On January 6, 2017, Judge Robert D. Drain of the Bankruptcy Court for the Southern District of New York orally approved a prepackaged plan of reorganization (a “Prepack”) in In re Roust Corporation, et al. (Case No. 16-23786), only seven days after Roust Corporation (“Roust Corp”) and two of its affiliates, CEDC Finance Corporation LLC (“CEDC Finco”) and CEDC Finance Corporation International, Inc. (together with Roust Corp, the “Debtors”), filed petitions for relief under Chapter 11.  By having a plan of reorganization confirmed in only seven days, In re Roust became the fourth shortest Chapter 11 reorganization in recent history, and the shortest in the Southern District of New York (Judge Drain noted that the average length of a true prepack in SDNY is thirty-five days).  This blog post examines the seven most important steps the Debtors took to achieve such a speedy confirmation, and, along the way, highlights several notable legal holdings made by Judge Drain at confirmation.

The Facts and Circumstances of In re Roust

The Debtors and the Debt

The Debtors, all holding companies, filed petitions for relief under Chapter 11 on December 30, 2016 (the “Petition Date”).  Roust Corp, the lead Debtor, wholly owned, directly or indirectly, the equity in several dozen non-Debtor affiliated entities (the “NDEs” and, together with the Debtors, the “Roust Group”).  Through its operating entities, the Roust Group comprised one of the largest vodka producers in the world and the largest integrated spirit beverages business in Central and Eastern Europe.  Roust Corp was ultimately wholly owned by a single individual—Roustam Tariko (“Tariko”), the founder and sole owner of the conglomerate known as the Russian Standard Group (“Russian Standard”), whose enterprises include Russian Standard Vodka (“RSV”), the largest domestic distiller and distributor of Vodka in Russia, and Russian Standard Bank, one of the largest Russian banks and leading consumer lender in Russia.  Tariko, through Russian Standard, wholly owned Roust Trading Limited (“RTL”), which itself owned 100% of the equity in Roust Corp and, therefore, 100% of the Roust Group.

Tariko and Russian Standard acquired the Roust Group through the Chapter 11 reorganization of Central European Distribution Corporation (“CEDC”), which filed for Chapter 11 relief in the District of Delaware in 2013 (Case No. 13-10738-CSS).  RTL had held a 19.5% equity stake in CEDC prior to its 2013 bankruptcy and, through a substantial capital contribution in CEDC’s Plan of Reorganization, acquired 100% of the equity in the reorganized CEDC, which was subsequently renamed Roust Corp.

As part of CDEC’s plan of reorganization in 2013, CEDC Finco was created and issued two set of notes: the Senior Secured Notes and the Senior Convertible PIK Notes (the “Convertible Notes” and, together with the Senior Secured Notes, the “Noteholders”), both due 2018.  At the time of the Debtors’ filing in 2016, approximately $488 million in principal of the Senior Secured Notes and $279 million in principal of the Convertible Notes were outstanding.  Although the NDE’s had various debts and credit facilities outstanding at the Petition Date, the Debtors did not propose to alter or impair any debts owed to non-Russian Standard third parties.

The Plan

Simultaneously with their petitions for relief, the Debtors filed their Amended and Restated Joint Prepackaged Plan of Reorganization (the “Plan”) [Docket No. 8].  On January 6, 2017, Judge Drain held a hearing at which he approved confirmation of the Debtors’ Plan [Docket No. 39] and on January 10, 2017, Judge Drain issued his Findings of Fact, Conclusions of Law and Order Approving Confirmation (the “Confirmation Order”) [Docket No. 41].  The Debtors provided two reasons for why it was necessary to have the Plan confirmed so quickly: (1) there was a severe stigma attached to bankruptcy in the Eastern European markets in which the NDEs operated and (2) the Roust Group was required to pay significant exist taxes in Russia in January, and the capital infusion provided for in the Plan was necessary for those taxes to be paid.  Confirmation Transcript [Docket No. 39] at p. 21, ln. 23 – p. 22, ln. 21.

