The debtor-in-possession lender in the Diamond Comic Distributors bankruptcy has had enough of the Chapter 11 reorganization bankruptcy proceedings and is requiring Diamond to convert the bankruptcy from Chapter 11 to a Chapter 7 liquidation, according to a motion filed on Friday. The DIP loan agreement expired on November 14 and JPMorgan Chase Bank N.A. declined to continue to fund a Chapter 11 case. The bank has agreed to a brief extension and to fund a limited additional amount to allow an “orderly transition” to Chapter 7. It will be first in line to get any money that comes in for its $6.5 million loan, and if it doesn’t get fully paid, Diamond owner Steve Geppi is personally on the hook.
The biggest change in the process under Chapter 7 vs. Chapter 11 is that the court will now appoint a trustee to liquidate assets and distribute any revenue; the bankruptcy will no longer be managed by Diamond or its consultants under court supervision. The trustee is also expected to move quickly to get money for any remaining assets and distribute it to creditors.
What are those assets? Diamond listed no receivables or inventory in the most recent balance sheet submitted to the court, but showed $11.5 million in current assets. In its filing, Diamond said that its remaining assets consist of “claims and causes of action,” and disputed interest in the consignment inventory, which it is attempting to seize and sell. The list of assets in the new DIP agreement provides a little more detail; it listed rights in holdback or escrow amounts, incentive fee payments or other contingent consideration, and deposits from the bidding procedures.
There are some continuing “incentive payments” from Sparkle Pop coming in related to its purchase of the comic and Diamond Select Toy parts of the businesses, and there may be others; Diamond noted that one such Sparkle Pop payment is due December 17. Diamond reported $1.08 million in revenue from sale of assets in October, so those amounts may still be meaningful.
There may be amounts in some other escrow accounts, and then there’s the $8.5 million of earnest money that Alliance Entertainment paid after it had been declared the winning bidder in the auction for Diamond’s assets. But that deal fell apart when Alliance Entertainment discovered that Alliance Game Distributors did not have an ongoing relationship with Wizards of the Coast, its largest supplier. Alliance Entertainment terminated its offer and sued Diamond, Diamond’s advisors, and Alliance Game Distributors co-CEOs Charlie Tyson and Dan Hirsch, alleging fraud (see “Alliance Sues Diamond”). Diamond is contesting those allegations, so the fate of that deposit is in dispute.
And then there’s the consignment inventory that was being stored by Diamond at the time of the bankruptcy filing in January, probably the biggest asset at stake, which Diamond is attempting to seize and sell for its own benefit. That inventory is currently being stored by Sparkle Pop in the warehouse formerly leased by Diamond in Olive Branch, Mississippi, at substantial cost: the budget for the conversion to Chapter 7 shows $128,286 in storage costs for November.
There’s also a lawsuit filed by Sparkle Pop over the hiring of former Diamond employees by Alliance Entertainment.
Diamond and the bank determined that “…these litigations can be most efficiently pursued in Chapter 7.”
How did we get here? As Diamond put it in its filing, “As the court is aware, these have been challenging cases.” The collapse of the deal with Alliance Entertainment, which would have sold substantially all of the company’s North American assets for $85.4 million, led to reductions in the prices the back-up bidders, Universal Distribution and Ad Populum acquiring company Sparkle Pop, were willing to pay, leading to a lower price for the company’s assets. When money from the sale came in, it mostly went to the bank, which was the only secured lender. Diamond has been unable to pay all of its bills for inventory received during the sale process, which were supposed to have been paid by DIP financing or other sources of cash.
In its October operating statement filed with the court, Diamond listed almost $10 million in post-petition debt, $604,000 in pre-petition priority debt and $38.2 million in prepetition unsecured debt. That’s a lot of money to cover with the assets Diamond lists, with the bank and bankruptcy costs first in line, so there’s going to be substantial blood in the water when this is all over. Ugly.
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