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UNITED STATES BANKRUPTCY COURT EASTERN DISTRICT OF MICHIGAN

SOUTHERN DIVISION IN RE: ) Chapter 11 ) COLLINS & AIKMAN ) Case No. 05-55927-R CORPORATION, et al., ) (Jointly Administered) ) Debtors. ) Honorable Steven W. Rhodes

GENERAL ELECTRIC CAPITAL CORPORATION’S OMNIBUS REPLY TO THE OBJECTIONS OF THE DEBTORS AND THE CREDITORS’ COMMITTEE TO

MOTION AND MEMORANDUM OF LAW OF GENERAL ELECTRIC CAPITAL CORPORATION TO COMPEL PAYMENTS FIRST DUE AT LEAST 60 DAYS AFTER

THE PETITION DATE UNDER MASTER LEASE AGREEMENTS

General Electric Capital Corporation (“GECC”), by and through its attorneys,

hereby files this omnibus reply (the “Reply”) to the objections of (i) the above-captioned debtors

(collectively, the “Debtors”) and (ii) the official committee of unsecured creditors (the

“Committee”) to the Motion and Memorandum of Law of General Electric Capital Corporation

to Compel Payments First Due At Least 60 Days After the Petition Date Under Master Lease

Agreements (the “Motion”).1 On April 19, 2006, one day after GECC filed the Motion, the

Debtors initiated an adversary proceeding (the “Products Adversary Proceeding”) seeking to

recharacterize the Products Leases as financing agreements. To date, the Debtors have not

initiated an adversary proceeding seeking to recharacterize the Becker Lease. GECC vigorously

disputes that the Leases are anything other than what they purport to be and submits that the

relief requested in the Motion is proper notwithstanding the commencement of the Products

1 For the convenience of the Court, except as defined herein, capitalized terms used herein have the

meanings assigned to such terms in the Motion.

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Adversary Proceeding.2

By repeatedly stating that Section 365 of the Bankruptcy Code only applies to

true leases, the Debtors and the Committee attempt to obfuscate and improperly reframe the sole

issue before the Court-- whether the Debtors should be required to comply with their obligations

under the Leases pending a final resolution of whether the Leases are true leases or disguised

financings, a determination which will be made in the Products Adversary Proceeding. GECC

does not dispute the well-settled body of case law, including In re Mahoney 153 B.R. 174, 176

(E.D. Mich. 1992), that the Debtors cite for the proposition that Section 365 of the Bankruptcy

Code only applies to true leases. That case law, however, is irrelevant3 to the question presently

before the Court-- whether the Debtors must perform under Section 365 pending a determination

that the Leases are true leases. The Debtors’ and Committee’s objections (together, the

“Objections”) fail because they attempt to circumvent applicable case law which requires this

Court to presume that the Leases are true leases until the Debtors prove otherwise.4 To date, the

2 As more fully set forth below, the request of the Committee to consolidate the Motion with the

Products Adversary Proceeding or, in the alternative, to continue the Motion until the conclusion of the Products Adversary Proceeding (a) ignores the presumption that the that the Leases are true leases until proven otherwise, (b) fails to recognize that the burden of proof in the Products Adversary Proceeding is on the Debtors and (c) provides no protection to GECC if GECC prevails in the Products Adversary Proceeding and the Debtors lack the financial wherewithal to pay the back rent.

3 For example, in Mahoney, the court was faced with determining whether, under Michigan Law, a rental purchase agreement was a true lease that was subject to assumption or rejection by a chapter 13 debtor. The Mahoney court found that the agreement at issue was a true lease. See Mahoney, 153 B.R. at 179. The Mahoney court was not faced with whether Section 365(d)(10) of the Bankruptcy Code requires a debtor to comply with its rent and other obligations pending a determination of whether the agreement at issue is a true lease. See id. at 176.

4 GECC shall briefly address the issue of the true nature of the Leases in this Reply in order to refute statements made by the Debtors and the Committee in the Objections. Since this issue is not presently before the Court, however, GECC reserves its right to submit additional memoranda and arguments concerning this issue at a later date.

