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IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE

Chapter 11 In re: Case No. 20-11043 (MFW) Enterprises, Inc., et al.,1 (Jointly Administered)

Debtors. Hearing Date: _____, 2020 at ______(ET) Objection Deadline: ______, 2020 at 4:00 pm (ET)

MOTION OF THE OFFICIAL COMMITTEE OF UNSECURED CREDITORS FOR AN ORDER GRANTING LEAVE, STANDING AND OTHERWISE PROVIDING AUTHORITY TO COMMENCE, PROSECUTE AND SETTLE CLAIMS AGAINST LION/HENDRIX CAYMAN LIMITED

The Official Committee of Unsecured Creditors (the “Committee”) of John

Varvatos Enterprises, Inc., et al., the above-captioned debtors and debtors-in-possession

(collectively, the “Debtors”), by and through its undersigned counsel, hereby files this motion (the

“Motion”) for entry of an order substantially in the form attached hereto as Exhibit A (the

“Proposed Order”) pursuant to sections 105, 1103 and 1109 of title 11 of the United States Code,

11 U.S.C. §§ 101 et seq., (the “Bankruptcy Code”) granting the Committee leave, standing and otherwise providing authority to commence, prosecute and settle the claims and causes of action against Lion/Hendrix Cayman Limited (“LHCL”) set forth in the draft complaint attached hereto as Exhibit B (the “Complaint”) on behalf of and for the benefit of the Debtors’ estates.2 In support of this Motion, the Committee respectfully represents:

1 The Debtors in these cases are as follows: John Varvatos Enterprises, Inc.; Lion/Hendrix Corporation; and John Varvatos Apparel Corp. 2 Capitalized terms used herein but not otherwise defined shall have the meaning ascribed to them in the Complaint.

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PRELIMINARY STATEMENT

1. By this Motion, the Committee seeks authority to prosecute and settle certain claims (the “Claims”) as set forth in the Complaint.

2. As set forth in the Committee’s sale objection filed contemporaneously herewith, the Committee is also objecting to LHCL’s right to credit bid alleged prepetition secured claims the Committee seeks to recharacterize as equity. Notwithstanding the limited discovery to date, the Committee has identified documents that demonstrate at a minimum a colorable claim to recharacterize all of the alleged $95 million of purported debt to equity. This $95 million bears all of the hallmarks of equity and LHCL, and its ultimate parent Lion Capital LLP (“Lion Capital”), internally recognized its capital contributions as equity, and not debt.

3. The Committee has also identified several categories of assets that are not subject to the LHCL’s liens, including its prepetition liens (the “Prepetition Liens”). The Debtors have stipulated to the validity of LHCL’s liens, and absent a challenge by the Committee, LHCL will be authorized to acquire such unencumbered assets as part of their credit bid. The Committee, therefore, seeks authority to pursue a challenge to the Prepetition Liens on such assets to preserve value for the Debtors’ creditors.

4. The Committee seeks to avoid the Prepetition Liens in the Debtors’: (i) cash, including but not limited to, cash in deposit accounts that are not subject to control agreements with LHCL or in LHCL’s possession and (ii) commercial tort claims and the proceeds thereof, because LHCL failed to perfect the Prepetition Liens in such assets in accordance with applicable law.

5. The Committee also seeks a declaratory judgment that the Prepetition Liens do not attach to: (i) the Debtors’ leasehold interests and the proceeds thereof because, upon information and belief, the applicable leases prohibit any such lien; (ii) chapter 5 avoidance actions

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and the proceeds thereof, because such actions did not arise until the Debtors filed bankruptcy and should inure to the benefit of unsecured creditors; and (iii) the Debtors’ foreign intellectual property and the proceeds thereof, because such interests were not registered in the applicable foreign jurisdiction in accordance with such jurisdiction’s law.

6. Absent the Committee’s pursuit of these claims, LHCL will be entitled to credit bid their prepetition claims, which have been partially rolled up into their DIP claim, which will eliminate the possibility of unsecured creditor recoveries in these cases. Prior to the filing of this Motion, the Committee made demand on the Debtors to pursue these clams and the Debtors declined to do so. The Committee, therefore, seeks authority to pursue the claims and preserve value for unsecured creditors.

JURISDICTION

7. The United States Bankruptcy Court for the District of Delaware

(the “Court”) has jurisdiction over the Debtors’ chapter 11 cases (the “Cases”) and this Motion pursuant to 28 U.S.C. § 1334 and the Amended Standing Order of Reference from the United States

District Court for the District of Delaware dated February 29, 2012. This is a core proceeding within the meaning of 28 U.S.C. § 157(b)(2). Venue of these cases in this district is proper under

28 U.S.C. §§ 1408 and 1409.

8. Pursuant to Local Rule 9013-1(f), the Committee consents to the entry of a final judgment or order with respect to this Motion if it is determined that the Court, absent consent of the parties, cannot enter final orders or judgments consistent with Article III of the United States

Constitution.

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BACKGROUND

I. Procedural Background

9. On May 6, 2020 (the “Petition Date”), each of the Debtors filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code with this Court. Since the Petition

Date, the Debtors have remained in possession of their assets and have continued to operate and manage their businesses as debtors-in-possession pursuant to sections 1107(a) and 1108 of the

Bankruptcy Code.

10. On May 18, 2020, the Office of the United States Trustee for Region 3 appointed a five-member Committee consisting of: (i) Tessa Knox, as the class representative of the class action claimants; (ii) Vornado Realty Trust; (iii) Verde Garment Manufacturing Limited;

(iv) Meenakshi India Limited; and (v) L Industries Limited. The Committee selected Kelley Drye

& Warren LLP as its lead counsel and Potter Anderson & Corroon LLP as local counsel.