The Plan impaired only three classes: the Senior Secured Notes, the Convertible Notes and Roust’s equity holder, RTL.  First, the Plan provided for the Senior Secured Notes to receive new senior secured notes in principal amount of $385 million at 10% interest, cash consideration of $20 million, the right to participate in a $55 million rights offering (the “Share Placement”) and a debt-to-equity conversion for 12.08% of the common stock in Reorganized Roust.  Second, the Plan provided for the Convertible Notes to receive 10.59% of the equity in Reorganized Roust through a debt-to-equity conversion, an additional 1.00% of equity contributed from Russian Standard and the right to participate in the Share Placement.  Finally, Russian Standard, through RTL, was to receive 57.04% of the equity in Reorganized Roust in exchange for contributing Russian Standard Vodka to Reorganized Roust and forgiving $116 million of debt owing from Roust and RSV to RTL and its non-Roust subsidiaries.  Additionally, $100 million owed to Roust by RTL and its non-Roust subsidiaries was deemed repaid.

The Plan also contained two broad categories of releases: (1) “Releases by the Debtors” [Art. 9(B)] and (2) “Releases by Holders of Claims” [Art. 9(C)].  Under Art. 9(B), the Debtors released all claims against the “Released Parties,” which included Noteholders, Notes Trustees, RSV, RTL, Russian Standard, the NDEs and all of the foregoing’s affiliates, subsidiaries, managers, etc.  Under Art. 9(C), the definition of “Holders of Claims” was all-encompassing; thus, every creditor and interest holder in the case was releasing the Released Parties.

Seven Steps to Confirmation in Seven Days

The long term significance of Roust is contingent on whether it provides clear guidelines for how, and under what circumstances, such a quick path to confirmation can be achieved.  The Seven Steps detailed below are an attempt to summarize the facts and legal issues Judge Drain focused on during the Confirmation Hearing, and, more importantly, the reasons Judge Drain found those facts and legal issues significant.  Some of these steps involve relatively unique features of In re Roust—but even the most unique features can be partially replicated in other cases.  For example, an extremely important feature in In re Roust was the fact that Tariko wholly owned the Russian Standard Group and therefore had the unilateral power to grant releases to the Debtors and NDEs.  While this fact was influential because it removed the need for Judge Drain to conduct an exhaustive analysis of the propriety of those releases, Judge Drain’s questions and comments during the Confirmation Hearing made clear that the more the Debtors accomplished through private contractual arrangements, and the less they invoked the coercive power of the Bankruptcy Court, the more comfortable he was with confirming the Plan in such a short period of time.  It is the lesson, not the fact, that might prove significant for prospective debtors attempting to secure a speedy confirmation of a prepackaged plan.  It goes without saying that following the seven steps below won’t guarantee confirmation in seven days; every Debtor and every Judge has different issues and concerns that must be addressed.

Step 1.  Secure Overwhelming—Preferably Unanimous—Support from All Impaired Classes under the Plan

First and foremost, Judge Drain made clear that such a quick confirmation would be all but impossible without the overwhelming support of creditors.  All parties impaired by the Plan—Russian Standard, the Senior Secured Noteholders and the Convertible Noteholders—unanimously supported the plan.  Not a single Noteholder voted against the Plan, with, by aggregate value, 90% of the Senior Notes and 93% of the Convertible Notes voting in favor of confirmation.  Confirmation Transcript at p. 8, ln. 24 – p. 9, ln. 6.  In contrast, only two parties objected to the Plan: the U.S. Trustee (the “Trustee”) and the IRS, and the latter’s objection was resolved consensually prior to the Confirmation Hearing.

