Hearing Date and Time: September 1, 2010 at 8:30 a.m.

(ET)

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HAYNES AND BOONE, LLP 1221 Avenue of the Americas, 26th Floor New York, New York 10020 Telephone: (212) 659-7300 Facsimile: (212) 884-8211 Lenard M. Parkins (NY Bar # 4579124) John D. Penn (NY Bar # 4847208 and admitted pro hac vice) Trevor Hoffmann (NY Bar # 4067229) Mark Elmore (admitted pro hac vice) Attorneys for Midland Loan Services, Inc. UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK In re: INNKEEPERS USA TRUST, et al., Debtors. ) ) ) ) ) ) ) Chapter 11 Case No. 10-13800 (SCC) Jointly Administered

OBJECTION OF MIDLAND LOAN SERVICES, INC. TO DEBTORS MOTION FOR AN ORDER (A) AUTHORIZING THE DEBTORS TO ASSUME THE PLAN SUPPORT AGREEMENT AND (B) GRANTING RELATED RELIEF

HAYNES AND BOONE, LLP 1221 Avenue of the Americas, 26th Floor New York, New York 10020 Telephone: (212) 659-7300 Facsimile: (212) 884-8211 Lenard M. Parkins (NY Bar# 4579124) John D. Penn (NY Bar # 4847208 and admitted pro hac vice) Trevor Hoffmann (NY Bar# 4067229) Mark Elmore (admitted pro hac vice) ATTORNEYS FOR MIDLAND LOAN SERVICES, INC.

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TABLE OF CONTENTS Page PRELIMINARY STATEMENT .................................................................................................... 1 FACTUAL BACKGROUND......................................................................................................... 5 A. B. C. D. E. F. Apollo Purchases 100% Of The Equity In The Debtors..................................................... 5 Midland Is The Debtors Largest Creditor.......................................................................... 6 Apollo Skirts Its Obligations To Midland Under Its PIP Guaranty.................................... 7 The Debtors Scheme With Apollo And Lehman To Create A New Value Plan ........... 8 Scheme For Apollo To Obtain New Equity Culminates In An Integrated Transaction Including The Lock-Up Agreement And Lehman-Apollo Side Agreements................... 11 Debtors Stonewall Higher And Better Offers................................................................... 11

ARGUMENT................................................................................................................................ 13 A. The Debtors Cannot Couch Their Attempt To Gain Approval Of The Lock-Up Agreement Under Section 365.......................................................................................... 13 (1) The Lock-Up Agreement Is Not An Ordinary Course Contract............................... 14 (2) The Lock-Up Agreement Was Not An Enforceable, Executory Contract Capable Of Assumption As Of The Petition Date .................................................... 14 (3) The Lock-Up Agreement Also Cannot Be Assumed Under Section 365 Because It Would Burden Rather Than Benefit The Debtors Estates ................................... 16 B. The Debtors Cannot Satisfy The Section 363 Standard For Approval Of The LockUp Agreement................................................................................................................... 19 (1) Because The Lock-Up Agreement Would Preserve Value For Apollo, The Motion Must Be Scrutinized Under A Heightened Standard ................................... 20 (2) The Lock-Up Agreements Fiduciary Out Is Illusory ........................................... 26 C. The Debtors Entry Into The Lock-Up Agreement Constitutes A Breach Of Fiduciary Duty................................................................................................................................... 28 (1) The Debtors Duty Is To Maximize Value For Their Estates................................... 29 (2) The Debtors Have Breached Their Duty Of Care..................................................... 29

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(3) Because Apollo Is On Both Sides Of The Transaction, The Debtors Cannot Rely On The Business Judgment Rule...................................................................... 30 (4) The Debtors Entry Into The Lock-Up Agreement Is A Breach Of Their Duty Of Loyalty................................................................................................................. 33 D. The Lock-Up Agreement Violates LaSalle....................................................................... 35

CONCLUSION............................................................................................................................. 38

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TABLE OF AUTHORITIES Page(s) CASES In re Adelphia Commcns Corp., 327 B.R. 143 (Bankr. S.D.N.Y. 2005).....................................................................................30 In re Adelphia Commcns Corp., 323 B.R. 345 (Bankr. S.D.N.Y. 2005)...............................................................................31, 32 In re Adelphia Commcns Corp., 336 B.R. 610 (Bankr. S.D. N.Y. 2006)..............................................................................35, 37 In re Atlantic Packaging Products, Inc., 99 B.R. 124 (Bankr. N.D. Ga. 1988) .......................................................................................33 Bank of Am. Natl Trust & Sav. Assn. v. 203 North LaSalle St. Pship, 526 U.S. 434 (1999).......................................................................................................5, 35, 36 Beal Bank, S.S.B. v. Water Edge Ltd. Pship, 248 B.R. 668 (D. Mass. 2000) .................................................................................................21 In re Bellevue Place Assocs., 171 B.R. 615 (Bankr. N.D. Ill. 1994) .....................................................................................19 In re Bidermann Indus. U.S.A., Inc., 203 B.R. 547 (Bankr. S.D.N.Y. 1997).........................................................................21, 24, 33 In re Blixseth, No. 09-60452-7, 2010 Bankr. LEXIS 585 (Bankr. D. Mont. Feb. 23, 2010)..........................20 COR Route 5 Co., LLC v. The Penn Traffic Co. (In re The Penn Traffic Co.), 524 F.3d 373 (2d Cir. 2008).....................................................................................................14 In re Davis, 262 B.R. 791 (Bankr. D. Az. 2001) .........................................................................................36 Davis v. Woolf, 147 F.2d 629 (4th Cir. 1945) ...................................................................................................28 Dorman v. Cohen, 413 N.Y.S.2d 377 (N.Y. A.D. 1st Dept. 1979)........................................................................16 In re Embrace Sys. Corp., 178 B.R. 112 (Bankr. W.D. Mich. 1995).................................................................................29 In re Fort Howard Corp. Shareholders Litig., No. 9991, 1988 Del. Ch. LEXIS 110 (Del. Ch. August 8, 1999) ............................................30
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Gantler v. Stephens, 965 A.2d 695 (Del. 2009) ..................................................................................................29, 30 In re General Bearing Corp., 136 B.R. 361 (Bankr. S.D.N.Y. 1992)...............................................................................24, 25 In re General Growth Props., et al., 09-11977 (Bankr. S.D.N.Y. filed April 16, 2009) ..................................................................35 In re Global Ocean Carriers Ltd., 251 B.R. 31 (Bankr. D. Del. 2000) ....................................................................................20, 36 Gross v. Russo (In re Russo), 762 F.2d 239 (2d Cir. 1985).....................................................................................................21 In re Hampton Hotel Investors, L.P., 270 B.R. 346 (Bankr. S.D.N.Y. 2001).....................................................................................28 In re III Enters., Inc. V, 163 B.R. 453 (Bankr. E.D. Pa. 1994) ................................................................................14, 15 In re Interwest Bus. Equip. Inc., 23 F.3d 311 (10th Cir. 1994) ..................................................................................................35 In re Lifschultz Fast Freight, 132 F.3d 339 (7th Cir. 1997) ...................................................................................................20 In re Lionel Corp., 722 F.2d 1063 (2d Cir. 1983)...................................................................................................25 In re Metaldyne Corp., 409 B.R. 661 (Bankr. S.D.N.Y. 2009).....................................................................................33 In re New Hampshire Elec. Coop., Inc., 131 B.R. 249 (Bankr. D.N.H. 1991) ........................................................................................19 In re NII Holdings, Inc., 288 B.R. 356 (Bankr. D. Del. 2002). .......................................................................................15 Northview Motors., Inc. v. Chrysler Motors Corp. (In re Northview, Inc.), 186 F.3d 346 (3d Cir. 1999).....................................................................................................19 Official Comm. of Subordinated Bondholders v. Integrated Res., Inc. (In re Integrated Res., Inc.), 147 B.R. 650 (S.D.N.Y. 1992)...........................................................................................31, 33 Official Comm. of Unsecured Creditors v. Aust (In re Network Access Solutions, Corp.), 330 B.R. 67 (Bankr. D. Del. 2005) ..........................................................................................30

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Official Comm. of Unsecured Creditors v. Bay Harbour Master Ltd. (In re BH S&B Holdings LLC), 420 B.R. 112 (Bankr. S.D.N.Y. 2009).....................................................................................29 In re Orion Picture Corp., 4 F.3d 1095 (2d Cir. 1993).......................................................................................................16 Pepper v. Litton, 308 U.S. 295 (1939)...........................................................................................................13, 17 In re Primedia Inc. Derivative Litig., 910 A.2d 248 (Del. Ch. 2006)............................................................................................29, 31 In re Pub. Serv. Co. of New Hampshire, 90 B.R. 575 (Bankr. D.N.H. 1988) ....................................................................................19, 22 Riccardi v. Modern Silver Linen Supply Co., 356 N.Y.S.2d 872 (N.Y.A.D. 1st Dept. 1974).........................................................................16 In re Situation Mgmt. Sys., Inc., 252 B.R. 859 (Bankr. D. Mass. 2000) .....................................................................................36 Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) overruled on other grounds by Gantler v. Stephens, 965 A.2d 695 (Del. 2009) ...............................................................................................................30 In re Star Broadcasting, Inc., 81 B.R. 835 (Bankr. D.N.J. 1988) ...........................................................................................35 In re Stations Holding Corp., Case No. 02-10882, 2002 Bankr. LEXIS 1617 (MFW) (Bankr. D. Del. 2002) ......................15 In re Summit Metals, Inc., No. 98-2870, 2004 U.S. Dist. LEXIS 15819 (D. Del. August 6, 2004) ..................................31 Tese-Milner v. TPAC, LLC (In re Ticketplanet.com), 313 B.R. 46 (Bankr. S.D.N.Y. 2004).......................................................................................29 In re Tri-Star Pictures, Inc. Litig., 634 A.2d 319 (Del. 1993) overruled on other grounds by Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031 (Del. 2004)...............................................................29 In re U.S. Wireless Data, Inc., 547 F.3d 484 (2d. Cir. 2008)....................................................................................................16 UIS, Inc. v. Walbro Corp., No. 9323, 1987 Del. Ch. LEXIS 490 (Del. Ch. 1987).............................................................30