II. The Debtors’

11. As of the Petition Date, Debtors John Varvatos Enterprises, Inc. (“JVE”) and John Varvatos Apparel Corp. (“JVA”) were parties to a senior secured credit agreement dated

April 22, 2019, with Wells Fargo Bank, National Association (“Wells Fargo”) as agent, and the lenders party thereto (the “Wells Fargo Facility”). Debtor Lion/Hendrix Corporation (“LHC”) guaranteed the Debtors’ obligations under the Wells Fargo Credit Facility. As of the Petition Date, the Debtors owed Wells Fargo $19.5 million under the Wells Fargo Facility.

12. The Debtors are executed a series of five subordinated secured promissory notes issued in favor of LHCL:

(i) a Second Amended and Restated Tranche A Joint and Several Secured Non- Negotiable Promissory Note, dated as of February 5, 2020 (the “Tranche A Note”) by JVE and JVA in favor of LHCL, and guaranteed by LHC;

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(ii) a Second Amended and Restated Tranche B Joint and Several Secured Non- Negotiable Promissory Note, dated as of February 5, 2020 (the “Tranche B Note”) by JVE and JVA in favor of LHCL, and guaranteed by LHC;

(iii) a Second Amended and Restated Tranche C Joint and Several Secured Non- Negotiable Promissory Note, dated as of February 5, 2020 (the “Tranche C Note”) by JVE and JVA in favor of LHCL, and guaranteed by LHC;

(iv) a Third Amended and Restated Tranche C-1 Joint and Several Secured Non- Negotiable Promissory Note, dated as of February 5, 2020 (the “Tranche C-1 Note”) by JVE and JVA in favor of LHCL, and guaranteed by LHC; and

(v) a Tranche D Joint and Several Secured Non-Negotiable Promissory Note, dated as of February 5, 2020 (the “Tranche D Note” and together with the Tranche A Note, the Tranche B Note, the Tranche C Note and the Tranche C-1 Note, the “LHCL Notes”) by JVE and JVA in favor of LHCL, and guaranteed by LHC.

13. LHCL directly and indirectly owns each of the Debtors. -based fund Lion Capital is the indirect majority owner of LHCL and ultimately owns 100% of the Debtors’ equity.

14. Pursuant to the DIP Order (as defined herein), the Debtors have stipulated to the validity of secured obligations totaling $94,779,483.00 under the LHCL Notes.3

III. Prepetition History

15. In 2012, Lion Capital acquired the Debtors for a $ investment.

Following the acquisition, the Debtors’ performance was carefully monitored by Lion Capital and

16. Contemporaneously with the acquisition, the Debtors entered into a

3 Pursuant the DIP Order, the Debtors stipulate that as of the Petition Date: (i) the outstanding balance of the Tranche A Note is $14,249,161.38; (ii) the outstanding balance of the Tranche B Note is $32,526,639.94; (iii) the outstanding balance of the Tranche C Note is $15,840,297.53; (iv) the outstanding balance of the Tranche C- 1 Note is $11,164,941.84; and (v) the outstanding balance of the Tranche D Note is $20,998,442.62. See DIP Order, ¶ J.

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17.

18.

19.

20.

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21.

22.

23.

24. On December 18, 2015, JVE and JVA issued the original Tranche A Note in the face amount of $ million (the “Original Tranche A Note”). The Original Tranche A Note provided for PIK interest to accrue at percent per annum and had a fixed maturity date of

.

25. Also on December 18, 2015,

and (iii) the Debtors issued to LHCL the original version of the Tranche B Note in

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the original principal amount of $ million (the “Original Tranche B Note”). The Original

Tranche B Note provided for PIK interest to accrue at percent per annum and had a fixed maturity date of .

26.

27.

Accordingly, on March 30, 2016, the Debtors issued what was publicly characterized as a Tranche

C “promissory note” with LHCL for up to $ (the “Original Tranche C Note”). The

Original Tranche C Note provided for PIK interest to accrue at percent per annum and had a fixed maturity date of

28.

29.

30.

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31. On March 3, 2017, the Debtors issued what was labeled as a Tranche C-1

“promissory note” to LHCL for up to $ (the “Original Tranche C-1 Note”). The Original

Tranche C-1 Note provided for PIK interest to accrue at percent per annum and a maturity date of

32. The Debtors struggled throughout 2017 and 2018, r

On April 22, 2019, the Debtors entered into

and Wells Fargo.

33. In connection with the Debtors’ entry into these facilities, each of the

Original Tranche A, B, C and C-1 Notes were amended and restated (collectively, the “First

Amended LHCL Notes”).

34.

35. On February 5, 2020, LHCL provided the Debtors a

36.

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37. At the same time, the Debtors amended and restated each of the First

Amended LHCL Notes to their current versions.

38.

39. As of the

Petition Date, the amounts due LHCL under the LHCL Notes totaled approximately $94.8 million, with

IV. The Bankruptcy Cases

40. The Debtors commenced these cases to close underperforming stores and sell substantially all of their assets to LHCL via a partial credit bid. Accordingly, on the Petition

Date, the Debtors filed a motion seeking approval of bid procedures and a stalking horse agreement with LHCL.

41. The LHCL bid is a $76 million credit bid of the LHCL DIP facility and a portion of the LHCL Notes, plus cash to satisfy the Wells Fargo first lien debt and cure costs for assigned contracts. LHCL will not assume any pre-closing administrative or priority liabilities.

The LHCL bid will also provide at most $250,000 for general unsecured creditors who are owed in excess of $26.1 million according to the Debtors’ Schedules (as defined below).

