It all finally ended in the wee morning hours on April 6 in the New York office of Cadwalader, Wickersham & Taft LLP, an auction for bankrupt Blockbuster Inc. that had started the day before. That the auction took so long and was so exhausting epitomized what had been described as a "three-ring circus" of a Chapter 11 case by many of the professionals involved with it. And the fact that not a single attorney or adviser would speak about it on the record indicates just how much power the players involved -- Carl Icahn, Dish Network Corp.'s Charlie Ergen, various hedge funds -- wield.

Ergen's $320 million bid prevailed just after a group of hedge funds owning secured note debt bowed out, enabling Blockbuster to live for another day. Indeed, since filing for Chapter 11 on Sept. 23, Blockbuster has definitely been taking it one day at a time. The Dallas movie rental giant went from a humdrum prenegotiated reorganization to acknowledging it was administratively insolvent to having to go on the auction block to facing the real possibility of liquidation. Creditors were on a similar roller coaster, with unsecureds going from healthy recoveries to battling over scraps, and with movie studios promised full payouts ultimately being left to pray for a spirited auction so they would at least extract enough of the sale proceeds to partially cover their losses.

"To have a bankruptcy case go from a prearranged filing in September to a hearing on a conversion to a Chapter 7 in March, that's just a tremendous turnaround in the wrong direction," says one source familiar with creditors' thinking. "There haven't been many cases that collapsed that spectacularly that I can remember."

The seeds for such an epic collapse had been sown months before Blockbuster submitted its petition to the U.S. Bankruptcy Court for the Southern District of New York in Manhattan. Prepetition talks were strained, as evidenced by the two reorganization plan outlines conferees went through before deciding on one. Then the inimitable Icahn, a former Blockbuster shareholder and board member, edged his way back onto the scene.

But Blockbuster had become a mess years before negotiations had even been broached. The digital format has come to dominate the video rental business, thanks to mail-order DVD rental provider Netflix Inc., video-on-demand services from cable providers and vending machine suppliers such as Redbox Automated Retail LLC, which offers $1 DVD rentals through supermarket kiosks and other outlets. But Blockbuster and its brick-and-mortar rivals were slow to pick up on these innovations. Its two biggest competitors, Movie Gallery Inc. and Hollywood Entertainment Corp., which merged, disappeared after Movie Gallery underwent two bankruptcies and eventually liquidated. In fact, Blockbuster was so out of sync that it launched an eyebrow-raising, unsolicited $1 billion bid for electronics retailer Circuit City Stores Inc. in April 2008 that it luckily withdrew three months later. A year later Circuit City liquidated.

Blockbuster, under former 7-Eleven Inc. CEO James Keyes, did try to compete with Netflix by creating its own by-mail subscription business as well as an online distribution channel. It also launched thousands of Blockbuster Express vending kiosks and signed agreements with electronics developers such as Samsung Group and Royal Philips Electronics NV to embed a Blockbuster application into Internet-connected TVs and Blu-ray players. But ultimately, Blockbuster couldn't escape its past. Retail outlets had produced its best margins, and given its bulk -- more than 3,000 leased U.S. stores and upwards of 5,000 worldwide -- the new distribution channels just couldn't make up for diminishing sales.

For years Blockbuster had also struggled with debt covenants. Problems began as early as 2004, and the company was able to delay a crisis in October 2009 only by issuing $675 million in 11.75% senior secured notes and $300 million in 9% unsecured senior subordinated notes to help refinance a revolver and term loan that were to expire in 2010 and 2011.

But Blockbuster fell woefully short of expectations in 2009's holiday season and hemorrhaged $558.2 million in cash that fiscal year, posting a $1 billion decrease in revenue and suffering a disastrous 15.6% decline in same-store sales. By late winter 2010, Blockbuster and its noteholders had begun to mobilize, with Rothschild and Weil, Gotshal & Manges LLP advising the company, Sidley Austin LLP and Houlihan Lokey Inc. providing counsel to senior noteholders, and Moelis & Co. and Paul, Weiss, Rifkind, Wharton & Garrison LLP representing the senior subordinated group.

