves as the largest music retailer in the United States.

After the COVID 19 pandemic, many brick-and-mortar stores saw a massive uptick in sales.

Many of these stores including Guitar Center, were showing 40% to 50% growth in a year.

436

Specifically, Guitar Center’s customers found a renewed interest in guitars, amps and other

musical instruments. Music industry experts forecasted 2022 to be the biggest year of guitar sales

in history and projected Guitar Center sales to reach a record of $2.5 billion.

437

Guitar Center’s

approach to its chapter 11 case allowed it to quickly navigate through a reorganization and

emerge ready to capitalize on surging consumer demand. The prepetition negotiations with key

creditors paved the way to a smooth transition from an over leveraged position to promising

future growth. This uptick in sales and favorable market forecast led Guitar Center to consider

filing confidential paperwork for an initial public offering, less than a year after emerging from

bankruptcy. However, Guitar Center is still relatively fresh out of bankruptcy, and it is likely the

434

Section 350 of the bankruptcy code requires the court to close the case after the estate is fully administered and

the trustee has been discharged 11 U.S.C. § 350.

435

Final Decree (I) Closing Chapter 11 Case and (II) Terminating Prime Clerk LLC as Claims, Noticing, and

Administrative Agent. Case 20-34656 (KRH). 410 at 5.

436

From Bankruptcy to IPO in a year? It’s a Tune Guitar Center might play, NPR, https://perma.cc/BT6N-4GJ3.

437

Id.

company will let the dust settle before filing any IPO paperwork.

438

Guitar Center is still a

privately held company today.

439

438

Guitar Center Stock- Can you purchase Shares?, Growing Savings, https://perma.cc/V8TV-3GPF.

439

Id.