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Union Savings Bank v. Augie/Restivo Baking Co. (In re Augie/Restivo Baking Co.), 860 F.2d 515 (2d Cir. 1988).....................................................................................................23 Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) ........................................................................................................31 In re Wingspread Corp., 92 B.R. 87 (Bankr. S.D.N.Y. 1988).........................................................................................20 Wolf v. Weinstein, 372 U.S. 633 (1963).................................................................................................................28 STATUTES 11 U.S.C. 363..............................................................................................................6, 15, 19, 22 11 U.S.C. 363(b) ...................................................................................................................19, 25 11 U.S.C. 365...................................................................................................................... passim 11 U.S.C. 506(a)(1).....................................................................................................................34 11 U.S.C. 1125(b) .......................................................................................................................15 11 U.S.C. 1125(g) .......................................................................................................................15 11 U.S.C. 1129(b)(2)(B)(ii) ........................................................................................................34 11 U.S.C. 1126(e) .......................................................................................................................15 OTHER AUTHORITIES Bruce A. Markell, Owners, Auctions, and Absolute Priority in Bankruptcy Reorganizations, 44 Stan. L. Rev. 69, *117-120 (1991) .........................................................36

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Midland Loan Services, Inc. (Midland), special servicer pursuant to that certain Pooling and Servicing Agreement dated as of August 13, 2007 (the Special Servicing Agreement) for the Fixed Rate Trustee (as defined below),1 files this objection (the Objection)2 to the Debtors Motion For An Order (A) Authorizing The Debtors To Assume The Plan Support Agreement And (B) Granting Related Relief (the Motion) (Docket No. 15) and respectfully represents as follows: PRELIMINARY STATEMENT 1. On the first day of these cases, the Debtors filed their Motion for authority to

assume a so-called plan support agreement (the Lock-Up Agreement). The Lock-Up Agreement is part of an integrated transaction that requires the Debtors to seek to confirm a new value plan granting 100% of the reorganized Debtors equity to Lehman (defined below) in exchange for its $220 million claim. As part of this integrated transaction, Lehman has contracted to sell 50% of that equity to Apollo (defined below) the Debtors current 100% equity owner. The Lock-Up Agreement and the Lehman-Apollo deal is opposed by substantially all of the Debtors constituents, including creditors holding approximately $1.06 billion in claims against the Debtors estates. 2. The Debtors seek to downplay the importance of the Motion by mischaracterizing

it as a motion to assume an arms-length executory contract under section 365(a), as if the Lock-

Midland is acting pursuant to the Special Servicing Agreement services and administers that certain secured loan in the amount of not less than $825,402,542 plus interest, costs and fees (as amended, the Fixed Rate Mortgage Loan) owed by certain of the above referenced Debtors. Contemporaneously herewith, the Appendix of Evidence in Support of the Objection of Midland Loan Services, Inc. to Debtors Motion for an Order (A) Authorizing the Debtors to Assume the Plan Support Agreement and (B) Granting Related Relief (the Appendix), the Declaration of Lenard M. Parkins (the Parkins Declaration) and the Declaration of Ronald F. Greenspan, Senior Managing Director with FTI Consulting, financial advisor for Midland (the Greenspan Declaration), have been filed in support of this Objection.
2

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Up Agreement were an ordinary pre-petition executory contract. The reality is much different. The Lock-Up Agreement was not a contract capable of being assumed as of the Petition Date. 3. More importantly, the Lock-Up Agreement contemplates a classic insider

transaction and therefore is subject to heightened scrutiny by the Court to ensure its entire fairness. The Debtors cannot meet this standard, however, since they cannot demonstrate either fairness of process or fairness of price. Both prior to and since the Petition Date, the Debtors have refused to market the company and its assets to anyone other than Lehman and Apollo. In fact, to this day they are refusing to engage in a fulsome, transparent marketing process or to subject the proposed Lehman-Apollo transaction to competitive higher and better offers. 4. Contrary to the Debtors and Apollos representations, Apollo is not just a

bystander to the Lock-Up Agreement or to the Lehman-Apollo plan it contemplates. The evidence uncovered by Midland during discovery proves that Lehman and Apollo began negotiating the Lock-Up Agreement as well as the terms of the proposed Lehman-Apollo plan months before the Petition Date. Apollo has been an active player in the negotiations since at least April 2010, and the intent has always been for Apollo to remain a large equity owner after bankruptcy. The evidence also shows that the Debtors and their CRO, Marc Beilinson (Beilinson) who was appointed to Innkeepers Apollo-controlled board in 2007, and then hired as CRO by the same board in 20083 have consistently acted in Apollos interests (not the Debtors) interests during these negotiations. For example: Lehman acknowledged that, from as early as April 22, 2010, the Debtors, Apollo and Lehman intended Apollo to be the party that would acquire the new equity. See

The Innkeepers USA Trusts board of trustees is controlled by Apollo. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), APP-00318 (five of the nine trustees are affiliated with Apollo). Beilinson, who serves as both the Debtors CRO and is one of the four so-called independent trustees for Innkeepers USA Trust, also serves on the board of directors for Apollo Commercial Real Estate Finance, Inc. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), APP-00334. Independent in this context only appears to mean they are not direct employees of Apollo.

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Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00424; see also Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00433 (answering that Lehman was only intending to sell the equity to Apollo); Lehman has filed pleadings in its own bankruptcy cases stating that the Lock-Up Agreement is part of an integrated deal, and Apollo has been central to the negotiations since the beginning. See Appendix, Exhibit 2, at APP-00081-83 (As set forth above, before confirmation by the Innkeepers Bankruptcy Court of Innkeepers plan of reorganization pursuant to the terms of the Plan Term Sheet, ALI and Apollo will enter into a stock purchase agreement (the AIC SPA) whereby ALI will agree to sell Apollo, and Apollo, subject to the terms therein, will agree to purchase from ALI the right to receive 50% of the New Equity that ALI receives in connection with the consummation of the plan. . . .); While the Debtors set up a data room for Lehman to conduct due diligence (a fact known to Midland because the Debtors have sought reimbursement for the cost of it), the Debtors have refused to provide Five Mile Capital Partners LLC (Five Mile) access to it in order to perform its own due diligence, even subject to a confidentiality agreement. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00347;4 The Debtors instructed Moelis & Company (Moelis) not to shop alternative transactions with parties outside the Debtors capital structure; See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00332; The Debtors continuously injected themselves into the negotiations between Apollo and Lehman with respect to Apollos purchase of the Lehman equity. See Appendix, Exhibit 18, at APP-00650 (July 17, 2010 e-mail exchange between Mr. Lascher, Lehmans business representative, and Beilinson, discussing consent rights between Apollo and Lehman); The Debtors are determined to use the exclusivity period as a sword to protect the Lehman-Apollo deal. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00347 (Im in my exclusive period where I intend to fulfill my obligations under the [LockUp Agreement] to file an internal plan of reorganization for the enterprise and will allow Midland and others to object to confirmation and to vote to accept or reject the plan.);

4 Q: Have you allowed any third parties to have access to due diligence information in order to make such a proposal since the beginning of the bankruptcy case? A: No. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00329. Q: Others have asked though, havent they? A: Yes but they havent presented proposals which I thought had viability or import. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00329 Q: Did you shop the deal to any outside investors to come in and do a third party restructuring of the company not within the confines of the creditor constituencies? A: No, I did not. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00331. Q: Did you shop it since the filing of the bankruptcy case? A: No, I have not. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00331.

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Beilinson, a fiduciary for the Debtors estates, does not believe it is a requirement to shop the Lehman-Apollo deal for higher and better offers. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00347 (Q: So at the present time you reject the concept of shopping this company to get a different alternative transaction? A: I dont think thats a requirement under the Bankruptcy Code or even during my exclusive period of time and I dont think thats in the best interest of thisbankruptcy estate.); On July 14, 2010 (five days before the petition date), Lehmans counsel wrote to Apollo with its understanding of the terms on which Lehman would resolve the open issues with Apollo. The terms included that Apollo will not be a signatory to the Lock-Up Agreement, and that Lehman will not consent to a third party purchaser. Lehman agreed that it would only sell the stock to Apollo. See Appendix, Exhibit 15 at APP-00637; and As late as July 18, 2010 (i.e., one day before the Petition Date), Beilinson sought Lehmans agreement that it would not terminate Apollo as the purchaser of the reorganized equity as proposed in the Lock-Up Agreement. See Appendix, Exhibit 16, at APP-00639 (In an e-mail exchange between Beilinson and Lascher, Beilinson wrote, I wont be amending our deal without your consent. Im trusting that you wont terminate [Apollo] in first 45 days . . . please do the same with me on this issue for this short period of time.). As the above evidence demonstrates, Apollo is, was, and always has been a

5.

central player in negotiating the Lock-Up Agreement and the insider deal it contemplates. In addition, the evidence shows that the Debtors and Beilinson have not acted and cannot act as fiduciaries for all parties in these cases. 6. The Court should deny the Motion and open up the plan process to competing

offers. As discussed herein, Five Mile (one of the proposed DIP lenders in these cases) has approached Midland with a commitment to fund $236 million of new money as a basis for a proposed plan of reorganization that could increase the Debtors enterprise value by $50 to $125 million over the enterprise value implicit in the Lehman-Apollo plan, while providing the other creditor constituencies a higher recovery more reflective of the intrinsic value of their collateral. The Five Mile proposal would also give the Debtors secured creditors the freedom to take their collateral if they do not wish to go along with the proposal. Finally, unlike the Lehman-Apollo

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plan, the Five Mile commitment is subject to higher and better offers, and contemplates the commencement of a fair marketing process approved by the Court through competing plans of reorganization or otherwise for the Debtors and their assets. 7. In sum, there is no reason for the Court to grant the Motion, and to allow the

Debtors to lock themselves up at this early stage of these cases. The Debtors are attempting to get the Court to bless an insider transaction that should have never seen the light of day. It was negotiated by and for the benefit of Apollo the Debtors sole equity holder and Lehman, and is opposed by substantially all other constituents in this case. The Lock-Up Agreement is a coercive attempt to circumvent the absolute priority rule and to give 50% of the reorganized Debtors equity to Apollo in violation of LaSalle.5 Alternatives exist, such as the Five Mile proposal. The Debtors Motion should be denied. FACTUAL BACKGROUND A. Apollo Purchases 100% Of The Equity In The Debtors 8. In June 2007, Apollo Investment Corporation acquired Innkeepers USA Trust (the

Apollo Acquisition) through the consummation of an Agreement and Plan of Merger, dated as of April 15, 2007 by and among Grand Prix Holdings LLC, Grand Prix Acquisition Trust, Innkeepers USA Trust, Innkeepers USA Limited Partnership and Innkeepers Financial Corporation. Under the Apollo Acquisition, Innkeepers USA Trusts previously publicly traded common shares of stock were acquired and then subsequently cancelled. Since that time, Innkeepers USA Trust has been privately held by Apollo. Upon information and belief, Apollo owns all of the membership interests of Debtor Grand Prix Holdings LLC, the direct or indirect parent of all the other Debtors. See Amended Declaration of Dennis Craven, Chief Financial

Bank of Am. Natl Trust & Sav. Assn. v. 203 North LaSalle St. Pship, 526 U.S. 434 (1999).