Such a mobilization, however, was too late in coming. Blockbuster began making emergency moves to boost liquidity, such as handing its movie studios liens on its Canadian operations for 30 days of credit. Senior subordinated noteholders proposed exchanging their securities for new equity and debt in a deal that included a backstopped rights offering. But the talks yielded nothing. "The seniors wanted a bigger paydown and better note terms than the subordinated [noteholders] could muster," says the creditor source. "They tried and failed, but there was some comfort -- [the company] had been market-tested."

Blockbuster hired Alvarez & Marsal North America LLC as restructuring advisers in April 2010 and named Jeff Stegenga its chief restructuring officer three months later (A&M didn't respond to several requests for comment). The thinking among advisers was that Blockbuster needed a $100 million infusion, but soon even that amount began sounding naive. Despite dabbling in potential deals with two unnamed "large, financially capable strategic parties," according to court documents, Blockbuster kept talks going with its advisers and creditors, and eventually they reached a deal. According to a source with knowledge of the prepetition talks, agreement had come on a term sheet for a reorganization plan that would have left Blockbuster with $400 million of new senior debt coming out of bankruptcy after some operational and management changes were made "immediately."

But when Icahn bought some 31% of Blockbuster's senior notes in mid-September and got himself a seat at the negotiating table, the complexion of the situation quickly changed, sources say. "He came in before the filing and threw a wrench into everything," says one source involved in the prepetition discussions.

Icahn and Blockbuster already had quite a history together. Icahn had bought shares in Blockbuster in 2004 when it was eyeing Hollywood Entertainment and then waged a proxy battle against the company a year later, winning seats for himself and two others and eventually pushing out CEO John Antioco (Keyes replaced him). Management may have gotten a false sense of security when Icahn stepped down from the board early in 2010 and sold off his shares, citing rising sentiments that one person shouldn't sit on too many boards.

Now Icahn was back, and soon the prenegotiated plan was "changed radically," morphing into a proposal that was, in essence, a "zero-debt plan" that would completely deleverage Blockbuster, says one creditor's adviser who asked not to be named. The idea wasn't necessarily crazy or unwarranted; many participants in Blockbuster saw Movie Gallery exit its first bankruptcy on May 20, 2008, with more than $800 million in debt on its balance sheet and still no true operational fix. What irked them about Icahn was that he wanted to push forward the zero-debt plan after the prenegotiated one had been months in the making.

Also angering participants was Icahn's taking part in intense closed-door meetings regarding the expenses of the Blockbuster bankruptcy and his desire to slash lawyer and other fees. One firm, Houlihan Lokey, which had worked on the case for months, resigned as financial adviser to Blockbuster's senior noteholder group because of the harsher attitudes toward fees and was replaced by Jefferies & Co. Then, one creditor notes, Icahn floated the idea of injecting $200 million into the company, though none of the other noteholders wanted to take the risk.

Still, the term sheet Blockbuster brought to the Manhattan bankruptcy court had Icahn's fingerprints all over it. The plan was to swap $630 million in senior secured notes into a 100% equity position for its noteholders. The senior subordinated group, due $300 million, was to be wiped out along with preferred and common stockholders, while unsecured creditors were initially promised warrants to buy 3% of the equity.

A $375 million debtor-in-possession loan from a group of the senior noteholders, consisting of a $125 million new-money revolver and as much as $250 million in notes rolled up from a portion of the prepetition secured notes, would finance the plan, with the DIP revolver packing an option for conversion into a like-sized exit financing. In theory, Blockbuster was preparing to whittle its debt down to $125 million from about $1.46 billion. Blockbuster's movie studio creditors -- Warner Home Video, Twentieth Century Fox Home Entertainment LLC, Sony Pictures Home Entertainment Inc., Walt Disney Co., Lions Gate Films Inc., Paramount Home Entertainment Inc., Summit Distribution LLC, Universal Studios Home Entertainment LLC and VPD IV Inc. -- were all on board, thanks to accommodation agreements under which they were promised payments in the ordinary course of business for goods shipped on customary credit terms. Noteholders holding 80.1% of the debt, or some $504.61 million of it, including Icahn-backed Icahn Capital Management LP, Värde Partners LP, Owl Creek Asset Management LP, Stonehill Capital Management LLC, Monarch Alternative Capital LP and Tenor Capital Management Co. LP, all signed the term sheet. Blockbuster filed for bankruptcy on Sept. 23.