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42. On June 9, 2020, the Court entered the final DIP order authorizing, among other things, a $21 million DIP facility from LHCL, which included $10.5 million of new money and a $10.5 million rollup of a portion of the Tranche B Note (the “Roll-Up”).4

43. Pursuant to the DIP Order, the Debtors stipulated to, among other things:

(i) the amount of the obligations owing to LHCL under the LHCL Notes; and (ii) the validity and perfection of LHCL’s liens in the Debtors’ assets.5

44. The Committee was granted until July 13, 2020 to investigate these liens and claims, including the prepetition liens and claims that were converted into DIP liens in connection with the Roll-Up.6

45. On June 30, 2020, the Debtors filed their schedules of assets (the

“Schedules”) and statements of financial affairs (the “SOFAs”) for each of the Debtors.7 The following information is included in the Schedules and SOFAs regarding the collateral challenged in connection with the Claims:

 Bank Accounts: JVE had bank accounts for which account control agreements were not executed by LHCL, which had a value of $350,000 in cash on the Petition Date (the “Bank Accounts”).

 Foreign Intellectual Property: Although the Schedules do not provide an itemized list of the Debtors’ intellectual property, the Committee understands from schedules to a prior security agreement between the Debtors and LHCL dated December 18, 2015, that the Debtors owned foreign intellectual property

4 See Final Order, Pursuant to 11 U.S.C. §§ 105, 361, 362, 363, 364, 503, 506, and 507, (I) Authorizing the Debtors to Obtain Secured Priming Post-Petition Financing, (II) Granting Liens and Superpriority Administrative Expense Claims, (III) Authorizing the Use of Cash Collateral, (IV) Granting Adequate Protection, (V) Modifying the Automatic Stay, and (VI) Granting Related Relief [D.I. 176] (the “DIP Order”). 5 DIP Order, ¶ J. 6 See id. ¶ 20. 7 See Docket Nos. 259-264, 266.

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registered, published, or pending in approximately four dozen foreign jurisdictions (collectively, the “Foreign IP”).

 Leasehold Interests: The Debtors were party to 27 real property leases (the “Leasehold Interests”) as of the Petition Date.

 Avoidance Actions: The SOFA for JVE lists nearly $1.4 million in payments made by JVE in the ninety days prior to the Petition Date and approximately $2.1 million of payments made to insiders in the one year prior to the Petition Date (collectively, the “Avoidance Actions”). The transfers may be subject to preference claims.

V. The Committee’s Claims and Causes of Action

A. The Recharacterization Claim

46. LHCL’s secured claims under the LHCL Notes should be recharacterized as equity. As set forth at length in the Complaint, LHCL and its affiliates

The fact that these equity investments were documented as loans under the LHCL Notes does not change their true nature, especially where, as here, Lion Capital was the ultimate controlling shareholder of the Debtors and exercised total control over the Debtors’ boards of directors and decision making authority.

47. Based upon the information produced to the Committee to date

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B. The Declaratory Relief Claims

48. The Debtors’ Leasehold Interests constitute “Excluded Property” under the

Security Agreement. Specifically, Excluded Property includes any contractual obligation, including obligations under a non-residential real property lease, that prohibits or requires the consent of any party, other than the Debtors, which consent has not been obtained. The Committee understands that the real property leases governing the Debtors’ Leasehold Interests prohibit the

Debtors from granting a lien in such Leasehold Interests, and none of the Debtors’ landlords provided their consent to the granting of a lien in such Leasehold Interests. Even if such consent was provided, LHCL did not file leasehold mortgages or deeds of trust, as is required to perfect an interest in a leasehold mortgage.

49. Avoidance Actions are not Prepetition Collateral under the Security

Agreement because avoidance actions under chapter 5 of the Bankruptcy Code do not come into existence until a debtor files a petition for relief under the Bankruptcy Code. As such LHCL’s

Prepetition Liens do not extend to the Avoidance Actions. Because the Prepetition Liens do not extend the Avoidance Actions, they likewise do not extend to the proceeds of such actions.

50. Foreign IP is not subject to LHCL’s Prepetition Liens because liens granted in copyrights, patents, trademarks and other intellectual property created under the laws of a foreign jurisdiction may be subject to the laws of those jurisdictions. At a minimum, the

Committee understands that many of those jurisdictions require liens to be registered in the intellectual property records of those countries, and that such law may supersede any United States law to the contrary. To the Committee’s knowledge, LHCL did not file, and did not have authority to file, a financing statement to perfect any prepetition lien asserted to be held by LHCL in any intellectual property pending, registered, or published in any applicable foreign jurisdiction.

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51. As a result, the Prepetition Liens do not attach to: (i) the Leasehold Interests,

(ii) the Avoidance Actions, or (iii) the Foreign IP (collectively, the “Declaratory Relief Claims”).

C. The Unperfected Lien Claims

52. Notwithstanding the security interest granted in the LHCL Notes, LHCL did not properly perfect its security interest in the certain of the Debtors’ assets (collectively, the

“Unperfected Lien Claims”):

53. First, security interests in the Debtors’ Bank Accounts must be perfected by possession or control. A lien against a deposit account that is held by a bank that is neither the lender nor its agent must be perfected by control pursuant to an account control agreement or similar agreement.8 Any prepetition lien asserted by LHCL on the Bank Accounts was unperfected as of the Petition Date because LHCL did not enter an agreement providing it with control over the Bank Accounts, as required under applicable state law.

54. Second, LHCL does not hold a perfected security interest in the Debtors’ commercial tort claims. The Security Agreement did not identify any potential commercial tort claims held by the Debtors. More importantly, the UCC-1 financing statements filed by LHCL did not expressly identify any commercial tort claims, as required by state law. Accordingly, any prepetition lien held by LHCL on the Debtors’ commercial tort claims was unperfected as of the

Petition Date. Because LHCL does not hold a properly perfected lien on the Debtors’ commercial tort claims, it likewise does not hold a lien on the proceeds of such claims.

