April 12th 2008

By John Driscoll
The Times-Standard
April 12, 2008

The Pacific Lumber Co. bankruptcy case remains deadlocked after a week of contentious hearings in which creditors tried to shake the foundations of each other's plans to rebuild the company.

U.S. Bankruptcy Judge Richard Schmidt told the parties Friday, before dismissing them until April 29, that there are problems with plans submitted by both main creditors.

Schmidt said in his Corpus Christi, Texas, court that there are legal problems with approving a plan by Palco creditor Marathon Structured Finance Fund and the Mendocino Redwood Co., mainly because they may not have put enough money on the table to make the main secured creditor whole.

"These problems aren't insurmountable," Schmidt said.

Schmidt said he clearly recognizes the value of the land to the state of California, and the importance of a functioning timber company to the Humboldt County economy. The bond holders plan -- whose $714 million in debt is secured by Palco subsidiary Scotia Pacific's 210,000 acres of timber -- has no provision to keep the Scotia mill running, which makes it less attractive, Schmidt said.

If he finds that both plans can be legally confirmed there are serious risks for both parties going forward. Schmidt said that negotiations between Marathon and the noteholders are perhaps the best course to take.

As for Palco's own plan to reorganize Scotia Pacific by selling 22,000 acres off for an exclusive high-end subdivision for the wealthy, Schmidt plainly said he did not believe it was feasible.

"It sounds to me that that plan is dead in the water," he said.

Palco also has not firmed up $150 million in exit financing, although its attorney Shelby Jordan said he hoped to have that secured by April 29, when the proceedings are to continue.

Another key comment by Schmidt was in regard to the value of the Scotia Pacific property. That value is imperative to how the case shakes out. He said the value of the timberlands appears to be between $500 and $600 million -- far lower than Palco's estimates, but not specific enough to indicate whether Marathon's value of $500 million and the noteholders value of $600 million is correct.

Essentially, Marathon and Mendocino Redwood sticking to the lower value risks Schmidt finding their plan unconfirmable by not treating the noteholders fairly. But if Schmidt determines the value is at that lower level, the noteholders -- whose biggest investor Beal Bank has bid $603 million for the land -- risk having both plans confirmed. Mendocino Redwood's plan covers both Palco and Scotia Pacific, and has received enormous support from regulators, the local community, unsecured creditors and environmental groups.

Schmidt said he'd have a tough time making the decision between the two plans, though seemed to believe Mendocino Redwood's was more appealing. Instead, he said he'd rather see the parties work out a deal.

On the stand Friday was Jacob Churner, a representative of a Beal Bank subsidiary that owns about 38 percent of the timber notes. Beal Bank is owned by real estate investor Andy Beal. Churner testified that the bank has the wherewithal to finance the $603 million deal.

"I'm here to tell you I have the authority to close the transaction as I have described to you," Churner said.

Under questioning by Mendocino Redwood attorney Brian Hale, Churner said that a reorganized Scotia Pacific would have about $395 million in debt, or a two-to-one debt-to-equity ratio. While Churner -- who repeatedly called the land a "tree farm" -- said that the harvest rate Beal Bank predicted for the timberlands could service that debt, he also testified that the bank representative that determined that has no experience in forestry.

Much of the information that Beal Bank used to get to its figure of $603 million was blacked out of court documents for confidentiality reasons. Marathon attorney David Neier railed against that, saying that if Beal was bidding more than what he believes is the fair market value, the court should know that, since that's how the bank arrived at its valuation.

Schmidt said there are other questions that might be raised as to the quality of the bids that have been made to the noteholders.

John Fiero, attorney for the Unsecured Creditors Committee, told Schmidt that feasibility of a plan is critical, and that it's in no one's interest to see any part of Palco end up in bankruptcy again. Fiero said it's not possible to render a decision without knowing how much an operator would cut and whether or not that would allow it to pay its debt.

It is precisely an imbalance of those two elements that landed Palco into bankruptcy in January of last year.

The hearings are scheduled to continue from April 29 to May 2.