Executing the plan, of course, became a different matter entirely. The DIP depended on several milestones being met -- a plan filing by Nov. 22, disclosure statement approval by Jan. 15 and plan confirmation by March 15 -- yet the hard-won term sheet was never turned into an official disclosure statement. Meanwhile, the company continued to unspool financially, taking a $36.5 million net loss on $177.8 million in revenue between Sept. 23 and Oct. 31 and then a $42.1 million net loss on $142.6 million in revenue between Nov. 1 and Nov. 28.

Again, the holiday season came with heavy financial pressure attached. This time, though, Blockbuster pinned its hopes on something it had that its competitors didn't -- the so-called 28-day window. According to court papers, the window, imposed by certain movie studios in 2009, gave Blockbuster access to new movies during the first 28 days of their release.

With the backing of noteholders, Blockbuster embarked on an expensive and massive ad campaign -- lenders poured some $30 million into it, sources say. But the ad blitz failed to spur sales. "The [noteholder] group was pretty upset about it," says one source familiar with the group's thinking. "That was the straw that broke the camel's back."

The creditor's adviser who asked not to be named offers another metaphor: "The wheels fell off the bus." The company waited until January to tell the movie studios, which continued to rack up postpetition claims, and others. Worse still, Blockbuster missed certain milestones tied to the plan support agreement outlining its never-filed reorganization plan and thus defaulted on its DIP, on which it had never even drawn down. But because it defaulted on the loan, Blockbuster tripped a provision causing noteholders to roll up $125 million of their securities into the loan, thus granting them superpriority treatment afforded any DIP lender.

Whirlwind discussions took place, during which the noteholders that had been funding Blockbuster's losses not only decided to pull the plug but, sources say, to split into two groups: one led by Icahn, the other by Monarch. The battle lines were drawn. The Monarch group went out and hired Milbank, Tweed, Hadley & McCloy LLP as its legal counsel and then re-engaged Houlihan Lokey as its financial adviser. Icahn grabbed Cadwalader as his counsel.

Creditors' advisers disagree on the sums that different groups said they'd invest in Blockbuster, with one indicating Icahn was willing to pony up a couple hundred million himself to help boost the digital business in return for absolute control of the reorganized entity. But the discord only made a sale the strongest alternative for Blockbuster.

"When the [financial] results appeared to be really, really poor, the magnitude of the postpetition administrative claims became clear, and it was clear that there was not going to be a consensus with the other lenders and Icahn, each of which had a blocking position," says a second source familiar with the noteholder group's thinking. "As a result of those things, the only option was a sale."

One noteholder source asserts that the split in the noteholder group was the best way to achieve maximum value for Blockbuster. "Icahn was always open to partnering up with others, but I think the Monarch group wanted to split off because there was an inherent distress because of Icahn bidding on the asset," the source says. "They wanted to make sure there was a healthy competition to push up the price as much as possible."

Rothschild pegged the Monarch-led group for the role of stalking horse after an informal search, with a vehicle named Cobalt Video Holdco LLC making a bid worth at least $265 million and potentially as much as $290 million that it filed with the bankruptcy court on Feb. 21. It was an intriguing offer because it included an "agency alternative," a provision mandating that in the court order approving the sale, the winning purchaser could convert the rental chain's case to a Chapter 7 liquidation under "certain circumstances." As part of the deal, too, Blockbuster sought to bifurcate the treatment of Chapter 11 expenses between unpaid presale administrative expenses and sale-related administrative expenses. The former were to remain unpaid, while the latter were to be given administrative priority-claim status.

More than 40 objections flooded in, leading U.S. Trustee Tracy Hope Davis to denounce the plan as "unfair discrimination," since it seemed to treat the movie studios and other administrative creditors differently from others. She criticized the sale motion as being "contrary to the Bankruptcy Code" and blasted Blockbuster for racking up administrative expenses without any likelihood of a reorganization as well as for handing its control over a potential case conversion to the buyer. The bifurcation request, she added, was an "implicit admission" of administrative insolvency.