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Debtors have failed to offer any evidence to overcome the presumption that the Leases are true

leases.

Therefore, this Court should compel the Debtors to perform their obligations

under the Leases, including their obligations to pay rent and taxes first due at least 60 days after

the Petition Date under the Leases. In support of the Reply and the Motion, and based on the

Affidavits of Joseph D. Catarina (the “Catarina Affidavit”) and Doby Rose (the “Rose

Affidavit”) attached to the Motion as Exhibits 4 and 5, respectively, GECC respectfully

represents as follows:

Background

1. On May 17, 2005 (the “Petition Date”), C&A and the other above-captioned

debtors and debtors-in-possession (collectively, the “Debtors”) commenced these cases by filing

voluntary petitions for reorganization under chapter 11 of the Bankruptcy Code.

2. Since that time, the Debtors have continued in possession of their property and

have operated and managed their businesses, as debtors in possession, pursuant to sections

1107(a) and 1108 of the Bankruptcy Code.

3. This Court has jurisdiction over this matter pursuant to 28 U.S.C. §§ 157 and

1334. This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2).

The Leases Are Presumed to be True Leases and the Burden is on the Debtors to Prove Otherwise

4. The Debtors cite a Connecticut bankruptcy court’s decision in In re Circuit-Wise,

277 B.R. 460 (Bankr. D. Conn. 2002), for the proposition that GECC is not entitled to the

payment of rent and other obligations under the Leases until and unless the Court determines the

Leases are true leases. See Debtors’ Objection ¶ 20. However, in Mirant, which was decided

after Circuit-Wise, a Texas bankruptcy court reasoned that Circuit-Wise was incorrect because

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(a) a lease is presumed to be a true lease until proven otherwise, (b) the burden of proof to

recharacterize a lease is on the party seeking recharacterization, and mere allegations, even if in a

complaint, do not meet that burden, and (c) even if the lease is later held to be a secured

financing, any payments made can be applied to reduce the secured claim of the lessor. See In re

Mirant, No. 03-46590, 2004 Bankr. LEXIS 1377, at *12-*13 (Bankr. N.D. Tex. Sept. 15, 2004).

5. In addition, in In re Lansing Clarion Ltd. Partnership, the Bankruptcy Court for

the Western District of Michigan reasoned in part:

This court is cognizant that what is denominated or labeled as a lease is presumed to be a true lease absent compelling evidence to the contrary.

132 B.R. 845, 850 (Bankr. W.D. Mich. 1991)(emphasis added); see also In re Mirant, 2004

Bankr. LEXIS 1377, at *12 (stating that the “terms of the documents- as they have been

presented to the court as of this date - are not inconsistent with a “true lease.” In the absence of

evidence at least sufficient to rebut the natural assumption that a document is in fact what it

purports to be, the court is not prepared to relieve Mirma [lessee] of compliance with Code §

365(d)(3).”).

6. One of the cases upon which the Debtors and the Committee rely, In re PCH

Associates, 804 F.2d 193 (2d Cir. 1986), actually reinforces the proposition that there is a

presumption that a lease is a true lease absent substantial evidence to the contrary. In PCH

Associates, the Second Circuit not only referred to the presumption but characterized it as a

strong presumption. Id. at 200 (emphasis added). The Second Circuit specifically stated that

“there is a ‘strong presumption that a deed and lease . . . are what they purport to be…’” Id.

(quoting Fox v. Peck Iron & Metal Co., 25 Bankr. 674, 688 (Bankr. S.D. Cal. 1982)).

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7. Likewise, in In re Uni-Rty Corp., No. 96-4573, 1998 U.S. Dist. LEXIS 8426, at

*10 (S.D.N.Y. June 9, 1998), aff’d, No. 98-5032, 1999 U.S. App. LEXIS 5731, at *5 (2d Cir.

Mar. 26, 1999), the United States District Court for the District of New York held that there is a

strong presumption under New York law, the law governing the Products Leases, that a deed and

lease are what they purport to be. The Uni-Rty case was an appeal from a bankruptcy court

decision holding that a sale leaseback transaction was not a disguised mortgage, but a true sale.