8 6 Del. C. §§ 9-104, 9-304, 9-312, 9-314.

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RELIEF REQUESTED

55. The Committee seeks an order pursuant to sections 105, 1103 and 1109 of the Bankruptcy Code granting the Committee authority and/or standing to commence, prosecute and, if appropriate, settle the Claims.

ARGUMENT

I. Legal Standard

56. Section 1109(b) of the Bankruptcy Code provides that “[a] party in interest, including . . . a creditors’ committee . . . may raise and may appear and be heard on any issue in a case under this chapter.”9 Granting derivative standing to a creditors’ committee to act on behalf of a debtor’s estate is an appropriate exercise of a bankruptcy court’s equitable powers.10

57. As the Court of Appeals for the Third Circuit confirmed in Official Comm.

Of Unsecured Creditors of Cybergenics Corp. v. Chinery, a bankruptcy court may grant a committee standing to litigate claims on behalf of a debtor’s estate pursuant to sections 105(a),

1103(c)(5) and 1109(b) of the Bankruptcy Code.11 Section 1103 sets forth the powers and duties of committees and provides that a committee may investigate the acts, conduct, assets, liabilities,

9 11 U.S.C. § 1109(b). 10 See Official Comm. of Unsecured Creditors of Cybergenics Corp. ex rel. Cybergenics Corp. v. Chinery, 330 F.3d 548, 567-68 (3d Cir. 2003) (determining that section 1109(b) and other sections of the Bankruptcy Code demonstrate Congress’ approval of derivative suits by creditors’ committees to recover property for the benefit of the estate, and that bankruptcy courts may exercise their equitable powers to confer such derivative standing); Infinity Investors Ltd ex rel. Yes! Entm’t Corp. v. Kingsborough (In re Yes! Ent’mt Corp.), 316 B.R. 141, 145 (D. Del. 2004) (“In Cybergenics, the Third Circuit recognized that the Bankruptcy Court, as a court of equity, has the power to authorize a creditor’s committee to sue derivatively to recover property for the benefit of the estate.”); see also PW Enters., Inc. v. N.D. Racing Comm’n (In re Racing Servs., Inc.), 540 F.3d 892, 904 (8th Cir. 2008) (stating that derivative standing is available to creditors’ committees); Commodore Int’l Ltd. v. Gould (In re Commodore Int’l Ltd.), 262 F.3d 96, 100 (2d Cir. 2001) (same); Fogel v. Zell, 221 F.3d 955, 965 (7th Cir. 2000) (same); Canadian Pacific Forest Prods. Ltd. v. J.D. Irving, Ltd. (In re Gibson Grp., Inc.), 66 F.3d 1436, 1446 (6th Cir. 1995) (same). 11 See Official Comm. Of Unsecured Creditors of Cybergenics Corp. v. Chinery (In re Cybergenics), 330 F.3d 548, 575 (3d Cir. 2003); see also Official Comm. Of Unsecured Creditors v. Barron (In re Polaroid Corp.), 2004 WL 1397582 (Bankr. D. Del. June 22, 2004); Official Comm. Of Unsecured Creditors v. Cablevision Sys. Corp. (In re Valley Media, Inc.), 2003 WL 21956410 (Bankr. D. Del. Aug. 14, 2003).

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and financial condition of the debtor, the operation of the debtor’s business and the desirability of such business, and any other matter relevant to the case or to the formulation of a plan.12

58. Granting derivative standing to a creditors’ committee is particularly appropriate where a debtor in possession exercises the powers that would otherwise vest in a bankruptcy trustee.13 The lack of a trustee “immediately gives rise to the proverbial problem of the fox guarding the henhouse.”14 “Debtors may be unwilling to pursue claims against individuals or businesses, such as critical suppliers, with whom it has an ongoing relationship that it fears damaging.”15 Granting derivative standing to a creditors’ committee thus “provides a critical safeguard against lax pursuit of avoidance actions” and other claims of the estate.16 Congress consciously built a measure of flexibility into the scope of a committee’s services to empower a bankruptcy court to authorize a committee to represent the estate where the usual representative is unable or unwilling to act.17

59. In the Third Circuit, a creditors’ committee may be granted derivative standing upon a showing that: (a) the trustee or debtor in possession unjustifiably refuses a demand to pursue an action; (b) the committee has a colorable claim or cause of action; and (c) the committee seeks and obtains leave from the bankruptcy court to prosecute the action for and in the name of the debtor or trustee.18 The Committee satisfies all three of these elements.

12 11 U.S.C. § 1103(c)(2). 13 Cybergenics, 330 F. 3d at 573–74. 14 Id. at 573. 15 Id. (citing Canadian Pac. Forest Prods. v. J.D. Irving, Ltd. (In re Gibson Group, Inc.), 66 F.3d 1436, 1441 (6th Cir. 1995). 16 Id. 17 Id. at 563. 18 See Cybergenics, 330 F.3d at 566; In re Yes! Ent’mt Corp., 316 B.R. at 145.

