Suspense builds ahead of SCO's bankruptcy hearing

ON TUESDAY MORNING, SCO will appear before Judge Kevin Gross in US Bankruptcy Court of Delaware for the first time.

Attorneys for Novell will almost certainly be there too. Also for IBM, probably, as well as possibly Red Hat and maybe Autozone and even Daimler-Chrysler. Lawyers for other SCO creditors might also be there. One imagines attorneys will occupy spectator seats and take turns at the counsel tables. It could be a busy courtroom and a long morning.

On Friday, SCO filed for Chapter 11 bankruptcy requesting court protection during reorganisation. It listed assets of $14.8 million and debts of $7.5 million.

It declared 21,784,164 shares of common stock outstanding. At its stock price of 71 cents per share a few days before filing bankruptcy, SCO's market capitalisation was $15.465 million and change. At Friday's closing stock price of 37 cents per share immediately after filing bankruptcy, SCO's market capitalisation had fallen to just over $8.059 million.

SCO's most recent SEC 10Q filing for Q2 2007 shows that it generated a net loss of just over $1.13 million per quarter, or about $4.54 million per year, mostly due to its ongoing SCOsource litigation expenses.

At its present burn rate, SCO could conceivably continue in operation for another 18 months. If it dropped its litigation expenses and cut back on research and development costs somewhat, it might even become marginally profitable.

But of course, SCO didn't file bankruptcy over its balance sheet and burn rate. SCO is in bankruptcy court because it's looking straight down the barrels of major counterclaims against it that have arisen in its own lawsuits against Novell and IBM, counterclaims that threaten to leave nothing more than a smoking crater where its headquarters once stood, figuratively speaking.

In particular, SCO admits in a bankruptcy declaration filing that the US District Court in Utah has ruled that Novell is entitled to receive at least part of $26 million in UNIX SVRX royalties, or as much as $37 million with accrued interest.

That's just SCO's potential liability to Novell, not including what SCO might also end up being found to owe to IBM on its counterclaims. Then there's also Red Hat, waiting in the wings with its own lawsuit against SCO requesting damages.

So, let's consider for a moment the context around SCO's initial Chapter 11 bankruptcy hearing on Tuesday morning.

The amounts of SCO's potential litigation related liabilities are uncertain, because none of these lawsuits have gone to trial yet. This presents a problem for the bankruptcy judge, who needs liability amounts that have been ascertained.

Entry into Chapter 11 bankruptcy is not automatic, but must be granted by the bankruptcy judge. Should the judge find insufficient cause for a company to be granted bankruptcy protection, he can dismiss the petition. If the judge finds that the petitioning firm is not a viable business, he can convert the bankruptcy into a liquidation under Chapter 7. What happens in a bankruptcy is always entirely up to the judge.

In most Chapter 11 bankruptcy proceedings, the petitioning management remains in control of the company as debtor in possession. However, the judge may throw out the company management and appoint a trustee in its place. Situations where that might happen are when executives have engaged in criminal acts or breached fiduciary duties, and similar.

The US District Court in Utah ruled that SCO breached its fiduciary duty to Novell in its SCOsource licencing program and converted Novell's UNIX SVRX licencing royalties to its own use. SCO failed to mention this in its bankruptcy filings.

Hmm. Perhaps attorneys for Novell and IBM might want to address SCO's bankruptcy judge about some of these things. You think?

Plausibly, Novell and IBM lawyers might suggest that the quickest and most efficient way of determining SCO's legal liabilities to them might be to lift the lawsuit stays just long enough for trials in SCO v. Novell and SCO v. IBM. SCO's lawyers have already been paid for these trials, after all.

Novell also might want to argue that SCO's remaining assets are really Novell's money, not SCO's. And one can't imagine Novell failing to point out that SCO's management has been ruled to have committed fiduciary breach and conversion.

Novell, IBM and Red Hat might even argue that SCO's legal liabilities so greatly overshadow its assets and ongoing net income generating capability that liquidation is inevitable.

Maybe one of them might even be willing to take over SCO's declining UNIX business in lieu of its liquidated damages. µ

L'INQS
Groklaw - The Bankruptcy Docket & All Filings...
Groklaw - SCO Files For Chapter 11 Bankruptcy...

See Also
SCO files Chapter 11 bankruptcy
SCO's Darl McBride remains defiant
Countdown starts to SCO v. Novell trial
Rats leave SCO's sinking ship
Novell wins Unix victory over SCO