One of the movie studios, Summit, then joined the fray, accusing Blockbuster of "intentional and coordinated misrepresentations" to its postpetition vendors, insisting that the company had never made good on its promise to pay them under the accommodation agreements and was also trying to enjoin vendors from reclaiming their goods or seeking payment for them.

Judge Burton Lifland of the Manhattan court, at a March 2 conversion hearing, called the stalking-horse bid "one of the most aggressive documents that I have seen in my ... 31 years on the bench." He added: "So I expect that if anything is going to fly, this garbage truck better sprout wings."

Once more, feverish negotiations ensued over the next eight days because "the judge made clear he wasn't going to let the secured lenders take this asset without paying at least a portion of those administrative claims," one creditor source notes.

If anything, the rancor continued to build, with lawyers shouting at each other in the hallway during a March 10 hearing. The root of the commotion was Blockbuster's lack of cash to pay its administrative claims, let alone more than $600 million in notes. As a result, lawyers representing various creditor groups -- noteholders, movie studios and others -- who initially stood to receive large, if not complete, recoveries, were now left to fight over crumbs. "There were some sharp elbows in there, a lot of people hot under the collar," says the creditor source.

The end result was an agreement that one lawyer, Richard Kanowitz of Cooley LLP, who represented the unsecured creditors' committee, called "the best of a bad case" at the hearing, records show. It included a waterfall agreement -- in which cash first flows to one set of creditors, then spills down to others -- that split the proceeds of the sale 75%-25% between noteholders and holders of administrative claims, which were no longer bifurcated.

In addition, about $3.5 million from Blockbuster's lenders' cash collateral was made available immediately to pay $40 million in pre-Feb. 24 administrative claims that were frozen. (A little more than $100 million was due to Blockbuster's administrative creditors, including the movie studios.) Those claims were due to so-called nonparticipating studios, which were considered as such because they didn't have a deal in place to continue doing business with Cobalt. Those creditors were promised $4 million from the sale proceeds after the $125 million in rollup notes tied to Blockbuster's DIP loan were paid off.

Unsecured creditors, who were initially to get warrants to purchase stock as part of the prenegotiated plan, were now left to hope for an auction for significant recoveries. "It was a multiheaded beast," says the creditor source. "That's what made a really ugly process fair and more palatable."

Yet the movie studios stood to potentially lose money if overbidding took place at an auction, court records show. As part of the Cobalt agreement, the movie studios were promised a recovery of about 24% -- roughly $24 million -- from the sale proceeds. But the deal had a weird twist: That recovery for the studios would drop to a $11.5 million floor once one bidder made an offer higher than Cobalt's.

The new deal did defang the conversion movement. Summit promptly withdrew its attempt to get the case changed to Chapter 7. The witty Lifland told the assemblage that he was glad all the acrimony had finally resulted in a solution. "I do want to express my appreciation for all of those who have been on a diet today and have not eaten at all, and really your efforts were all in the best interest of all stakeholders," he said. "There [have] been a lot of unhappy stakeholders here. There's been a lot of give-ups in order to make it possible, and I appreciate that, without in any way indicating how I might come out in an adversarial context if one should come up."

But the tumult was far from over. For the Blockbuster auction, the baseline for bidding was set around the figure promised to administrative creditors -- $24.5 million -- and on April 5, five different bidding groups stepped forward in Lifland's courtroom: Cobalt; an Icahn-led consortium that ominously included liquidator Great American Group LLC; South Korea's SK Telecom Co. Ltd.; a group consisting of wind-down specialists Gordon Brothers Group LLC and Hilco Merchant Resources LLC; and Ergen's Dish Network.

The surfacing of Dish was particularly interesting. "They made proposals early on in the case," says one noteholder source, "then disappeared and came back [later]."

Ergen's reappearance was fortuitous, since it gave Blockbuster, at worst, a 40% chance of surviving as a going concern. Sources contend that Icahn planned to shutter Blockbuster's stores, liquidate the inventory and buy up the digital business -- a strategy similar to the one the Monarch group planned to employ, even though it didn't have a wind-down specialist as part of its bidding team. Both SK Telecom and Dish, meanwhile, appeared to offer Blockbuster a glimmer of hope. The Gordon Brothers-Hilco group wouldn't be a factor. It never made an official bid, with one source at the auction dismissing the team as just "hanging by the hoop."