The Trustee made numerous objections, but devoted most of its written objection to four issues: (1) insufficient notice; (2) unconfirmable non-Debtor releases; (3) inadequate evidence of feasibility; and (4) improper allowance of administrative claims for professionals retained by the Noteholders.  U.S. Trustee’s Objection, Docket No. 22, at p. 11-20.  And Judge Drain, in overruling the first three objections, repeatedly cited the impaired classes’ overwhelming support of the Plan as a basis for his rulings.  When considering whether notice was sufficiently given, Judge Drain twice noted the sheer size of the Plan’s support.  Confirmation Transcript at p. 40, ln. 3-5, p. 43, ln. 18-19.  When considering the accuracy of the Debtors valuation, he reasoned that the overwhelming support of the impaired classes implied an accurate valuation.  Confirmation Transcript at p. 72, ln. 8-14.  When determining the propriety of the Plan’s releases, he noted that “the parties affected by it, now, have voted unanimously in favor of the Plan” and that “the lack of any objecting party with an economic stake” implied “that such parties are not aware of any potentially valuable claims against any of the released parties.”  Confirmation Transcript at p. 85, ln. 17 – p. 86, ln. 2, p. 86, ln. 24 – p. 87, ln. 8.

Step 2.  Give Notice—Lots of Notice

Second, the Debtors went above and beyond the requirements of the Code in giving pre-petition notice to the interested parties of both the terms of the Plan and the accelerated timeline in which the Debtors were seeking to confirm the Plan.  First, nearly two months prior to filing, the Debtors sought and received a tentative date for their combined hearing on the Disclosure Statement and confirmation of the Plan.  Second, on December 1, 2016, the Debtors mailed notice of the combined hearing to all parties in interest, mailed their solicitation materials and ballots to all parties entitled to vote upon the Plan and posted all of these documents online with Epiq Bankruptcy Solutions, LLC (“Epiq”) the Debtors’ voting and noticing agent.  Third, the Debtors published notice of the hearing in the international edition of the Financial Times.

This, however, was not enough for the Trustee, who objected on the grounds that the Debtors had not met the notice requirements of Bankruptcy Rule 3017, which requires that holders and claims and interests be given at least 28 days notice of the hearing on approval of the DS, and Bankruptcy Rule 2002, which requires 28 days notice of the deadline for filing objections to approval of the DS.  U.S. Trustee’s Objection at pp. 11-14.  The Trustee also argued that the Debtors had failed to give “any party in interest any ability to object because the objection deadline passed even before the Petitions were actually filed.”  Id. at p. 14.

Judge Drain, however, disagreed, on the basis that “Bankruptcy Rule 2002 provides for twenty-eight days’ notice.  It doesn’t say twenty-eight days after the Petition Date.”  Confirmation Transcript at p. 36, ln. 11-13.  As he explained, the Bankruptcy Code clearly contemplates prepackaged plans of reorganization and neither Bankruptcy Rule 2002 nor Rule 3007 tie their required notice periods to the date of the petition.  Id. at p. 44-45.  Thus, so long as the notice was not deficient and twenty-eight days’ notice was given to the required parties, “you’ve complied with the rules.”  Id. at p. 37, ln. 11-16.  Judge Drain also rejected the Trustee’s contention that the parties in interest lacked the ability to object, noting that (1) the parties in interest were still given thirty days to object (by mailing an objection to the Debtors pre-petition) and (2) the Court would have given any objecting party more time if someone had requested additional time.  Id. at p. 42, ln.. 4-9.

This is perhaps the most significant legal ruling in In re Roust; as Judge Drain noted, the average duration of a prepack “is about thirty-five days.”  Id. at p. 45, ln. 13.  Although few prepacks might have the necessary characteristics that allow confirmation seven days after filing, many prepacks may have some of these characteristics, which may enable confirmation fifteen, twenty, or twenty five days after filing.  Although many prospective debtors will have substantial reasons not to publicly disclose their impending bankruptcy filing—most notably, publicly traded companies or debtors with significant confidentiality concerns—Judge Drain’s interpretation of Bankruptcy Rules 2002 and 3007 pave the way for debtors without need of confidentiality to significantly shorten the period of time they spend in Chapter 11.

