April 28th 2008

By David McLaughlin
Dow Jones Newswires
April 28, 2008

A mediation session aimed at resolving a battle over the Pacific Lumber Co.'s post-bankruptcy future failed over the weekend, which could force a judge to decide the fate of the struggling logging company.

Settlement talks that took place on Friday and Saturday between rival creditors in the case didn't result in a deal, according to people with knowledge of the mediation who spoke on condition that they not be identified.

With mediation failing, Judge Richard Schmidt of the U.S. Bankruptcy Court in Corpus Christi, Texas, will continue a hearing Tuesday to approve a plan to take Pacific Lumber out of bankruptcy.

Schmidt ordered the mediation on April 18 during a break in the hearing, urging the rival creditor groups who are fighting to take control of Pacific Lumber's assets to reach a settlement.

Referring to himself as a "loose cannon," Schmidt warned them that he would have to resolve the dispute if they didn't. It was the second time he had ordered mediation in the case.

The confirmation hearing is set to resume Tuesday, with Pacific Lumber scheduled to present testimony in support of its plan to reorganize, a proposal that calls for building luxury homes on a small portion of its timberlands in Northern California.

The plan does not have enough support from creditors to win confirmation, and Schmidt has called it "dead in the water."

That has left creditors fighting for control of the company. Bondholders of Pacific Lumber subsidiary Scotia Pacific Co. want Schmidt to allow them to auction Scotia Pacific's 200,000 acres of timberlands, the collateral securing their notes.

Meanwhile, Pacific Lumber's bankruptcy lender, hedge fund Marathon Asset Management, and California logging company Mendocino Redwood Co. LLC have offered to pump new money into Pacific Lumber and take control of the company.

Both camps have urged Schmidt to reject their rival's plan, but Schmidt has signaled during the confirmation hearing that he see problems with each one.

At the end of testimony on April 11, the judge said the bondholders' proposal has "practical problems" because it only applies to Scotia Pacific but doesn't affect Pacific Lumber, according to a transcript.

Schmidt also questioned whether the Marathon-Mendocino plan should increase the proposed recovery for bondholders. As of Pacific Lumber's bankruptcy filing in January 2007, bondholders were owed $740 million in principal and interest on their secured notes. But the Marathon-Mendocino plan only pays them $175 million in cash plus $325 million in new notes.

That has left both sides battling over the value of the timberlands, which Schmidt will have to rule on. Marathon and Mendocino have set a value of $430 million, while bondholders say that's too low and point to a $603 million offer from bondholder Beal Bank in Plano, Texas.

Bondholders, represented by The Bank of New York Mellon Corp. (BK), have warned Schmidt that approving the Marathon-Mendocino plan "would severely damage an already shaky credit market."

"The MRC/Marathon plan, if confirmed, would do more than simply cause irreparable harm to the current noteholders - it would signal to the markets that, despite the representations of an issuer of secured notes or the specific terms of their issuance, holders of secured notes cannot depend on, at least, the return of their collateral," the Bank of New York said.

But Marathon-Mendocino have won the support of unsecured creditors in the case as well as California and federal agencies in charge of regulating logging. Marathon and Mendocino say unlike the bondholders, their plan ensures Pacific Lumber's survival.

"The MRC/Marathon plan, unlike any other plan that has been proposed, will maintain the economic vitality of Northern California by preserving business operations, going-concern value, jobs and pensions," they said.