Dish began the auction with a $284 million bid. SK Telecom tried to establish itself early, adding $500,000 to the Dish offer. Sources say SK Telecom had crafted a deal with the movie studios, which would be paid $60 million -- a vast improvement from the $24.5 million they'd get under Cobalt's baseline bid.

But Blockbuster's advisers disagreed, calling the bid neither higher nor better than the previous offer. The source present at the auction says that SK Telecom simply made a mistake; the auctioneer didn't give it any flexibility to shift the $60 million portion over to the adjusted cash purchase price (the figure was instead deemed an assumed liability). As a result, the bid wasn't deemed better than Dish's offer, and SK Telecom immediately bowed out. "Had they taken $30 million and just moved it to the cash purchase price, they would've been real contenders," says the auction source.

Instead, Dish, Icahn and the Monarch-led noteholder faction went at it the rest of the day and into the early-morning hours, the proceedings moving from the bankruptcy court, which closed at 6 p.m., to Cadwalader's 1 World Financial Center offices just a few blocks away.

Icahn was the first of the three to drop out, or be disqualified, which the auction source found somewhat surprising, given how serious his intent was in acquiring Blockbuster compared to the other noteholders.

"At the end of the day, I don't think [the Monarch-led group] was ever very serious about owning the asset," the auction source says. "I think [their] strategy was to hang in there for a few rounds of bidding and drive the price up."

But Icahn appeared more than willing to continue bidding higher -- "significantly" higher, the auction source notes. Problem was, Icahn's final bid created confusion about valuation. The auction source explains that Icahn's final bid contained a spread, including a floor and a cap that Great American Group was willing to pay for its portion of the bid. The Icahn group initially thought that Blockbuster didn't have a problem with the spread, but was instead blind-sided early Wednesday morning when their offer was penalized by some $10 million because of the "uncertainty of the spread" and the risk of the inventory count in the proposal.

"Blockbuster wanted Icahn to take all of the risk, as the Cobalt bid was doing, but the problem was the methodology," the auction source says. "The way Blockbuster and Icahn valued the inventory was different."

The various parties couldn't come to an agreement as to how the inventory was valued, despite trying to bridge the difference, and after a break that another auction source says lasted hours, Icahn failed to change the bid. After some "objections and shouting," this source says, Icahn departed.

Instead of clearing away the tension, Icahn's exit only served to heighten it. "They were concerned they were going to lose Dish," says the auction source about the advisers conducting the bidding. "There was pressure to move the auction forward."

But it didn't last much longer. Dish made a $320 million bid, and the Monarch-led noteholders, which had last offered about $12 million less, bowed out between 1 a.m. and 2 a.m.

Four hours later, Dish issued a press release proclaiming its victory and estimating that it expected to pay about $228 million in cash following several adjustments.

Of the total, $125 million was reserved for the rollup notes, with the rest split according to the waterfall agreement between noteholders and administrative creditors. Noteholders stood to recover just 26% of their claims.

The question now is, will Blockbuster remain a going concern? One observer who closely watched the case but didn't participate, David Berliner, a partner with BDO Consulting, doesn't expect Dish to keep many of Blockbuster's physical stores in the long run, but sees Ergen's company using the outlets for synergistic purposes to expand Dish's satellite-TV customer base. "Long term, I don't think they're into running a retail operation," he says. "I look at this as a real inexpensive gamble, so to speak."

The movie studios, which didn't do as well as they first thought they might in the Blockbuster bankruptcy, may still hold the key. As Berliner notes, Blockbuster can survive only as long as those vendors allow it to by shipping product. The good news is that Dish can negotiate with the studios directly, without the sprawling cast that characterized every crucial discussion during Blockbuster's bankruptcy stay.

"There was a lot at stake," says the creditor source. "You had some very aggressive personalities in the room, and people did not exactly see eye to eye on a lot of things."

A Hollywood ending it wasn't, but given Blockbuster's operational and financial challenges, the mere fact it could ride off into the sunset is a victory in its own right.