June 11th 2008

By John Driscol
The Times-Standard
June 11, 2008

A federal bankruptcy court has put off hearing issues that could possibly unravel his intended confirmation of a plan to allow Mendocino Redwood Co. to take over the Pacific Lumber Co.

U.S. Bankruptcy Court Judge Richard Schmidt on Monday decided to push the key hearings to start on June 30. The biggest issue on the table is a claim by the noteholders, whose $714 million in debt is secured by Palco's 210,000 acres of timber.

While perhaps one of the less convincing claims put forward by the noteholders, if granted -- or partially granted -- it could unglue Mendocino's plan to pay off the notes for $530 million.

Essentially, the bond holders are arguing that the value of their secured claim -- the timberlands -- declined hundreds of millions of dollars since the January 2007 Chapter 11 filing. Another $20 million was lost in administrative expenses, they argue. The noteholders are asking the judge to award them a super-priority claim.

The judge, however, set the value of the timberlands at not more than $510 million. That's what Mendocino would have to pay the noteholders. A super-priority claim could be tacked on top of that, and if it were, it could undercut Mendocino's plan.

Scotia Pacific, the timber-holding arm of Palco, has said that the noteholders' collateral was adequately protected because trees are growing faster than they are logged, making the land more valuable. It also initially claimed that the timberlands were worth more than the full amount of the bonds.

The bond holders now argue that Scotia Pacific never presented any evidence that tree growth exceeded harvest.

The court itself has allowed Scotia Pacific to use cash based on the idea that the trees are growing faster than they are logged. Scotia Pacific's attorneys argued that if anything, the value of the timberlands has gone up, not down.

"Whatever the value is, however, no one has introduced a shred of evidence that the value has declined since the petition date," the attorneys wrote.

It would be up to the noteholders to produce evidence that the value of the land has dropped, argued attorneys for Mendocino Redwood and its partner in the case, creditor Marathon Structured Finance Fund.

"The noteholders' claim was undersecured at the time these cases commenced," Mendocino Redwood attorneys wrote.

Indeed, the noteholders themselves in the initial months of the case put a value of $375 to $420 million on the timberlands. Not until earlier this year did they raise that to $603 million, based on a bid by the largest noteholder Beal Bank, a bid which the judge recently called laden with conflict.

The judge may have some leeway on the $510 million figure he ultimately decided. He ruled that the value of the lands is "not more than" $510 million, leaving him with the possibility of reducing that value by the amount of the noteholders' claim, if it's granted.

The hearing on that matter is set for June 30. July 1 and 2 are set to hear the noteholders' request for a stay pending an appeal of Schmidt's ruling, and their request to appeal to another court.