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II. The Committee Should Be Granted Standing To Litigate The Claims

A. The Claims Are Colorable

60. The first element to assess is whether the Committee asserts “a colorable claim or claims for relief that on appropriate proof would support a recovery.”19 The burden to satisfy the requirement that the Committee have colorable claims and causes of action is a

“relatively easy one to make.”20 The standard to determine whether a claim is colorable requires the same analysis as when a defendant moves to dismiss a complaint for failure to state a claim.21

61. That analysis is related to the pleading requirement of Rule 8 of the Federal

Rules of Civil Procedure.22 Rule 8(a) requires only that the complaint “contain a short statement of the claim showing that the pleader is entitled to relief.”23 A motion to dismiss may be granted only if, after accepting the allegations in the complaint as true and viewing them in the light most favorable to the plaintiff, the plaintiff is still not entitled to any relief.24

19 G-1 Holdings, Inc. v. Those Parties Listed on Exhibit A (In re G-1 Holdings, Inc.), 313 B.R. 612, 631 (Bankr. D. N.J. 2004) (quoting In re STN Enters., Inc., 779 F.2d at 905). 20 Adelphia Communs. Corp. v. Bank of Am. (In re Adelphia Communs. Corp.), 330 B.R. 364, 376 (Bankr. S.D.N.Y. 2005). 21 In re Centaur, LLC, No. 10-10799, 2010 Bankr. LEXIS 3918, *13 (Bankr. D. Del. Nov. 5, 2010). 22 Id. (citing Official Comm. of Unsecured Creditors v. Goldman Sachs Credit Partners, L.P. (In re Fedders N.A., Inc.), 405 B.R. 527, 537 (Bankr. D. Del. 2009)). 23 Id. 24 Doug Grant, Inc. v. Greate Bay Casino Corp., 232 F.3d 173, 183 (3d Cir. 2000), cert. denied, 532 U.S. 1038, 121 S. Ct. 2000, 149 L. Ed. 2d 1003 (2001).

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62. In the context of motions for derivative standing, Delaware courts favor a general analysis of the allegations over a line-by-line or claim-by-claim analysis of proposed complaint.25 To determine if a colorable claim exists, a court need not undertake a mini-trial,26 and the required showing is “a relatively easy one to make.”27 A committee is not required to present its proof when seeking derivative standing.28 To be colorable, the claim must only be plausible or not without some merit.29 As set forth below, the Committee’s Claims easily satisfy the colorability threshold.

(i) The Recharacterization Claim (Counts I and II) is Colorable

(a) Case Law Supports Recharacterization of the LHCL Notes as Equity

63. “The focus of recharacterization . . . is ‘whether the parties called an instrument one thing when in fact they intended it as something else.”30 That intent may be inferred from (1) what the parties say in their contracts, (2) what they do through their actions, and (3) the economic reality of the surrounding circumstances.31 The question is whether the transaction created a debt or equity relationship from the outset.32 Accordingly, in characterizing an

25 See In re Distributed Energy Systems, Corp., No. 08-11101-KG (Bankr. D. Del. July 30, 2008), Transcript of Proceedings at 44 (“And the colorable claim issue, of course, is plausibility. . . . I don’t even have to find that it has merit; I just have to find that it’s not without merit.”). 26 Unsecured Creditors Comm. of STN Enters., Inc. v. Noyes (In re STN Enters., Inc.), 779 F.2d 901, 905-06 (2d Cir. 1985). 27 Adelphia Communications Corp. v. Bank of Am., N.A. (In re Adelphia Communications Corp.), 330 B.R. 364, 376 (Bankr. S.D.N.Y. 2005). 28 Id. 29 In re America’s Hobby Ctr., Inc., 223 B.R. 275, 282 (Bankr. S.D.N.Y. 1998) 30 In re Friedman’s Inc., 452 B.R. 512, 518 (Bankr. D. Del. 2011) (citing In re SubMicron Sys. Corp., 432 F.3d 448, 456 (3d Cir. 2006)). 31 Id. 32 Id. n. 7 (citing In re Cold Harbor Assocs., L.P., 204 B.R. 904, 915 (Bankr. E.D. Va. 1997).

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instrument as debt or equity, a court must focus its inquiry to a point at the very beginning of the parties’ relationship.33

64. To determine whether the transaction was intended as a debt or equity, a court will not rely on a mechanistic scorecard but will assess the facts that confer context on a case-by-case basis.34 Courts have considered the following factors to determine whether recharacterization is proper; these factors include:

(1) the names given to the instruments, if any, evidencing the indebtedness;

(2) the presence or absence of a fixed maturity date and schedule of payments;

(3) the presence or absence of a fixed rate of interest and interest payments;

(4) the source of repayments;

(5) the adequacy or inadequacy of capitalization;

(6) the identity of interest between the creditor and the stockholder;

(7) the security, if any, for the advances;

(8) the corporation's ability to obtain financing from outside lending institutions;

(9) the extent to which the advances were subordinated to the claims of outside creditors;

(10) the extent to which the advances were used to acquire capital assets; and

(11) the presence or absence of a sinking fund to provide repayments.35

33 United States v. State St. Bank & Trust Co., 520 B.R. 29, 74 (Bankr. D. Del. 2014) (citing Bayer Corp. v. MascoTech, Inc. (In re Autostyle Plastics, Inc.), 269 F.3d 726, 748-49 (6th Cir. 2001). 34 In re SubMicron, 432 F.3d at 454. 35 Moll Indus., 454 B.R. at 581-82 (citing Official Comm. of Unsecured Creditors v. Credit Suisse First Bos. (In re Exide Techs., Inc, 299 B.R. 732, 740 (Bankr. D. Del. 2003).

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(b) The Circumstances and Characteristics of the LHCL Notes Support Recharacterization

65. As set forth in greater detail in the Complaint, recharacterization of LHCL’s purported secured claim as equity is warranted. Historically, as shown

Despite labeling the LHCL Notes as “promissory notes,” each advance was intended to be a further investment in the Debtors.

66. The totality of the circumstances, in conjunction with the multi-factor analysis, reveals that the funds advanced under the guise of the LHCL Notes were truly equity infusions. Among other things, although the LHCL Notes were labeled “promissory notes” and contained maturity dates and interest rates, these facts are belied by the economic reality of the surrounding circumstances.