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Officer of Innkeepers USA Trust, in Support of First Day Pleadings dated July 19, 2010 (the Amended Craven Declaration) (Docket No. 33) at 8. B. Midland Is The Debtors Largest Creditor 9. Midland services and administers that certain secured loan in the amount of not

less than $825,402,542 plus interest, costs and fees (the Fixed Rate Mortgage Loan) owed by certain of the above referenced Debtors (the Midland Debtors). 10. The Fixed Rate Mortgage Loan was made pursuant to that certain loan agreement

dated as of June 29, 2007 (as amended, the Fixed Rate Mortgage Loan Agreement), and is evidenced by (i) a certain Replacement Note A-1 and (ii) a certain Replacement Note A-2, each dated as of August 9, 2007, and each in the original principal amount of $412,701,271. Replacement Note A-1 was assigned to LaSalle Bank National Association as trustee for the holders of the LB-UBS Commercial Mortgage Trust 2007-C6. Bank of America, N.A. is the successor-in-interest to LaSalle Bank National Association (the Fixed Rate Trustee). Replacement Note A-1 is currently held by the Fixed Rate Trustee. Replacement Note A-2 was assigned to and is currently held by the trustee for the holders of the LB-UBS Commercial Mortgage Trust 2007-C7. The Midland Debtors defaulted under the Fixed Rate Mortgage Loan Agreement on April 9, 2010. 11. The Fixed Rate Mortgage Loan is secured by cross-collateralized and cross-

defaulted first priority mortgages, liens and security interests on forty-five (45) hotel properties and their contents and assets related thereto (collectively, the Midland Properties) and the other collateral, including all cash collateral as such term has meaning under section 363 of the Bankruptcy Code, generated by the Midland Debtors hotel and business operations with respect to the Midland Properties, as set forth in the Fixed Rate Mortgage Loan Agreement.

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12. Midland is by far the largest secured creditor of the Debtors. Midlands claim

comprises $825 million of the approximate $1.25 billion of the Debtors total property-secured debt. Midlands debt is larger than all other debt (whether on a stand-alone or combined basis) existing in the Debtors other collateral pools. By comparison, Lehman ALI Inc. (Lehman) is the lender under that certain floating rate loan agreement (the Floating Rate Loan) with a $220 million claim. The Floating Rate Loan is secured by only twenty (20) hotel properties and is not cross-collateralized with the Midland Properties. See Appendix, Exhibit 4, at APP-00185.6 C. Apollo Skirts Its Obligations To Midland Under Its PIP Guaranty 13. In connection with their entry into the Fixed Rate Mortgage Loan Agreement, the

Debtors were obligated to make certain capital improvements (the Required Capital Improvements) to the hotel properties. Apollo executed that certain Required Capital Improvements Guaranty dated June 29, 2007 (the Apollo Guaranty) in favor of the lender under the Fixed Rate Mortgage Loan Agreement with respect to the Required Capital Improvements. Under the Apollo Guaranty, Apollo was obligated to pay for or cause performance of the necessary PIP work on the Midland Debtors hotels. 14. Beginning in or about March 2010, the Debtors and Apollo received numerous

notices of default arising from the Debtors failure to comply with specified property improvement plans or programs (the PIPs). Specifically, Marriott notified the Debtors that it would terminate sixteen (16) franchise agreements for hotels in the Midland collateral pool for failure to complete the PIPs. 15. To put the potential impact of the threatened Marriott terminations in perspective,

Midlands collateral pool contains forty-five (45) hotels, of which thirty-three (33) carry the
While the chart prepared by the Debtors indicates a $238 million debt to Lehman, Lascher testified that Lehmans debt is $220 million. See Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00445.
6

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Marriott flag. Apollo has taken no action to pay for or complete the Required Capital Improvements or even to initiate steps to commence such work.7 D. The Debtors Scheme With Apollo And Lehman To Create A New Value Plan 16. In mid-April, 2010, representatives from the Debtors, Lehman and Apollo first

met at Lehmans office to discuss a possible restructuring transaction that eventually culminated in the Lock-Up Agreement. See Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00423. The Debtors, Lehman and Apollo then met again at the offices of Kirkland & Ellis, LLP on April 22, 2010 to discuss a more concrete framework for the transaction. See Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00424. This time, the Debtors through their investment banker, Moelis, distributed a presentation titled, Project Tavern dated April 22, 2010 (the April 22 Moelis Presentation). See Appendix, Exhibit 9, at APP-00553. The April 22 Moelis Presentation contained an illustrative pro forma structure contemplating the ownership of the reorganized company by Lehman/Investor. See Appendix, Exhibit 9, at APP-00565. Although the name of the investor was not disclosed in the presentation materials, all parties at the meeting knew that the investor was in fact Apollo.8 17. Six days later, on April 28, 2010, the Debtors and their advisors met with advisors

from Midland at Midlands offices in Overland Park, Kansas. During this meeting, the Debtors distributed a presentation prepared by Moelis to Midland dated April 28, 2010 (the April 28 Moelis Presentation). See Appendix, Exhibit 10, at APP-00569. Unlike the April 22 Moelis
Midland has filed suit in the Supreme Court of the State of New York, County of New York, styled Midland Loan Services, Inc. v. Apollo Investment Corporation, for specific performance of Apollos obligations as guarantor under the Fixed Rate Mortgage Loan Agreement. In connection with the Lock-Up Agreement and as part of the overall integrated Lehman-Apollo transaction, Apollo has negotiated with Lehman to eliminate its exposure under the Apollo Guaranty. 8 Q: As we look at page 13 here A. Uh-huh. Q: it says Parent Equity, Lehman/Investor, Apollo was intended to be the investor; isnt that correct, in your understanding? A: Yes. Q: Did you ever go to a meeting with Innkeepers regarding this structure A: Uh-huh. Q: where someone other than Apollo was intended to be the investor? A: No. See Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00424.
7

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Presentation to Lehman and Apollo, the April 28 Moelis Presentation to Midland did not discuss the proposed transaction with Apollo as the investor in the reorganized entity. In fact, the April 28 Moelis Presentation omitted the three pages from the April 22 Moelis Presentation that provided the detail of the Illustrative Pro Forma Structure and the Illustrative Deal Structure Scenario. Compare Appendix, Exhibit 9, at APP-00565-67 with Appendix, Exhibit 10, at APP00569-83. Beilinson attended the meeting for the Debtors. Beilinson withheld from Midland that he had conducted a meeting with Lehman and Apollo on April 22nd and at that meeting also failed to disclose that he had provided a plan proposal to Lehman and Apollo that would (i) eliminate at least $275 million of Midlands claims and (ii) provide Apollo with equity in reorganized Innkeepers without paying any money to the estates all without a market test. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00345. 18. After the April 22, 2010 meeting, the Debtors, Lehman and Apollo continued to

meet and discuss the details of the transaction. During one such meeting on or about May 20, 2010, Beilinson continued to advocate the proposed transaction with Apollo, but also highlighted the risks to Lehman associated with proceeding with the transaction. As confirmed by Lehman, Beilinson discussed the following risks associated with the proposed transaction: (a) Lehman and Apollo would need to agree to a post-reorganization capitalization of the reorganized debtors; (b) an impaired accepting class would be needed to confirm a plan of reorganization over Midlands objection; (c) the proposed transaction was subject to attack as a sub rosa new value plan; and (d) the need to fund and complete the Marriott property improvement projects (PIPs) would need to be addressed. See Appendix, Exhibit 11, at APP-00589; Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP00415.

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19. Thereafter, during their three-way negotiations, the Debtors, Apollo and Lehman

created and circulated a number of term sheet iterations outlining the structure and substance of the proposed transaction. Apollo was always to be a substantial equity owner no matter what form the documents would take. On or around May 25, 2010, a term sheet titled Illustrative Terms of Proposed Restructuring dated May 25, 2010 was circulated (the May 25 Term Sheet). See Appendix, Exhibit 21, at APP-00665. The May 25 Term Sheet provided that Apollo would provide a backstop to purchase 62.18% of the equity of the in the reorganized debtors. See Appendix, Exhibit 21, at APP-00666. On June 17, 2010, the parties circulated a term sheet entitled Term Sheet Alternative A Illustrative Terms of Proposed Restructuring dated June 17, 2010. See Appendix, Exhibit 20, at APP-00653. In this term sheet, the proposed transaction had morphed to Apollo purchasing approximately 50% of the reorganized equity from Lehman, but now included Apollo as a signatory to the Lock-Up Agreement. See Appendix, Exhibit 20, at APP-00658. 20. On June 29, 2010, the Debtors, Lehman and Apollo circulated a term sheet dated

June 29, 2010 that removed Apollo as a signatory to the Lock-Up Agreement, but continued to include as a condition that Lehman reach an agreement with Apollo. See Appendix, Exhibit 21, at APP-00669. Again, in a July 6, 2010 term sheet, the condition that Apollo execute the LockUp Agreement reappeared in the term sheets this time in a version prepared by Apollos attorneys, Paul, Weiss, Rifkind, Wharton & Garrison LLP. See Appendix, Exhibit 13, at APP00620. As late as five days prior to the Petition Date, Lehman and Apollo were still considering whether to include Apollo as a signatory to the Lock-Up Agreement, but the ultimate end game did not change Apollo would eventually acquire 50% of the equity in the reorganized Debtors. See Appendix, Exhibit 15, at APP-00637. The negotiations culminated in the

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execution of the Lock-Up Agreement, which in Lehmans view was part of an overall integrated transaction that included the sale of 50% of the equity in the reorganized Debtors to Apollo. See Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00081-83. E. Scheme For Apollo To Obtain New Equity Culminates In An Integrated Transaction Including The Lock-Up Agreement And Lehman-Apollo Side Agreements 21. On July 19, 2010 (the Petition Date), the Debtors filed voluntary petitions for

relief under Chapter 11 of the Bankruptcy Code and initiated the above-captioned chapter 11 cases. 22. On the Petition Date, the Debtors filed the Motion. Through the Motion, the