The District Court affirmed, reasoning:

Under New York law, the burden of establishing that a deed absolute on its face was intended as a mortgage is onerous and rests entirely on the party seeking to recharacterize the transaction. (citations omitted). There is a strong presumption that a deed absolute on its face is what it purports to be, and a party can only overcome that presumption by a showing of clear and convincing evidence proving the precise terms of the alleged mortgage. (citations omitted).

Id.

8. It is well settled that the party asserting that a transaction is other than what it

purports to be in a written agreement bears the burden of proof on recharacterization. See In re

Owen, 221 B.R. 56, 60 (Bankr. N.D.N.Y. 1998). Here, as in Mirant, the Court has only been

presented with unsubstantiated allegations in the Debtors’ Objection and the Complaint. A

debtor’s burden to prove that leases are secured financings “is not met by mere allegations, even

when the allegations are presented in the form of a complaint under Fed. R. Bankr. Pro. 7001.”

Mirant, 2004 Bankr. LEXIS 1377, at *13.

9. In Elder-Beerman, which was cited with approval in Mirant, the subject lease was

unambiguously titled as a lease and had been treated that way at all times by the parties prior to

the commencement of the bankruptcy. See In re Elder-Beerman Stores Corp., 201 B.R. 759,

764-65 (Bankr. S.D. Ohio 1996). The Elder-Beerman court held that Section 365(d)(10) requires

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performance of all obligations thereunder “until given leave by the court to do otherwise.” Id.

The court further opined that the debtor could not “circumvent the requirements of § 365(d)(10)

while challenging the nature of the agreements.” Id. at 764; see also In re Mirant, 2004 Bankr.

LEXIS 1377, at *12.

10. Here, not only are the Leases titled “leases” but the Debtors and their accountants

treated them as such in every respect. Moreover, the Debtors explicitly agreed in Section 18 of

each of the Products Leases that they were true leases. Thus, consistent with Elder-Beerman and

Mirant, the Leases are presumptively true leases, requiring the Debtors’ compliance with their

obligations thereunder, including payment of rent and taxes, until and unless this Court enters a

final judgment in an adversary proceeding determining that they are not true leases.

11. Finally, although GECC’s answer to the Debtors’ Complaint in the Products

Adversary Proceeding is not yet due, GECC intends to deny the vast majority of the allegations

in the Debtors’ Complaint, including, without limitation, the Debtors’ allegation that “GECC

paid nearly three times the value of the equipment purportedly purchased, leaving itself seriously

under-secured.” See Debtors’ Objection ¶ 2. GECC has substantial evidence supporting its

contention that the Leases are what they purport to be and such evidence and whatever additional

evidence is gleaned from discovery will be presented in the Products Adversary Proceeding.

The Debtors Must Comply with Section 365(d)(10)

12. Because under New York law the Leases are presumed to be true leases unless

and until the Debtors’ meet their burden to prove otherwise, pending the Court’s determination

of the issues regarding the nature of the Leases, the Debtors must comply with their obligations

under Section 365(d)(10) of the Bankruptcy Code. Section 365(d)(10) of the Bankruptcy Code

was enacted in 1994 to protect lessors who are at the mercy of debtors, as GECC is here, from

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being subjected to this very type of dilatory and unfair conduct. Under Section 365(d)(10),

debtors have the burden of filing a motion with the bankruptcy court to reject a lease during the

sixty (60) day “breathing period” following commencement of a case. If they choose not to do

so, they are bound to begin timely performance under the lease after such “breathing period” and

until the bankruptcy court orders otherwise. See In re Eastern Agri-Systems, Inc., 258 B.R. 352,

354-55 (Bankr. E.D.N.C. 2000); In re Russell Cave Co., 247 B.R. 656, 660 (Bankr. E.D. Ky.

2000). The Debtors’ attempt to recharacterize the Leases at this point in the cases does not

relieve them of the obligations they have incurred under the Leases from and after July 16, 2005

(i.e., sixty (60) days after the order for relief was entered in this case) to the present and should

not relieve them of their obligations under the Leases in the future, including making rent

payments as and when due.