67. In addition, the Debtors were always thinly capitalized with sales consistently falling below budget and EBITDA declining yearly. As a result of the , the Debtors relied on the cash infusions from LHCL, as approved by Lion

Capital, Lion

Capital and LHCL are the direct and indirect owners of the Debtors and had a vested interest in infusing capital into the Debtors to avoid a liquidation.

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68. Moreover, LHCL was even willing to subordinate its advances to the secured claims of third parties to protect its investment.

69. Because the LHCL Notes are subject to recharacterization as equity contributions, the Roll-Up must be unwound to avoid prejudice to the Debtors’ creditors for the benefit of LHCL. The Roll-Up remained subject to the Committee’s challenge rights under the

DIP Order.36 If the claims under the LHCL Notes were not secured prior to the Petition Date, permitting an equity investment to be converted into a superpriority DIP claim post-bankruptcy would unquestionably harm the Debtors’ creditors, who would otherwise be entitled to payment ahead of LHCL. For this reason the Committee is entitled to a declaratory judgment that the Roll-

Up must be unwound. Because the recharacterization claim is colorable for the reasons set forth above, this declaratory judgment claim is also colorable.

(ii) The Declaratory Relief Claims Are Colorable

70. The Complaint (Counts IV, VI and VII) seeks declaratory relief that the

Prepetition Liens do not attach to: (i) the Debtors’ Leasehold Interests and the value thereof; (ii)

Avoidance Actions and their proceeds; and (iii) the Foreign IP. As set forth below, the Declaratory

Relief Claims easily satisfy the colorability threshold.

(a) Leasehold Interests (Count IV)

71. As of the filing of this Motion, the Debtors had Leasehold Interests in 27 unexpired real property leases with various commercial landlords. Generally, a secured creditor cannot obtain a lien on a leasehold interest if such a lien is prohibited in the underlying lease. Most retail commercial leases prohibit liens on the leasehold interest itself. Moreover, the Uniform

36 DIP Order, at ¶20.

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Commercial Code does not address security interests in real property, which are governed by state law.

72. State law typically requires that a secured party record its leasehold mortgage in the local filing office where the real property is located. The Committee requested

LHCL produce all security and perfection documents as part of its investigation. LHCL did not produce any leasehold mortgages or evidence of recordation of any such leasehold mortgages.

Accordingly, the Committee has a colorable claim for a declaratory judgment that the Prepetition

Liens do not extend to the Leasehold Interests and their proceeds.

(b) Avoidance Actions (Count VI)

73. Avoidance actions do not come into existence until a debtor files a petition for relief under the Bankruptcy Code.37 Moreover, it is the trustee, acting on behalf of all creditors, who has the sole authority to recover preference payments.38 Accordingly, the Avoidance Actions and their proceeds are not Prepetition Collateral under the LHCL Notes.

(c) Foreign IP (Count VII)

74. The Committee understands that many foreign jurisdictions require liens to be registered in the intellectual property records of those countries, and that such law may supersede any United States law to the contrary. To the Committee’s knowledge, LHCL did not file, and did not have authority to file, a financing statement to perfect any prepetition lien asserted to be held by LHCL in any intellectual property pending, registered, or published in any applicable foreign jurisdiction. Accordingly, the Foreign IP is not subject to LHCL’s Prepetition Liens.

37 See PAH Litig. Trust v. Water St. Healthcare Partners L.P. (In re Physiotherapy Holdings, Inc.), Case No. 13-12965, 2016 Bankr. LEXIS 2810, *53-54 (Bankr. D. Del. June 20, 2016) (“Post-petition avoidance actions can only be brought by the trustee after the petition is filed”). 38 See In re Guiliano v. Schnabel (In re DSI Renal Holdings, LLC), 574 B.R. 446, 479 (Bankr. D. Del. 2017) (interpreting sections 323(a), 323(b) and 541 of the Bankruptcy Code to grant the trustee exclusive standing to assert causes of action, including those existing at the time the bankruptcy action commences).

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(iii) The Unperfected Lien Claims Are Colorable

75. The Complaint (Counts III and V) seeks to avoid the Prepetition Liens as unperfected with respect to certain types of collateral. For the reasons discussed below, each of the Committee’s Unperfected Lien Claims are colorable.

(a) The Bank Accounts (Count III)

76. The Debtors’ Schedules reveal that, as of the Petition Date, the Debtors had at least $350,000 of cash in the Bank Accounts. A secured party must have control of a deposit account to perfect a security interest therein. To establish control, the secured party must either:

(i) be the institution where the account is maintained, or (ii) enter an agreement providing the secured party with control over the account. The Bank Accounts were not maintained at LHCL and LHCL has not produced control agreement with respect to such accounts. Further, LHCL bears the burden to present evidence that the cash in the Bank Accounts can be traced to its

Prepetition Collateral, which LHCL has failed to do. Therefore, the Prepetition Liens are not perfected against the Bank Accounts or the cash in such accounts.

(b) Commercial Tort Claims (Count V)

77. To hold a perfected security interest in a commercial tort claim, the security agreement and the UCC-1 must identify the claim specifically; a general identification of

“commercial tort claims” is insufficient.39 To perfect a security interest in a commercial tort claim,

39 See N.Y. U.C.C. § 9-108(e) (stating that a description only by type of collateral is an insufficient description of a commercial tort claim).