Debtors seek court approval of the assumption of the Lock-Up Agreement that locks the Debtors into the pursuit of a plan of reorganization whereby Lehman will receive 100% of the equity in reorganized Innkeepers in satisfaction of Lehmans $220 million secured claim. The Lock-Up Agreement further provides that on account of Midlands $825 million secured claim, Midland will receive a cramdown note of up to $550 million resulting in a haircut of at least $275 million. What the Lock-Up Agreement does not provide on its face, but what has come to light through review of the various drafts of the Lock-Up Agreement and all the other relevant evidence is that the Debtors, Lehman and Apollo always agreed that 50% of the equity in reorganized Innkeepers would always rest with Apollo. See Appendix, Exhibit 8, at APP-00527. F. Debtors Stonewall Higher And Better Offers 23. Purporting to act as a fiduciary for all of the Debtors bankruptcy estates, the

Debtors have openly rejected the concept of shopping the company, with Beilinson stating that shopping the company is not . . . a requirement under the Bankruptcy Code or even during my exclusive period of time. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00347. Beilinson has gone as far as to say that shopping the Debtors is not in the best interest of this

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bankruptcy estate. Midlands insistence that the Lock-Up Agreement be tested against the market has been consistently rebuffed by the Debtors. 24. Notwithstanding the Debtors determination to go forward with the Lock-Up

Agreement and refusal to test the terms of the Lock-Up Agreement against the market, financially viable entities remain interested in the Debtors assets. On August 20, 2010, Five Mile, through an affiliate, conveyed a Binding Commitment for the Acquisition of Innkeepers USA Trust (the Five Mile Commitment) to Midland. See Appendix, Exhibit 17, at APP00640. Although the Five Mile Commitment is still under internal review at Midland, the plain terms of the Five Mile Commitment are far superior for all constituencies other than Lehman and Apollo as compared to the Lock-Up Agreement. (a) The Five Mile Commitment provides for a new capital structure of $803.4 million in aggregate indebtedness and $236.6 in new equity capital (cash) to be invested by Five Mile. See Appendix, Exhibit 17, at APP-00641. (b) The Five Mile Commitment provides for approximately $67.24 million in additional recovery value for the non-Lehman Pre-Petition creditors or 9% more and $184.1 million in cash pay downs of indebtedness, including retirement of $67.75 of DIP financing and the purchase of the B-Notes for $16.4 million. See Appendix, Exhibit 17, at APP-00646. (c) The Five Mile Commitment contains proposed treatment of the Lehman Floating Rate Mortgage Loan that better reflects the value of the collateral supporting the Lehman obligation. See Appendix, Exhibit 17, at APP00646. (d) The Five Mile Commitment will benefit the Debtors through an increase in enterprise value of the Debtors by at least $50-$125 million over the valuation contemplated in the Lock-Up Agreement. See Appendix, Exhibit 17, at APP-00646. (e) The Five Mile Commitment provides for committed exit financing necessary for the success and emergence of Innkeepers from bankruptcy. See Appendix, Exhibit 17, at APP-00643.

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(f) The Five Mile Commitment includes reasonable bid protections for Five Mile because it provides for an open marketing process to seek higher and better bids.9

(g) Finally, no secured creditor is locked into the proposed recovery. The Five Mile Commitment contemplates that a non-consenting secured creditor retains the right to take ownership of its collateral in full satisfaction, settlement, release and exchange for its claim. See Appendix, Exhibit 17, at APP-00645. 25. Unlike the Lehman-Apollo deal, no secured creditor will be forced to take a

cramdown secured note unsatisfactory to that secured creditor and without recovery on the balance of its deficiency clams. Rather, the flexibility provided by the Five Mile Commitment allows parties unhappy with their treatment to simply take their collateral in full satisfaction of their claims. ARGUMENT A. The Debtors Cannot Couch Their Attempt To Gain Approval Of The Lock-Up Agreement Under Section 365 26. The Debtors attempt to portray the Lock-Up Motion as a simple motion to

assume an executory contract is disingenuous. Section 365(a) provides in relevant part that the trustee, subject to the courts approval, may assume or reject any executory contract or unexpired lease of the debtor. Section 365 assumption motions are intended to permit debtors to continue to operate their businesses pursuant to agreements in place pre-petition and to maintain the status quo. While the Debtors tout the phrase business judgment as a mantra of legitimacy for this transaction, Pepper v. Litton10 requires the Court to apply the heightened rigorous scrutiny standard. This agreement, signed the day before these cases were filed and couched as an executory contract, has a pervasive effect that could be destructive to the Chapter 11 process.

The refusal to provide for a market test to seek higher and better bids has been a fundamental objection by Midland from the onset. 10 Pepper v. Litton, 308 U.S. 295 (1939).

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The Court should cut through the Debtors words there is no legitimacy to this transaction and it should be denied. (1) 27. The Lock-Up Agreement Is Not An Ordinary Course Contract The Lock-Up Agreement was not an existing, ordinary course executory contract

as of the Petition Date. It is the culmination of months of intense negotiations for an integrated transaction among the Debtors, Apollo and Lehman for ownership and a new value plan of reorganization. Lehman, one of the beneficiaries of the proposal represents approximately $220 million out of the $1.254 billion in total pre-petition property-secured claims in these cases. Approval of the Lock-Up Agreement would improperly drive the direction of these cases for eight months, legitimizing the Debtors conduct and binding the Debtors with judicial safeharbor to propose the Lehman-Apollo plan. If approved, the transaction would allow the Debtors to make an end run around LaSalle in abdication of their fiduciary duties. The Court should reject this effort. (2) 28. The Lock-Up Agreement Was Not An Enforceable, Executory Contract Capable Of Assumption As Of The Petition Date Bankruptcy Code section 365 requires, among other things, the existence of an

enforceable executory contract as of the Petition Date. See COR Route 5 Co., LLC v. The Penn Traffic Co. (In re The Penn Traffic Co.), 524 F.3d 373, 381 (2d Cir. 2008) (noting that whether a contract is executory is determined as of the petition date); In re III Enters., Inc. V, 163 B.R. 453, 459 (Bankr. E.D. Pa. 1994) (It is elementary to observe that, before the debtor can assume or reject a contract, or for that matter, before [a party] can seek to enforce a contract, there must be a contract to assume, reject or enforce.). 29. While the Lock-Up Agreement was executed pre-petition, it never became

operative and binding pre-petition for at least two reasons. First, it contained a condition

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precedent that had not been satisfied as of the Petition Date. Specifically, the Lock-Up Agreement provides that this Agreement shall not become binding on Lehman unless and until . . . (b) the bankruptcy court presiding over the Lehman Bankruptcy Cases enters an order approving this Agreement . . . See Appendix, Exhibit 1, at APP-00012. It is uncontroverted that Lehman was not bound to the Lock-Up Agreement as of the Petition Date because Lehmans obligations under the Lock-Up Agreement remained subject to approval by its bankruptcy court. Lehman ALI was required to receive Bankruptcy Court approval before entering into the transaction.11 As a result, Lehman was not bound and could not be bound to perform under the Lock-Up Agreement until it obtained Bankruptcy Court approval in its bankruptcy case.12 Lehman filed its motion for Bankruptcy Court approval on July 27, 2010. The Motion was only granted on August 18, 2010 (Lehman Docket No. 10877). Therefore, as a matter of law, there was no executory contract capable of assumption by this Bankruptcy Court as of the Petition Date. In re III Enters., 163 B.R. at 459. The Debtors attempt to have this Court bless the Lock-Up Agreement under section 365 fails. 30. Second, as a matter of law, there was no enforceable contract in existence as of

the Petition Date, since the Lock-Up Agreement was not binding on Lehman as of that date. It is black letter law that if one partys promise does not actually bind him or her to some
11 Motion of Lehman Commercial Paper Inc. Pursuant to Section 363 of the Bankruptcy Code For Authority to (I) Consent to its Non-Debtor Affiliate Lehman ALI Inc. (A) Entry Into Plan Support Agreement Related to the Restructuring of Innkeepers USA Trust; and (B) Consummation of the Transaction Set Forth in the Plan Term Sheet; and (II) Provide Funds to Solar Finance Inc., a Non-Debtor Affiliate, to Provide Debtor-In-Possession Financing. (Lehman Docket No. 10465) (the Lehman Motion); Order Pursuant to 363 of the Bankruptcy Code and Bankruptcy Rule 6004 Authorizing the Transfer of Loans From Variable Funding Trust 2007-1 to Non-Debtor Affiliates (Lehman Docket No. 9025). 12 In light of the fact that the Lock-Up Agreement was not operative as of the Petition Date, the Lock-Up Agreement does not fall within the safe harbor of Bankruptcy Code section 1125(g). Rather, because it seeks to lock up Lehmans vote post-petition, it constitutes an impermissible post-petition lock-up agreement in violation of Bankruptcy Code section 1125(b). See 11 U.S.C. 1125(b), (g). Midland reserves its rights to move under Bankruptcy Code section 1126(e) for designation of any vote by Lehman in favor of the plan contemplated by the Lock-Up Agreement. See, e.g., In re Stations Holding Corp., Case No. 02-10882, 2002 Bankr. LEXIS 1617 (MFW) (Bankr. D. Del. 2002); In re NII Holdings, Inc., 288 B.R. 356 (Bankr. D. Del. 2002).

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performance or forbearance, it is an illusory promise, and there is no enforceable contract. Thus, unless both parties to a contract are bound to perform, neither party is bound. Riccardi v. Modern Silver Linen Supply Co., 356 N.Y.S.2d 872, 875 (N.Y.A.D. 1st Dept. 1974) ( . . . as in any bilateral agreement both parties must be bound or neither is bound.) (emphasis added); Dorman v. Cohen, 413 N.Y.S.2d 377, 380 (N.Y. A.D. 1st Dept. 1979) (While mutuality of obligation does not mean equality of obligation, it does mean that each party must be bound to some extent.). (3) 31. The Lock-Up Agreement Also Cannot Be Assumed Under Section 365 Because It Would Burden Rather Than Benefit The Debtors Estates Even if the section 365 standard did apply (which it does not), the Debtors could

not satisfy it. The general standard under section 365 requires the Bankruptcy Court to place itself in the position of the trustee or debtor-in-possession and determine whether, based on a review of the totality of the circumstances, assuming the contract would be a good business decision or a bad one. See In re U.S. Wireless Data, Inc., 547 F.3d 484, 488 (2d. Cir. 2008), citing In re Orion Picture Corp., 4 F.3d 1095, 1099 (2d Cir. 1993) ([A] bankruptcy court reviewing a trustees or debtor-in-possessions decision to assume or reject an executory contract [pursuant to 365] should examine a contract and the surrounding circumstances and apply its best business judgment to determine if it would be beneficial or burdensome to the estate to assume it.). 32. The Debtors argue in the Motion that the Lock-Up Agreement is an arms-length

agreement negotiated in good faith, and should therefore be reviewed under a typical reasonable business judgment standard. This is disingenuous. While the Debtors have consistently attempted to downplay Apollos role in this transaction, the reality of the situation is that Apollo

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is and always has been central to it.13 Because the Motion relates to an insider transaction, it must be scrutinized under a heightened standard. See Pepper v. Litton, 308 U.S. 295 at 306 (holding that the dealings of insiders with a corporation in the bankruptcy context are subjected to rigorous scrutiny). Here, the Lock-Up Agreement and the transactions it contemplates have been entered into for the benefit of Lehman and Apollo, which will each end up owning 50% of the reorganized Debtors equity. 33. Looking at the totality of circumstances, and in light of Apollos role in the

transaction, it would not be beneficial to the Debtors estates (and, specifically, any constituencies other than Lehman and Apollo) to permit the Debtors to lock themselves up to the Lehman-Apollo deal at this early stage of these cases. The Debtors need to fully-shop the Debtors and their assets, ensure compliance with LaSalle, and require that any transaction be subject to higher and better offers. The Lock-Up Agreement would prevent this from happening.