The Equities of the Case Require the Debtors’ Compliance with Section 365(d)(10) of the Bankruptcy Code

13. The equities of these cases support the relief requested in the Motion-- the

Debtors’ full compliance with their obligations under the Leases. Allowing the Debtors to

escape their obligation to pay rent while they benefit from the use of the equipment is inequitable

given the clear and irrefutable prejudice to GECC. The Debtors’ failure to fulfill their

obligations under the Leases should not be rewarded-- if the Debtors want to reap the benefits of

the Leases (the use of the equipment), they should also bear the bargained for burdens (the

payments thereunder).

14. The Debtors’ statements that they have paid GECC in excess of the amounts

GECC seeks in the Motion not only are incorrect, but also fail to address future obligations under

the Leases. GECC not only seeks immediate payment of all rent and other obligations under the

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Leases (other than the Sixty Day Payments) due as of the date hereof, but also the payment of all

rent and other obligations under the Leases from the date hereof through the date of final

resolution of the Products Adversary Proceeding.

15. The Debtors paid GECC the rent (but not certain taxes) due under the Products

Leases during the first 60 days of these chapter 11 cases. At that time, the Debtors did not

dispute that the Products Leases were true leases. Pursuant to section 365(d)(10) of the

Bankruptcy Code, the Debtors could have chosen not to pay such amounts until the conclusion of

such 60-day “breathing spell.” However, section 365(d)(10) does not permit the Debtors to seek

disgorgement or reapplication of payments already made (especially not in an objection to a

motion to compel payment of rent) merely because the Debtors chose to make such payments

when due rather than 60 days later.

16. Months ago, counsel for GECC sent counsel for the Debtors copies of

approximately $186,000 in tax invoices together with all of the supporting documentation. It is

disingenuous of the Debtors to allege they are “reconciling” such invoices. The reality is that the

Debtors are refusing to pay these invoices, notwithstanding their agreement to do so. GECC will

present evidence of the amount due under the Leases at the hearing on the Motion.

17. GECC has drawn approximately $3.952 million from a single letter of credit

posted to secure Products’ obligations under only one of the three Products Leases, the Master

Lease Agreement dated as of June 25, 2004, as amended, between GECC and Products, a copy

of which is attached hereto as Exhibit A. Pursuant to Section 12(b)(iii) of such lease, upon the

occurrence of an event of default under such lease, the “Stipulated Loss Value” of the leased

equipment plus all unpaid rent and other sums due under the lease are immediately due. That

amount far exceeds $3.952 million. Even if GECC were to apply a portion of the $3.952 million

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to first quarter 2006 rent under such lease --which GECC is not required to do-- first quarter

2006 rent and taxes under the other two Products Leases would still be due.

18. While it would be inequitable for the Debtors to benefit from the use of the

equipment under the Leases while the Products Adversary Proceeding is pending, it would be

even more inequitable if the Debtors lacked the financial wherewithal to pay the back rent and

taxes upon resolution of the recharacterization issues in GECC’s favor. Even the Circuit-Wise

court recognized that it would be appropriate in cases such as this for a debtor to post security to

protect the putative equipment lessor’s accruing claim for administrative rent in the event that the

lessor ultimately prevails on the true lease issue. Circuit-Wise, 277 B.R. at 463.

19. Although there is no way to predict the amount of time in which it will take to

litigate the Products Adversary Proceeding, 5 while the Products Adversary Proceeding is being

litigated, obligations under the Leases will continue to accrue. As set forth in the Motion and

accompanying affidavits, yearly rental obligations under the Leases are approximately

$13,814,061.89. See Catarina Affidavit ¶ 6 and Rose Affidavit ¶ 6. Given the magnitude of

these obligations and the Debtors’ precarious financial situation, the relief requested in this

Motion is particularly appropriate. There is a substantial risk that the Debtors will lack the

financial wherewithal to pay the back rent and taxes upon resolution of the recharacterization

issues in GECC’s favor.