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the claim must be in existence at the time it is encumbered.40 Moreover, an after acquired property clause is ineffective to attach a lien to a commercial tort claim that arises after a UCC-1 is filed.41

78. Neither the Security Agreement nor the financing statements list any commercial tort claims, and therefore, do not provide the specificity required under the Uniform

Commercial Code to perfect the Prepetition Liens in any commercial tort claims. Accordingly, the Prepetition Liens do not extend to the Debtors’ commercial tort claims and their proceeds.42

B. The Debtors Have Refused To Prosecute The Claims

79. The second factor a court must consider to determine whether to grant a committee derivative standing is whether the debtor has refused to bring the claims.43 A committee or other party-in-interest is not required to make a formal demand that a debtor pursue claims where it is “plain from the record that no action on the part of the debtor would have been forthcoming” and that such a demand would be futile.44

80. Here, any request that the Debtors pursue the Claims would be futile because the DIP Order specifically bars the Debtors from pursing such claims. Paragraph J(viii)

40 See Bayer CropScience, LLC v. Stearns Bank Nat’l Ass’n, 837 F.3d 911, 916 (8th Cir. 2016) (noting the requirement that the commercial tort claim be in existence at the time it is encumbered). 41 See N.Y. U.C.C. § 204(b)(2) (“[a] security interest does not attach under a term constituting an after-acquired property clause to … a commercial tort claim”); See Bayer, 837 F.3d at 916 (“We hold that the drafters of the UCC, in implementing the heightened identification requirements of commercial tort claims including the requirement that the commercial tort claim be in existence at the time it is encumbered, intended for the proceeds of a commercial tort claim to be excluded from an after-acquired general intangibles clause”). 42 See, e.g., Helms v. Certified Packaging Corp., 551 F.3d 675, 681 (7th Cir. 2008) (“The agreement does not mention [two tort claims] and while it purports to grant [the secured creditor] a security interest in after-acquired property, such a grant is ineffective when the property is a commercial tort claim.”). 43 See Centaur, 2012 Bankr. LEXIS 3918 at *13 (entitlement to derivative standing includes an analysis of whether the trustee unjustifiably refused to pursue the claim). 44 Official Comm. of Unsecured Creditors of Nat’l Forge Co. v. E. Roger Clark (In re Nat’l Forge Co.), 326 B.R. 532, 544 (W.D. Pa. 2005) (finding that a formal request of the debtor to bring an action waived under DIP financing orders would have been futile as debtor could not have “seriously entertained the idea”); see also Louisiana World Exposition, Inc. v. Fed. Ins. Co. (In re Louisiana World Exposition, Inc.), 832 F.2d 1391, 1397-98 (5th Cir. 1987) (stating that the court would not remand so that the committee could make formal demand upon debtor where conflicts would likely prevent debtor from pursuing litigation adverse to its directors and officers).

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of the DIP Order provides that the stipulations in that order are “binding on the Debtors and their respective representatives” subject solely to any challenge brought by any party in interest, including the Committee.45 The stipulations in the DIP Order that the Committee seeks to contest thus are binding on and cannot be challenged by the Debtors. No formal demand that the Debtors pursue the Claims is required.46

81. Despite these limitations, on July 3, 2020, the Committee sent a letter to the

Debtors demanding that they assert the Claims on behalf of the Debtors’ estates. On July 7, 2020,

Debtors’ counsel responded that the Debtors were unable to challenge the Prepetition Liens because of the stipulations contained in the DIP Order. The second factor is therefore satisfied.

C. The Committee Is Seeking Court Approval To Prosecute The Claims

82. The third factor the Court must consider is whether the Committee has obtained prior Court approval to assert the Claims on behalf of the Debtors’ estates. By this

Motion, the Committee is seeking such approval.

83. The Committee is the proper party to litigate the Claims because it is the entity charged with safeguarding the interests of the estates and maximizing value for general unsecured creditors.47 Section 1103(c) of the Bankruptcy Code sets forth the Committee’s duties, including performing such services as are in the interest of the general unsecured creditors.48

Given the Debtors’ inability and unwillingness to assert the Claims, the Committee seeks authority to pursue the Claims to comply with its fiduciary duties.

45 See DIP Order at § J(viii). 46 In re Nat’l Forge Co., 326 B.R. at 544. 47 In re Enron Corp., 279 B.R. 671, 689 (Bankr. S.D.N.Y. 2002) (quoting Collier on Bankruptcy ¶ 1103.05[1][a] at 1103-22 (15th ed. rev. 2002) (“the primary purpose of a committee … is to maximize the return to the constituency represented by the committee and all actions undertaken by the committee should be with that goal in mind.”). 48 See 11 U.S.C. § 1103(c)(5).

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D. Exclusive Authority of the Committee to Settle the Standing Claims

84. The Committee requests the exclusive authority to negotiate and enter into settlements regarding the Claims, subject to Court approval pursuant to Bankruptcy Rule 9019.

Exclusive authority to settle claims is frequently included in orders conferring standing upon a creditors’ committee.49

85. The exclusive authority to settle the Claims is especially appropriate in this case given the Debtors’ close relationship with and financial reliance upon LHCL. The same conflicts of interest that exist with respect to the Debtors’ assertion of the Claims also affect the settlement of such claims. The Committee should have the sole right to settle the Claims to ensure that the value of such Claims has been maximized for the benefit of the estate and its creditors.

E. The Benefit of Pursuing the Claims

86. The Committee further submits that the benefits to general unsecured creditors from litigating the Claims more than outweigh the potential costs of litigation. The

Committee is seeking to recharacterize more than $95 million of “debt,” which

LHCL has already credit bid $76 million of its purported secured claim and it may credit bid up to the full $95 million. Unless LHCL’s claim is