As discussed above, the Debtors and Apollo have consistently tried to circumvent LaSalle and bury Apollo from sight within the Lock-Up Agreement and the mandated scrutiny of the Court when considering insider deals. The Debtors began this case with impaired credibility on the issue as a result of their failure to disclose Apollos role in their initial first day filings. Compare Declaration of Dennis Craven, Chief Financial Officer of Innkeepers USA Trust, in Support of First-Day Pleadings dated July 19, 2010 (the Craven Declaration) (Docket No. 2) at 13 with Amended Craven Declaration at 13. Even in the Amended Craven Declaration, the Debtors downplayed Apollos real role, stating only that [i]t is the Debtors understanding that, subject to certain terms and conditions, AIC may become the purchaser. Amended Craven Declaration 13. The statement was a vast understatement by Mr. Craven. Beilinson knew there was a signed Apollo agreement with Lehman prior to the first day hearing, and that Lehman, Apollo and the Debtors (through Beilinson) had been in exclusive negotiations for a deal since April 2010 in order to make this transaction happen. See Appendix, Exhibit 3, at APP-00162 (letter agreement between Apollo and Lehman executed on the Petition Date); see Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00323 (acknowledging involvement in discussions with Lehman regarding its desire to sell post-confirmation equity to Apollo); see Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00424 (affirming that Lehman understood the Parent Equity Lehman/Investor to be Apollo at the April 22, 2010 meeting with the Debtors). There was no mistake and there was no uncertainty at filing. Indeed, as evidenced by Lehmans filings with Bankruptcy Court, as of the date of the Debtors filed the Amended Craven Declaration, Lehman had already entered into an agreement to sell 50% of the equity to Apollo, subject to Bankruptcy Court approval in Lehmans bankruptcy case. See Appendix, Exhibit 3, at APP-00159; see Appendix, Exhibit 8, at APP-00527 (Apollo discloses the existence of its agreement to purchase the reorganized equity from Lehman). Furthermore, as little as two weeks prior to the Petition Date, Apollo had been included as a signatory to the Lock-Up Agreement, as a result of months of three-party negotiations among the Debtors, Apollo and Lehman. See Appendix, Exhibit 13, at APP-00620. It was just 10 days prior to the filing when the three parties decided to restructure the deal by taking Apollo off the Lock-Up Agreement. See Appendix, Exhibit 12, at APP-00595. The last minute change of structure to conceal Apollos role in the transaction does not change the deals substance. Apollo remained in the deal just as it was from the start.

13

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34. The Debtors entry into the Lock-Up Agreement would compromise their ability

to negotiate with potential investors, since that would constitute a breach of the Lock-Up Agreement that would, among other things, terminate the Debtors right to use Lehmans cash collateral. See, Appendix, Exhibit 1 at APP-00007 & APP-00010. Section 5(c) of the Lock-Up Agreement provides: Each party agrees to use its commercially reasonable efforts to . . . (iv) not take any actions inconsistent with this Agreement, the Plan Term Sheet or other Plan Related Documents. Neither Party shall, directly or indirectly, seek, solicit, negotiate, support or engage in any discussions relating to or enter into any agreements relating to, any restructuring, plan of reorganization, dissolution, winding up, liquidation, reorganization, merger, transaction, sale or disposition (or [sic] all or substantially all of their assets or equity) other than as set forth in the Plan Term Sheet and the Plan, nor shall either Party solicit or direct any person or entity, including, without limitation, any member of any of the Parties board of directors or, as to the Company, any holder of equity in the Company, to undertake any of the foregoing; provided, however, that the Parties may agree to modifications to the Plan Related Documents as provided herein. See Appendix, Exhibit 1 at APP-00007. This is just one of the coercive provisions of the LockUp Agreement that would prevent the Debtors from exercising their fiduciary duties to maximize value for these estates.14 In this light, with credible parties such as Five Mile showing interest15 in the Debtors, and given the widespread opposition that exists to the transaction contemplated under the Lock-Up Agreement, the Debtors cannot justify handcuffing themselves to the Lehman-Apollo transaction.16 Indeed, by approving the Debtors entry into the Lock-Up
14

A chart identifying certain other provisions of the Lock-Up Agreement that would prevent the Debtors from negotiating potential investments is attached as Annex 2 to this Objection. Five Mile is committing to put in $236 million in new cash and will provide tens of millions of dollars in incremental benefit to these estates versus the Lehman-Apollo plan. While Marriott has filed a limited objection reserving its consent right over the future control of the Debtors, Midland does not believe that Marriott would be opposed to Midland owning or controlling the Midland Debtors hotels post-effective date. Indeed, Marriott has previously provided comfort letters in connection with the Fixed Rate Loan Agreement, providing that Midland would have an opportunity to cure any franchise default and

15

16

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Agreement, the Court would essentially be blessing the Debtors desire to handcuff themselves and abdicate their fiduciary duties to the other $1.2 billion of pre-petition creditor constituencies in these estates.17 35. For the foregoing reasons, based on the totality of the circumstances, the Debtors

cannot meet the requirements for assumption of the Lock-Up Agreement under Bankruptcy Code section 365. As discussed below, the Lock-Up Agreement should also be rejected under the section 363. B. The Debtors Cannot Satisfy The Section 363 Standard For Approval Of The Lock-Up Agreement 36. The Motion should be examined under Bankruptcy Code section 363, rather than

section 365, since it seeks permission for the Debtors to enter into the Lock-Up Agreement, outside the ordinary course of business. See 11 U.S.C. 363(b) (The trustee, after notice and a hearing, may use, sell or lease, other than in the ordinary course of business, property of the estate . . .); Northview Motors., Inc. v. Chrysler Motors Corp., (In re Northview, Inc.), 186 F.3d 346, 351 (3d Cir. 1999) (Relying on section 363, we have held that a contract providing for use or sale of estate property outside the regular course of business is unenforceable absent court approval.). The closer the transaction gets to the heart of the reorganization process, the more scrutiny the Court has to give that matter. In re New Hampshire Elec. Coop., Inc., 131 B.R. 249, 252 (Bankr. D.N.H. 1991) (citing In re Pub. Serv. Co. of New Hampshire, 90 B.R. 575

additionally, in the event of a lender foreclosure, Marriott would agree to Midlands continued operation of the Midland Debtors hotels under the Marriott flags pursuant to the terms of certain comfort letters provided in connection with the June 2007 financing. See Appendix, Exhibit 14, at APP-00628.
17

Aside from making no business sense, the decision to lock themselves up and to freeze potential investors out also has implications for whether the Debtors should even be permitted to remain in control as debtors-inpossession. See, e.g., In re Bellevue Place Assocs., 171 B.R. 615, 616 (Bankr. N.D. Ill. 1994) (finding the appointment of a trustee was in the best interests of creditors and other interest holders where a pre-petition lock-up agreement between the debtor and a secured creditor required a debtor to favor the interests of the secured creditor and thus restricted the debtors ability to exercise its fiduciary duties as a debtor in possession).

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(Bankr. D.N.H. 1988)). Nothing could be more vital to these bankruptcy cases at this time than the Courts consideration of the terms of the Lock-Up Agreement. (1) Because The Lock-Up Agreement Would Preserve Value For Apollo, The Motion Must Be Scrutinized Under A Heightened Standard The Debtors Motion seeks the Courts blessing of a deal and process designed to

37.

permit Apollo, which owns 100% of the Debtors equity, to retain 50% of the Debtors upside for itself in violation of LaSalle and the absolute priority rule. No matter how the Debtors, Apollo and Lehman made their last minute change of format of documentation, the result of Apollo ending up with no less than 50% of the Equity has never been in doubt. 38. While the Motion cites to cases applying the business judgment standard, courts

do not give deference to debtors business judgment where insiders are involved. Rather, because the Lock-Up Agreement embodies an insider deal, the Bankruptcy Court should apply heightened scrutiny to the Debtors Motion. See In re Lifschultz Fast Freight, 132 F.3d 339, 344 (7th Cir. 1997) (applying rigorous scrutiny in the context of a loan from insiders to a corporation for purposes of equitable subordination); In re Blixseth, No. 09-60452-7, 2010 Bankr. LEXIS 585, *31 (Bankr. D. Mont. Feb. 23, 2010) (holding that the business judgment rule did not apply to a proposed sale where the sale was to an entity with a close relationship with the debtor, the trustee had not intensively explored non-insider proposals, and where the proposed bidding procedures contained terms aimed at cutting off other competing bids); In re Global Ocean Carriers Ltd., 251 B.R. 31, 48 (Bankr. D. Del. 2000) (noting that sales to insiders [are] subject to special scrutiny in bankruptcy cases); In re Wingspread Corp., 92 B.R. 87, 93 (Bankr. S.D.N.Y. 1988) (holding that [s]ales to fiduciaries are necessarily subjected to heightened scrutiny because they are rife with the possibility of abuse and issuing an injunction in order to provide the Court with the opportunity to further consider the circumstances
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surrounding a sale); In re Bidermann Indus. U.S.A., Inc., 203 B.R. 547 (Bankr. S.D.N.Y. 1997) (applying heightened scrutiny to a proposed sale which would benefit insiders).18 39. In applying heightened scrutiny, courts are concerned with determining the

fairness of the transaction. In essence, the purpose of heightened scrutiny is to ensure that insiders do not receive more favorable terms at the expense of impaired creditors. Beal Bank, S.S.B. v. Water Edge Ltd. Pship, 248 B.R. 668, 680 (D. Mass. 2000) (noting that insider private transactions, which are not at arms length, raise the very real spectre that insiders might receive more favorable terms at the expense of impaired creditors[and] require greater scrutiny by the bankruptcy court to ensure fairness). Thus, especially in the context of an insider or related party transaction, courts look to ensure the integrity of the transaction, whether the process was tainted by wrongdoing, whether the transaction was conducted at arms length, whether the sale was conducted in good faith, and whether, in the case of a sale, competing offers have been encouraged or permitted. See, e.g., Gross v. Russo (In re Russo), 762 F.2d 239 (2d Cir. 1985), in which the Second Circuit held that while a former trustee was not per se banned from purchasing assets from the estate he had formerly administered, additional scrutiny was necessary to ensure the integrity of the sale. Specifically the Court considered whether the bid tainted the proceedings with wrongdoing, stifled competition for the asset, or whether the bidder had taken unfair advantage of confidential information possessed by virtue of his former position as trustee.