5 In In re Worldcom, on November 17, 2003, the debtors filed a complaint seeking, among other things, recharacterization of an equipment leasing agreement with GECC as a financing or security arrangement (the “WorldCom Recharacterization Litigation”). See In re WorldCom Inc., No. 02-13533, 2006 WL 280797, at *3 (Bankr. S.D.N.Y. Feb. 7, 2006). More than three years later, on February 7, 2006, the Bankruptcy Court for the Southern District of New York issued an opinion denying both parties’ motions for summary judgment. Id. at *52. Presumably, the parties in the WorldCom Recharacterization Litigation, will now, more than three years after the WorldCom Recharacterization Litigation was commenced, proceed with a trial on the merits.

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20. In addition, as noted by the Elder-Beerman court, by requiring the Debtors to

make payments due under the Leases as and when due, GECC is protected in the event that the

case is converted to Chapter 7 or the estate becomes administratively insolvent. 201 B.R. at 764.

Here, the Debtors’ pre-petition and post-petition secured lenders have pre-petition and post-

petition liens on, and superpriority claims against, substantially all of the Debtors’ assets. Unless

GECC is paid rent and other obligations as and when due, GECC is unaware of any

unencumbered funds from which back rent could be paid.

21. In Mirant, 2004 Bankr. LEXIS 1377, *13, the court saw no harm in requiring the

debtor to pay rent pending a determination of the recharacterization issue because if the lease in

Mirant was found to be a secured financing, the amount paid would simply be applied to

principal. The Debtors assert that the replacement value of the leased equipment is $21 million.

See Debtors’ Objection ¶ 28.6 The Debtors also refer to additional security in the form of a

$3.952 million letter of credit and affiliate guarantees secured by additional equipment pledges.

See Debtors’ Objection ¶¶ 29 and 30. Based on the Debtors’ calculations, if GECC were held to

be a secured creditor, its secured claim would be equal to $24.952 million plus the value of the

additional pledged equipment. Therefore, as in Mirant, any rent paid to GECC during the

pendency of the Products Adversary Proceeding could be applied to principal if the Products

Leases were found to be secured financings.

22. Therefore, GECC respectfully requests that this Court order the Debtors’

compliance with the Leases (including, without limitation, ordering the Debtors’ immediate

6 The Debtors assert that the leased equipment is essential to their business. See Debtors’

Objection ¶ 3. Presumably then, the Debtors will retain such equipment in a reorganization. In Associates Commercial Corp. v. Rash (In re Rash), 117 S.Ct. 1879 (1997), the United States Supreme Court held that replacement value, not wholesale or liquidation value, should be used to value collateral that was going to be retained by a debtor pursuant to its chapter 13 plan.

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payment to GECC of all amounts which have accrued under the Leases since July 16, 2005 and

payment of all future obligations under the Leases as and when due) pending the Court’s

determination of the Debtors’ challenge of the Products Leases.

Notice

23. Notice of this Reply has been served in accordance with the First Amended

Notice, Case Management and Administrative Procedures, and all applicable Bankruptcy Rules

and Local Rules.

WHEREFORE, GECC respectfully requests that the Court (i) overrule the

Objections, (ii) compel the Debtors to timely perform all obligations first due at least 60 days

after the Petition Date, including, without limitation, the obligation to pay rent, taxes and

attorneys’ fees, and (iii) grant such other and further relief as the Court deems just and proper.

May 9, 2006 /s/ Erin L. Toomey Judy A. O’Neill (P32142) Erin L. Toomey (P67691) FOLEY & LARDNER LLP One Detroit Center 500 Woodward Avenue, Suite 2700 Detroit, Michigan 48226 Telephone: (313) 442-6490 Facsimile: (313) 234-2800

etoomey@foley.com -and- David S. Heller Josef S. Athanas LATHAM & WATKINS LLP 233 South Wacker Drive Sears Tower, Suite 5800 Chicago, Illinois 60606 Telephone: (312) 876-7700 Facsimile: (312) 993-9767

ATTORNEYS FOR GENERAL ELECTRIC CAPITAL CORPORATION

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Exhibit A