49 See In re Evergreen Solar, Inc., Order Granting Leave, Standing and Authority to the Official Committee of Unsecured Creditors of Evergreen Solar, Inc. to Commence, Prosecute, and Settle Claims on Behalf of the Debtor’s Estate and Related Relief, Case No. 11-12590-MFW (Bankr. D. Del. Oct. 28, 2011) [D.I. 382] (granting derivative standing to unsecured creditors’ committee and providing that the committee “shall have the exclusive right and authority to negotiate and enter into settlements on behalf of the Debtor’s estate” with respect to certain causes of action); In re Majestic Capital, Ltd., Order (I) Authorizing the Official Committee of Unsecured Creditors to (A) Assert and Prosecute Certain Claims and Causes of Action in the Name of and on Behalf of the Debtors’ Estates, and (B) Move for Authority to Compromise Any Such Claims and Causes of Action, and (II) Granting Related Relief, Case No. 11-36225-CGM (Bankr. S.D.N.Y. Dec. 12, 2011) [D.I. 211] (granting derivative standing to unsecured creditors’ committee and providing that it “shall have the exclusive right, without further order of the Court, to move for authority, pursuant to Bankruptcy Rule 9019, to compromise any of the Estate Claims”); In re Old Carco LLC, Order Authorizing the Official Committee of Unsecured Creditors to Pursue Certain Claims on Behalf of the Estate of Debtor Old Carco LLC, Case No. 09-50002-AG (Bankr. S.D.N.Y. Aug. 13, 2009) [D.I. 5151] (granting creditors’ committee derivative standing, including “exclusive right to prosecute and settle these claims on behalf of CarCo estate”).

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invalidated, the sale process will be a fait accompli because no others bidders will be willing to exceed the credit bid.

87. The Committee’s concerns are real. The Debtors have received meaningful interest from several potential bidders.

Unless the Committee is authorized to pursue the Claims, LHCL’s credit bid will effectively freeze bidding and eliminate the possibility of bids that may provide additional value to the business and the Debtors’ creditors.

NOTICE

88. Notice of this Motion has been provided to (i) counsel to the Debtors;

(ii) counsel to LHCL; (iii) the United States Trustee; and (iv) those parties who have requested service pursuant to Bankruptcy Rule 2002. In light of the nature of the relief requested, the

Committee submits no other or further notice need be provided.

NO PRIOR REQUEST

89. No prior request for the relief requested in this Motion has been made to this Court or any other court.

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WHEREFORE, the Committee respectfully requests the Court enter an order, substantially in the form annexed hereto as Exhibit A (a) granting the Committee leave, standing and authority to commence and prosecute the Claims on behalf of the Debtors’ estates; and

(b) granting such other and further relief as the Court deems appropriate.

Dated: July 9, 2020 Wilmington, Delaware

POTTER ANDERSON & CORROON LLP

/s/ Jeremy W. Ryan Jeremy W. Ryan (DE Bar No. 4057) R. Stephen McNeill (DE Bar No. 5210) 1313 North Market Street, 6th Floor Wilmington, Delaware 19801 Telephone: (302) 984-6000 Facsimile: (302) 658-1192 Email: [email protected] [email protected]

and

KELLEY DRYE & WARREN LLP Eric R. Wilson (admitted pro hac vice) Jason R. Adams (admitted pro hac vice) Maeghan J. McLoughlin (admitted pro hac vice) 101 Park Avenue New York, New York 10178 Telephone: (212) 808-7800 Facsimile: (212) 808-7897 Email: [email protected] [email protected] [email protected]

Counsel to the Official Committee of Unsecured Creditors of John Varvatos Enterprises, Inc., et al.

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EXHIBIT A

IMPAC 6787456v.4 Case 20-11043-MFW Doc 329-1 Filed 07/14/20 Page 2 of 3

IN THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF DELAWARE

Chapter 11 In re: Case No. 20-11043 (MFW) John Varvatos Enterprises, Inc., et al.,1 (Jointly Administered)

Debtors. Re: Docket No. ____

ORDER GRANTING THE COMMITTEE LEAVE, STANDING AND AUTHORITY TO COMMENCE, PROSECUTE AND SETTLE CLAIMS

Upon the motion (the “Motion”)2 of the official committee of unsecured creditors

(the “Committee”) of the above captioned debtors and debtors in possession (collectively, the

“Debtors”), for entry of an order (the “Order”) granting the Committee leave, standing and otherwise providing authority to commence, prosecute and settle the Claims against Lion Hendrix

Cayman Limited; and due and proper notice of the Motion having been given; and it appearing that no other or further notice is required; and it appearing that the Court has jurisdiction to consider the Motion in accordance with 28 U.S.C. §§ 157 and 1334; and it appearing that this is a core proceeding pursuant to 28 U.S.C. § 157(b)(2); and it appearing that the relief requested is in the best interest of the Committee, the Debtors, their estates, and creditors, and after due deliberation, and sufficient cause appearing, it is hereby

ORDERED that all objections, if any, to the Motion or the relief requested therein that have not been withdrawn, waived, or settled including all reservations of rights included therein, which are not otherwise resolved in this Order, are overruled on the merits; and it is further

1 The Debtors in these cases are as follows: John Varvatos Enterprises, Inc.; Lion/Hendrix Corporation; and John Varvatos Apparel Corp. 2 Capitalized terms not otherwise defined herein shall have the meaning ascribed to them in the Motion.

IMPAC 6787456v.4 Case 20-11043-MFW Doc 329-1 Filed 07/14/20 Page 3 of 3

ORDERED that the Committee shall be, and hereby is, granted standing on behalf of the Debtors’ estates to commence and prosecute to conclusion the Claims, with the full rights and privileges of, and in the stead of, the Debtors; and it is further

ORDERED that to the extent necessary, the right to prosecute and settle the Claims is hereby assigned to the Committee and the stipulations and releases provided by the Debtors in the DIP Order shall not limit the Committee’s right to prosecute and settle the Claims; and it is further

ORDERED that the Committee shall have the exclusive right and authority to negotiate and enter into settlements on behalf of the Debtors’ estates with respect to the Claims; and it is further

ORDERED that the Court shall retain jurisdiction with respect to all matters arising from and related to the implementation of this Order.

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EXHIBIT B

Entirety of Document Filed Under Seal