18

See also cases regarding entire fairness doctrine in the context of breach of duty of care discussion, below.

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40. Here, the Lock-Up Agreement cannot survive the Courts heightened scrutiny.19

While the version of the Lock-Up Agreement filed with the Court carefully avoids mentioning Apollo, the evidence proves that Apollo was always intended to get equity either directly, as a back-stop party, or through a side deal with Lehman negotiated just before the Petition Date. Moreover, as Beilinson testified, he did not shop the deal prior to entering into it, and has no intention of shopping it. Instead, he handed it to Apollo, who hired him to work at Innkeepers (one of Apollos portfolio companies). See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP00316 (contacted by Rick Press at Apollo to serve as an independent board member of Innkeepers). 41. This is precisely the kind of insider case that concerns courts, since without a

complete marketing process subject to higher and better offers, it is impossible for the Court to determine whether the insider is getting a sweetheart deal. Rather, as a result of the control relationship that exists here as well as the refusal of the Debtors to subject the Apollo deal to the market the presumption has to be that the deal is unfair. This conclusion is bolstered by the fact that substantially every creditor and equity holder in these cases (other than Apollo and

19

Because Apollo participated in negotiating, and stands to benefit from, the Lock-Up and the Lehman-Apollo plan it contemplates, the Court should apply heightened scrutiny to the transaction. In any event, the Lock-Up Agreement also could not survive the section 363 business judgment standard applicable to non-insider transactions, since there is no justifiable reason why, at this early stage of the bankruptcy cases, the Debtors need to lock themselves into the direction of a flawed plan of reorganization. As discussed herein, there are higher and better offers available to test the market to determine what is best for the entire creditor constituency in these estates. See, e.g., In re Pub. Serv. Co. of New Hampshire, 90 B.R. 575 (Bankr. D. N.H. 1988): Considering the particular business transaction here involved, i.e., a restructuring of the very entity in reorganization, I believe that an appropriate standard for approval or disapproval of the transaction by the reorganization court is whether good cause has been shown to implement the transaction of this stage of this proceeding, i.e., does it have valid business reasons supporting it and does it make good sense in the overall context of the reorganization process? Phrased negatively, the standard might be whether the proposed transaction might improperly and indirectly lock the estate into any particular plan mode prematurely, and without the protection afforded by the procedures surrounding a disclosure statement and confirmation hearing, in a plan of reorganization. Public Service Co. at 581.

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Lehman) all of whom will either be negatively impaired or wiped out opposes the LockUp Agreement. 42. The Debtors argue that the Lehman-Apollo deal is necessary because Lehmans

agreement to take equity rather than a note will de-leverage the company. The Debtors refusal to shop the deal conceals the fact that less coercive alternatives could achieve the same end result. The Five Mile proposal is an example of what is available in the market. See Greenspan Declaration at 24-26. 43. The Lehman-Apollo plan is premised on the concept that Lehman, which is not a

creditor in the Midland pool, can somehow obtain value from that pool, without paying Midland for it.20 The Debtors cannot by sleight of hand simply shift assets, values and upside from one estate to another, without regard to the legal rights and preferences of each individual debtors estate. The fact that the Lehman-Apollo plan may be beneficial to the Lehman asset pool has no bearing whatsoever on whether it is beneficial to Midland with respect to the Midland Debtors. Given that Midland has not consented to the stripping away of the upside in Midland collateral, the Debtors have no right to take it and give it to Lehman and Apollo without compensating Midland.

20

These estates have not been substantively consolidated. Based on Midlands understanding of the facts, it is also unlikely that they could be. See Union Savings Bank v. Augie/Restivo Baking Co. (In re Augie/Restivo Baking Co.), 860 F.2d 515, 518 (2d Cir. 1988). Here, the Debtors estates were grouped in pools of assets, each of which operated independently from each other pool. While cash flowed up through a central cash management system, the Debtors have argued (and the Court accepted on an interim basis) that the Debtors are fully capable of tracking and segregating all cash flows. Importantly, the various asset pools were not operated as an integrated enterprise. Instead, Island Hospitality Management, Inc. has been employed as manager for the hotels. The CMBS market is premised upon the concept of corporate separateness, including separateness of each asset pool from each other asset pool. Thus, for example, the Midland Pool had its own financial statements and observed all corporate formalities. In fact, each asset pool had its own servicer (and now has its own special servicer) imbued with fiduciary duties for its specific asset pool. Moreover, the Debtors did not operate as an Innkeepers brand. Rather, the various hotels operated under a variety of flags, including Marriott, Residence Inn and Hilton Suites. See Greenspan Declaration at 14.

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44. In short, while the Debtors may be able to demonstrate a benefit to Lehman or to

Apollo, they cannot show a benefit to the Debtors other estates, such as the Midland Debtors (other than a supposed general de-leveraging benefit, which as Midland has already explained is no benefit at all to the Midland debtors since (i) the Midland Pool is perfectly capable of servicing its own debt, and (ii) in any event, there may be less coercive alternatives that could de-leverage the Debtors without stripping the individual Debtors of value and siphoning it off to Lehman and Apollo). See Greenspan Declaration at 6, 13. 45. In In re Bidermann Indus. U.S.A., Inc., the Bankruptcy Court applied heightened

scrutiny to the approval of a letter agreement which would put in motion an anticipated leveraged buyout of the debtors by a third party and the company owned by the Debtors CEO. Bidermann at 549. The Court found that the sale did not withstand scrutiny where the proposed sale [did] not reveal the effective exercise of business judgment but rather the illicit manipulation of a boards deliberative process by self-interested corporate fiduciaries as no investment bank was hired to test the marketplace for other expressions of interest, and additional offers were not encouraged. Id. at 551 (internal citations omitted). See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00332 (under Beilinsons instructions, Moelis was not charged with shopping the Lehman transaction outside the Debtors capital structure). The Court noted a conflict because the CEO was on both sides of the transaction, but also because the primary shareholder was receiving incentives. Ultimately, the Court found that both due care and disinterstedness were lacking. Id. 46. The facts in In re General Bearing Corp., 136 B.R. 361 (Bankr. S.D.N.Y. 1992)

are also remarkably similar to the facts in this case (with the major difference being the fact that the debtor in General Bearing actually engaged in some marketing process). The debtor in

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General Bearing sought permission from the court to sell certain of its interests to certain of its insider equity holders. While the debtor had marketed its entire ball bearing company to approximately 180 people in the ball bearing business, the debtor never marketed the interests in question separately from its entire asset base. One of the debtors creditors objected to the sale because it believed the price to be unreasonably low and there was no proof that the debtor had made an attempt to market the assets. Following its recitation of the facts, the Court began its ruling with the following statement: The proposed offer from World, the corporation formed by the debtors insiders, reflects an indirect end run around the bankruptcy concepts of absolute priority and new value. Id. at 365. The Court then explained: In considering the standards for selling a debtors assets outside the ordinary course of business pursuant to 11 U.S.C. 363(b), the court considers the salient factors applicable to the transaction. In re Lionel Corp., 722 F.2d 1063 (2d Cir. 1983). Although the assets to be sold are of no present value to the debtor and may be decreasing in value, there is no proof that the offer reflects the highest and best price for the interests sold or that the debtor ever attempted to market them separately. The proposed sale price was not arrived at as a result of arms length negotiations but was established by insiders as the most money that they could raise. . . . Id. at 365. The Court ultimately reasoned that section 363(f) was applicable to the transaction, not section 363(b), but denied the debtors motion on the basis that the debtor could not satisfy the section 363(f) standard either. Concurrently, the Court denied the debtors motion to extend its exclusivity period, thus opening up the process. The facts in these cases are worse than those in General Bearing, since the Debtors have refused to market the company to anyone other than Apollo. Here, too (and as discussed below), the Debtors are attempting an end-run around the absolute priority rule and LaSalle. As in General Bearing, the Court should deny the Debtors motion to approve the Lock-Up Agreement and open up the process.

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(2) 47. The Lock-Up Agreements Fiduciary Out Is Illusory The Lock-Up Agreement seeks to bind the Debtors to move forward to confirm a

plan that will result in Apollo retaining 50% of the Debtors equity, while tying the hands of the Debtors so that they cannot market the property under a robust and transparent process. The Debtors claim that the Lock-Up Agreement contains a fiduciary out, but the terms of such provision are completely a-typical, and render it illusory.21 In the Motion, the Debtors misleadingly state: notwithstanding anything else contained in the Plan Support Agreement, as discussed above the obligations of the Debtors are subject to the fulfillment of their fiduciary duties and compliance with the Bankruptcy Code. Indeed, the Plan Support Agreement provides that the Debtors and their directors and officers, at any time prior to confirmation of the Plan, retain the ability, subject to certain limited exceptions, to take any action, or to refrain from taking any action, including a decision to terminate the Plan Support Agreement, that such person determines in good faith, after consultation with counsel, is consistent with its or their fiduciary obligations under applicable law. Motion at 26. 48. What the Debtors fail to explain (presumably these are the limited exceptions

the Debtors are referring to) is the fact that, instead of providing that the Debtors can do whatever they need to do to act in the best interests of all of the Debtors estates, the fiduciary out provides that the Debtors must ensure that any other deal must be provide a higher and better recovery to Lehman (as opposed to the Debtors estates) to change one of the

21

Midland has researched back several years to locate plan support agreements and/or lock-up agreements that were used and promoted in court by either the Debtors counsel, Kirkland & Ellis LLP, or Mr. Beilinsons former firm, Pachulski Stang Ziehl & Jones LLP. None contained a fiduciary out in favor of anyone other than the debtor. None contain provisions like those contained in the Lock-Up Agreement conditioning a fiduciary out upon an enhanced recovery to a contracting party. A chart summarizing the results of that search and the underlying plan support agreements is attached hereto as Annex 1.

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milestones. This requirement effectively nullifies the Debtors fiduciary out. See Appendix, Exhibit 1, at APP-00016. Section 25(c) of the Lock-Up Agreement provides: The Company agrees that the Fiduciary Out shall not apply, and may not be used, to annul, modify, amend, or otherwise alter any of the Plan Milestones or any of the remedies in respect thereof; provided, however, that if the Company secures a binding and firm written commitment with respect to an alternative transaction that will provide Lehman with a higher and better recovery than the recovery proposed under the Plan (a Firm Alternative Transaction), the Company shall provide Lehman with at least ten (10) Business Days to determine whether Lehman will consent to such Firm Alternative Transaction. If Lehman does not consent to such Firm Alternative Transaction, the Company may only exercise the Fiduciary Out after it has obtained an order from the Bankruptcy Court authorizing the Company to exercise the Fiduciary Out in accordance with the terms hereof. The Company agrees that in determining whether a Firm Alternative Transaction is higher and better, all factors must be considered including contingencies, conditionality, legal and financial execution risk, economics and Lehmans opinion as to whether such Firm Alternative Transaction is higher and better. Appendix, Exhibit 1, at APP-00016. 49. Section 25(c) makes clear that the fiduciary out only applies to Firm Alternative

Transactions, and would not, for example, permit the Debtors to market themselves or to talk to prospective buyers looking to conduct due diligence. Moreover, as the final sentence of section 25(c) makes clear, the Debtors concept of higher and better is a completely subjective standard, and includes considering Lehmans opinion of whether a Firm Alternative Transaction is higher and better. This provision is especially troubling in light of the e-mails that were exchanged between Lehman and Beilinson just days before their entry into the LockUp Agreement. See Appendix, Exhibit 16, at APP-00639 (Beilinson writes I wont be amending our deal without your consent. Im trusting that you wont terminate AIC in first 45 days please do the same with me on this issue for this short period of time.); see Appendix, Exhibit 15, at APP-00637 (In an effort to resolve open issues between Lehman and Apollo, a few

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days before the filing, Lehman counsel writes to Apollo that Lehman will not consent to a third party purchaser.). 50. The evidence proves that the Debtors and Lehman negotiated behind the scenes to

lock themselves (and Apollo) up and to lock all third parties out! On the basis of this evidence, under any standard of review by a bankruptcy court, in light of the Apollo relationship and its control over the Debtors (through Beilinson), this Court should reject the Lock-Up Agreement, and open the bankruptcy process up to market competition for the company. The Debtors have proven that they are incapable of acting as neutral fiduciaries for any of their constituents other than Lehman and Apollo. C. The Debtors Entry Into The Lock-Up Agreement Constitutes A Breach Of Fiduciary Duty 51. The Motion also should not be approved because the Debtors entry into the

Lock-Up Agreement (and their attempt to move forward with it now) constitutes a breach of their fiduciary duties of care and loyalty to all of their estates by favoring the Lehman pool and Apollo over all other constituencies. See, e.g., In re Hampton Hotel Investors, L.P., 270 B.R. 346, 361 (Bankr. S.D.N.Y. 2001) (citing Wolf v. Weinstein, 372 U.S. 633, 649 (1963) for proposition that so long as the Debtor remains in possession, it is clear that the corporation bears essentially the same fiduciary obligation to the creditors as does the trustee for the Debtor out of possession. . . .); id. (citing Davis v. Woolf, 147 F.2d 629, 633 (4th Cir. 1945)) (The law by the great weight of authority seems to be settled that when a corporation becomes insolvent, or in a failing condition, the officers and directors no longer represent the stockholders, but by the fact of insolvency, become trustees for the creditors. . . .).

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(1) 52. The Debtors Duty Is To Maximize Value For Their Estates The Debtors are fiduciaries for all of these estates. Accordingly, their fiduciary

duty is to maximize value for these estates. See, e.g., In re Embrace Sys. Corp., 178 B.R. 112, 123 (Bankr. W.D. Mich. 1995) (When a debtor desires to sell an asset, its main responsibility, and the primary concern of the bankruptcy court, is the maximization of the value of the asset sold.).22 For the Debtors to do the right thing, they should dispense with the Lock-Up Agreement, since it has been engineered to give substantial value to only Apollo and Lehman rather than to maximize value for all creditors of all estates. The Debtors refusal to open up the process to bidders that could increase value for these estates, illustrates their ongoing failure to fulfill their duty to maximize value. Accordingly, the Court should reject the Motion. (2) 53. The Debtors Have Breached Their Duty Of Care While fiduciaries always owe duties of care and loyalty, these duties apply with

equal or greater force in the context of a sale of assets. In re Tri-Star Pictures, Inc. Litig., 634 A.2d 319, 328 (Del. 1993) overruled on other grounds by Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031 (Del. 2004). The duty of care refers to the responsibility of a corporate fiduciary to exercise, in the performance of his or her tasks, the care that a reasonably prudent person would use under similar circumstances. Tese-Milner v. TPAC, LLC (In re Ticketplanet.com), 313 B.R. 46, 62 (Bankr. S.D.N.Y. 2004). The duty of care requires that a fiduciary consider all material information reasonably available in making business decisions. Official Comm. of Unsecured Creditors v. Bay Harbour Master Ltd. (In re BH S&B Holdings LLC), 420 B.R. 112, 146 (Bankr. S.D.N.Y. 2009). The duty of care also includes the
22

Corporate officers owe fiduciary duties that are identical to those owed by corporate directors. Gantler v. Stephens, 965 A.2d 695, 708 (Del. 2009). Controlling shareholders have also been held to owe fiduciary duties. See In re Primedia Inc. Derivative Litig., 910 A.2d 248, 257 (Del. Ch. 2006) (recognizing fiduciary duties of controlling shareholders in transactions where shareholder exercises control or owns more than 50% of voting power in a corporation).

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responsibility to reasonably inform oneself of alternatives. UIS, Inc. v. Walbro Corp., No. 9323, 1987 Del. Ch. LEXIS 490, *5 (Del. Ch. 1987). As explained by the Delaware Chancery Court in In re Fort Howard Corp. Shareholders Litig.: It is essential for valid director action that it be taken on an informed basis. Indeed, it is essential of any rational human choice that alternatives to the proposed action be considered. The more significant the subject matter of the decision, obviously, the greater will be the need to probe and consider alternatives. When the decision is to sell the company, or to engage in a recapitalization that will change control of the firm, the gravity of the transaction places a special burden upon the directors to make sure that they have a basis for an informed view. No. 9991, 1988 Del. Ch. LEXIS 110, *4-5 (Del. Ch. August 8, 1999). (3) 54. Because Apollo Is On Both Sides Of The Transaction, The Debtors Cannot Rely On The Business Judgment Rule The business judgment rule is commonly asserted as a defense to actions for

breach of duty of care. Here, the Debtors cannot justify their entry into the Lock-Up Agreement on the basis of the business judgment rule. The business judgment rule provides a presumption that in making business decisions not involving direct self-interest or self-dealing, corporate directors act on an informed basis, in good faith, and in the honest belief that their actions are in the corporations best interest. Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985) overruled on other grounds by Gantler v. Stephens, 965 A.2d 695 (Del. 2009); Official Comm. of Unsecured Creditors v. Aust (In re Network Access Solutions, Corp.), 330 B.R. 67, 75 (Bankr. D. Del. 2005). 55. A debtor may only invoke the business judgment rule where the following

elements are present: (1) a business decision, (2) disinterestedness, (3) due care, (4) good faith, and (5) according to some courts and commentators, no abuse of discretion or waste of corporate assets. In re Adelphia Commcns Corp., 327 B.R. 143, 154 n.1 (Bankr. S.D.N.Y. 2005) quoting

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Official Comm. of Subordinated Bondholders v. Integrated Res., Inc. (In re Integrated Res., Inc.), 147 B.R. 650 (S.D.N.Y. 1992). 56. Here, under the control of the Debtors Apollo-dominated board, the Debtors

structured the Lock-Up Agreement (and the transaction contemplated therein) specifically to give value to Apollo (their 100% equity owner). This is the epitomy of self-dealing, selfinterested behavior. Indeed, where, as here, the Debtors controlling shareholder, Apollo, stands on both sides of the transaction (i.e., Apollo controls the Debtors and is also the major beneficiary of the Debtors Lock-Up Agreement), the entire fairness doctrine negates the Debtors reliance upon the business judgment rule. 57. The Debtors need to carry the burden of proving the entire fairness of the Lock-

Up Agreement. Weinberger v. UOP, Inc., 457 A.2d 701, 710 (Del. 1983) (noting that where one stands on both sides of a transaction, he has the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts); In re Adelphia Commcns Corp., 323 B.R. 345, 355 (Bankr. S.D.N.Y. 2005) (applying entire fairness in bankruptcy context where insiders sought to advance defense costs); In re Summit Metals, Inc., No. 98-2870, 2004 U.S. Dist. LEXIS 15819, *46-49 (D. Del. August 6, 2004) (noting that the entire fairness standard applies where a transaction is with a controlling shareholder); In re Primedia Inc. Derivative Litig., 910 A.2d at 257 (recognizing fiduciary duties of controlling shareholders in transactions where shareholder exercises control or owns more than 50% of voting power in corporation and holding that a higher level of scrutiny such as entire fairness is appropriate in analyzing propriety of such transactions). As noted by the court in Adelphia, the burden of proving entire fairness is often a daunting task involving a standard so exacting that it ordinarily, but not invariably, results in a finding of liability. Adelphia, 323 B.R. at 385, quoting Weinberger, 457 A.2d at

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710. Entire fairness requires justification under both elements of a two pronged inquiry into the fair process and the fair price of the transaction. Adelphia, 323 B.R. at 385. Further, if a decision is made while an entity is insolvent the entire fairness test requires consideration of the needs and concerns of the company as a whole, with due regard to the priorities of stakeholders to the companys assets which means, as a practical matter, that the needs and concerns of creditors, and not just shareholders, must be taken into account, along with the higher priority that creditors have to an insolvent companys assets. Id. at 355. For all of the reasons discussed in this brief, including the Debtors refusal to subject the Lock-Up Agreement to a transparent marketing process subject to higher and better offers, the Debtors cannot satisfy their burden. Nothing the Debtors have done in these cases has been fair. 58. Because the Debtors have engaged in a self-interested, self-dealing integrated

transaction which directly benefits their equity owner in violation of LaSalle, they cannot simply stand up in Court and mouth the words business judgment to legitimize their conduct. See Appendix, Exhibit 7 (Lascher Depo. Tr.), at APP-00438 (Lehman has only negotiated with Apollo for the sale of the new equity). Rather, the Debtors have the burden of showing that they engaged in a fair process and obtained a fair price in connection with their decision to enter into the Lock-Up Agreement. They cannot satisfy their burden. First, there is no evidence that the Debtors board exercised due care or engaged in a fair process with respect to their decision to lock themselves into the Lehman-Apollo transaction. As testified to by both Beilinson and Lascher (of Lehman), there was no bidding or shopping of the Apollo deal to ensure that the Lehman-Apollo deal would maximize value for their various estates. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00332, APP-00347, Exhibit 7 (Lascher Depo. Tr.), at APP-00430. Indeed, despite the fact that the Lock-Up Agreement was not effective as against Lehman (and

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thus not binding on the Debtors either), the Debtors chose to behave as though they were already bound by it, refusing to permit potential investors to engage in due diligence. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00349. Second, because the Debtors have refused to subject the transaction embodied by the Lock-Up Agreement to the market, the Debtors cannot show that they have obtained a fair price. See Appendix, Exhibit 6 (Beilinson Depo. Tr.), at APP-00346-47. In short, because the Debtors are incapable of satisfying their burden under the entire fairness doctrine, the Lock-Up Agreement cannot be approved. (4) 59. The Debtors Entry Into The Lock-Up Agreement Is A Breach Of Their Duty Of Loyalty The Debtors have also breached their fiduciary duty of loyalty, under which the

Debtors are obligated to maximize value for their estates. See, e.g., In re Metaldyne Corp., 409 B.R. 661, 667 (Bankr. S.D.N.Y. 2009) (recognizing the fiduciary duties of directors to get the best possible value noting that it is the overarching objective of sales in bankruptcy to maximize value to the estate); In re Integrated Res., 147 B.R. 650, 659 (S.D.N.Y. 1992), citing In re Atlantic Packaging Products, Inc., 99 B.R. 124, 130 (Bankr. N.D. Ga. 1988) (It is a wellestablished principle of bankruptcy law that the objective of bankruptcy rules and the [Debtors] duty with respect to sales is to obtain the highest price or greatest overall benefit possible for the estate.); Bidermann, at 551 (noting that once the debtors made the decision to offer themselves for sale, it became [the fiduciarys] obligation to help ensure that the debtors received the highest and best offer available). Here, the Debtors are clearly more interested in shutting off creditor claims and maximizing value for Lehman-Apollo than they are for their creditor constituencies. Indeed, the only creditor that will benefit from the Lehman-Apollo deal is Lehman. As evidenced by the widespread creditor opposition (and that expected from the holders of preferred equity) to the proposed Lock-Up Agreement, no parties aside from

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Lehman & Apollo are better off under the Lock-Up Agreement, and all oppose it as an anathema to their position. 60. For example, the Lehman-Apollo plan proposes to provide a $550 million note to

the $825mm Fixed Rate CMBS Pool (the Midland Pool) in full satisfaction of Midlands $825 million secured claim. The plan cuts off Midlands right under Bankruptcy Code section 506(a)(1) to recover on its deficiency claim. The plan further cuts off all of Midlands upside in its collateral represented by increased cash flow and value accretion. Instead, the plan upstreams the Midland cash flow and upside value to the Debtors ultimate parent (Grand Prix Holdings LLC), and then provides it to Lehman, which is a creditor of a completely different set of Debtors and has rights in a different set of hotel collateral and therefore has no entitlement whatsoever to the Midland deficiency or other rights. The next step in the integrated transaction is Lehmans sale of 50% of the Midland Equity to Apollo for $107.5 million. Incredibly, the proceeds of the sale of the Midland Equity will go to Lehman (which has no claim to the Midland Equity), not to the Midland Debtors or to Midland. The end result is that Apollo will retain a 50% stake in the company in violation of the absolute priority rule. See 11 U.S.C. 1129(b)(2)(B)(ii). 61. The Debtors cannot seriously argue that the Lehman-Apollo plan benefits anyone

other than Lehman and Apollo. The Midland Pool does not require being part of the Debtors proposed enterprise. With recovery limited to a note of $550 million (and using the Debtors own revenue projections and projected 6% interest rate) the Midland Pool is fully capable of producing $17.5 million of EBITDA in excess of debt service. Greenspan Declaration at 8. All of the Midland collateral value should remain with Midland, and should not be upstreamed to Lehman and Apollo for no value to the Midland Pool.

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62. The Debtors refusal to subject the Lehman-Apollo deal to higher and better

offers and to respect the separateness of the Debtors estates, only compounds the problem, and highlights the fact that the Lehman-Apollo deal is a sweetheart deal (i.e., if the Debtors had any confidence in the deal, then they would not be afraid to market it). As a result, aside from any other remedy the Court believes to be appropriate as to the Debtors violations of their fiduciary duties, the Court should deny the Motion.23 D. The Lock-Up Agreement Violates LaSalle 63. As discussed, the proposed Lock-Up Agreement embodies a new value plan

that would give Apollo the Debtors existing equity the exclusive right to purchase 50% of the Debtors post-effective equity. The Lock-Up Agreement is the centerpiece of an integrated transaction that violates LaSalle, since it is designed to prevent others from offering higher value through an auction through competing plans. This constitutes a clear violation of the absolute priority rule. See Bank of Am. Natl Trust & Sav. Assn v. 203 North LaSalle St. Pship, 526 U.S. 434 (1999) (holding that absolute priority rule was violated where debtors plan only permitted its shareholder to invest new capital to obtain all the equity in the new company). 64. As explained by the Supreme Court in LaSalle, the problem with granting old

equity the exclusive right to the property: is that the exclusiveness of the opportunity, with its protection against the markets scrutiny of the purchase price by means of
Given the self-dealing that has gone on in these cases, these may be appropriate cases for the Court to consider ordering that the Debtors be disqualified or recused from acting in these cases with respect to the Lock-Up Agreement and the transactions contemplated therein. See In re Adelphia Commcns Corp., 336 B.R. 610 (Bankr. S.D. N.Y. 2006); In re Interwest Bus. Equip. Inc., 23 F.3d 311, 316 (10th Cir. 1994) (requiring separate counsel who can fairly and fully advise each debtor as to its rights and responsibilities) (emphasis in original); In re Star Broadcasting, Inc., 81 B.R. 835, 841 (Bankr. D.N.J. 1988) (concluding that dual representation where one estate is indebted to the other, there exists two groups of creditors which have conflicting claims and payment for one group is necessarily at the expense of the other warranted disqualification); see also In re General Growth Props., et al., 09-11977 (Bankr. S.D.N.Y. filed April 16, 2009) (debtors retaining co-counsel at outset of case to advise on matters relating to certain subsidiary debtors).
23

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competing bids or even competing plan proposals, renders the partners right a property interest extended on account of the old equity position and therefore subject to an unpaid senior creditor classs objection. LaSalle, 526 U.S. at 456. The problem is most prevalent where, as is the case with Apollo here, the insiders possess and exercise control over the Debtors. See also Bruce A. Markell, Owners, Auctions, and Absolute Priority in Bankruptcy Reorganizations, 44 Stan. L. Rev. 69, *117-120 (1991) (Termination of exclusivity can thereby provide a potent check on owners latitude with respect to the initial setting of reorganization value and plan structure. If creditors disagree with the amount of value allocated to them under the plan, they may automatically propose their own plan, thus neutralizing owners use of their control of the debtor.). 65. In In re Global Ocean Carriers Ltd., 251 B.R. 31, 49 (Bankr. D. Del. 2000), the

Delaware Bankruptcy Court followed LaSalle where the debtors controlling equity holder sought, through his control of the debtor, to sell the equity to a non-shareholder his daughter holding that the plan violated the absolute priority rule. As a result, the Bankruptcy Court ruled that [t]o avoid this result the Debtors must subject the exclusive opportunity to determine who will own [the Debtors] to the market place test . . . . This can be achieved by either terminating exclusivity and allowing others to file a competing plan or allowing others to bid for the equity. . . . Id.; see also In re Davis, 262 B.R. 791 (Bankr. D. Az. 2001) (refusing to extend exclusivity where proposed plan would violate absolute priority rule by permitting individual debtors to retain equity); In re Situation Mgmt. Sys., Inc., 252 B.R. 859 (Bankr. D. Mass. 2000) (finding cause to terminate exclusivity to permit competitive bidding). 66. The Supreme Court in LaSalle cautioned that in the context of a new value plan

in favor of a debtors insiders (i.e., existing equity), the process must be open to competing bids

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as a procedural safeguard to ensure that insiders are not able to steal away the property in violation of the absolute priority rule and for inadequate consideration. 67. As with LaSalle and the other cases cited herein, the plan process should be

opened up for competitive bidding, whether through a court-supervised process or competing plans of reorganization. But in all events, a robust marketing process for higher and better offers should occur. 68. As discussed above, the Debtors cannot continue to argue that their supposed

fiduciary out is anything more than a sham. The Debtors and Lehman have never had any intention of ever permitting any party other than Apollo to bid for the company. The proposed Five Mile Commitment is evidence that there are third parties with interest in investing in the Debtors. In light of the Debtors conduct favoring its existing equity owner, and the fact that Debtors, Apollo and Lehman have already spent months pre-petition formulating their coercive plan, it is time to level the playing field and let the real parties-in-interest have a say.24 The Court should open the process to competitive bidding and deny the Debtors motion to approve the Lock-Up Agreement.

24

See, e.g., In re Adelphia Commcns Corp., 336 B.R. at 677 (explaining that while cause to terminate exclusivity had not been demonstrated by the Arahova Noteholders, [t]his Court, like other bankruptcy courts, has been quite willing to terminate exclusivity where a debtor has been unduly intransigent in dealing with its creditors; has inappropriately sought to favor equity or another stakeholder group; has sought to feather the nest of incumbent management; or has caused the Court to lose confidence that it could ever come up with a confirmable plan).

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CONCLUSION WHEREFORE, for the foregoing reasons, Midland respectfully requests that the Court deny the Motion and grant such other and further relief as is just and proper. Respectfully submitted this 23rd day of August, 2010.

/s/ Lenard M. Parkins HAYNES AND BOONE, LLP 1221 Avenue of the Americas, 26th Floor New York, New York 10020 Telephone: (212) 659-7300 Facsimile: (212) 884-8211 Lenard M. Parkins (NY Bar# 4579124) John D. Penn (NY Bar # 4847208 and admitted pro hac vice) Trevor Hoffmann (NY Bar# 4067229) Mark Elmore (admitted pro hac vice) ATTORNEYS FOR MIDLAND LOAN SERVICES, INC.

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