Step 3.  Identify All of Your Unsecured Creditors

Perhaps the most unusual characteristic of In re Roust, in comparison to a typical corporate Chapter 11 case, was the unsecured creditor pool.  First, because all three Debtors were holding companies, they had only eleven unsecured creditors.  Id. at p. 26, ln. 10 – p. 27, ln. 5.  Second, all of these unsecured creditors were professionals, a fact that proves significant in Step Four.  Id. at p. 27, ln. 1-5.  Third, the Debtors had identified each unsecured creditor specifically and had given notice of the confirmation hearing to each unsecured creditor individually.  Id. at p. 33, ln. 19 – p. 34, ln. 16.  The de minimis number of unsecured creditors, the Debtors’ specific identification and noticing of each unsecured creditor, and the fact that the unsecured creditors were not being impaired, combined, seemed to play a significant role in minimizing any concerns Judge Drain may have had regarding the adequacy of notice by making it extremely reasonable for Judge Drain to infer that it was highly unlikely that any unsecured creditors had not been given notice and a chance to be heard.

Step 4.  Demonstrate that All Interested Parties, Especially Impaired Parties, Are Sophisticated and Capable of Protecting Their Own Interests

Fourth, the fact that all of the Debtors’ creditors were sophisticated parties clearly increased Judge Drain’s comfort with the notice given by the Debtors and with the speed of confirmation.  In responding to the Trustee’s assertion that it wasn’t clear whether the unsecured creditors were sophisticated enough to know if they should, or even how to, object to confirmation, Judge Drain immediately responded that “looking at who they are, I think they are.”  Confirmation Transcript at p. 39, ln. 20 – p. 40, ln. 11.  In overruling the Trustee’s objection that insufficient or inadequate notice had been given, Judge Drain specifically noted that “this is not a request to bless a notice to moms and pops or even dentists and doctors.”  Id. at p. 49, ln. 6-13.  Similarly, in approving the Disclosure Statement, Judge Drain found it important that “the people who are impaired here are all qualified institutional investors” and therefore the Disclosure Statement was sufficient “under the securities laws, too.”  Confirmation Transcript at p. 50, ln. 20 – p. 51, ln. 11.  Finally, in approving the releases under the Plan, Judge Drain noted that “with sophisticated advisors and they [the Noteholders] themselves being sophisticated,” the release language in the ballots and the Plan more than sufficiently “warned parties of their contents.”  Id. at p. 85, ln. 17-25.

In short, the sophistication of the parties in interest belied any concern Judge Drain may have had that seven days from filing to confirmation was too short a time for the affected parties to digest the terms of the Plan or to determine how their interests would be affected.  In combination with the overwhelming support of the Noteholders, and the miniscule number of unsecured creditors, it appears that Judge Drain concluded that elongating the case would serve no useful purpose.

Step 5.  Achieve as Much as Possible Through Contractual Arrangements and Minimize Usage of the Coercive Power of the Bankruptcy Court

In contrast to the Trustee’s objections, Judge Drain’s focus was on ensuring that the Plan distinguished between (1) what actions in the Plan Judge Drain was ordering under the authority of the Bankruptcy Code and (2) what actions in the Plan were occurring as the result of private negotiations by and among the Debtors, Noteholders and Russian Standard.  In determining that the third party releases in the Plan were appropriate, Judge Drain repeatedly sought clarification from the Debtors that the releases by Russian Standard entities of claims against the Debtors and the NDEs were not being foisted upon Russian Standard by Judge Drain, and instead were being released voluntarily by Russian Standard.  Confirmation Transcript at Transcript at p. 15, ln. 24 – p. 16, ln. 1., p. 40, ln. 24 – p. 41, ln. 4., p. 73, ln. 14 – p. 80, ln. 9.  Similarly, the Plan provided that intercompany claims would be reinstated, but “subject to the express contractual subordination to the new Senior Secured Notes” or “released, waived and discharged, treated as a dividend, or contributed to capital or exchanged for equity.”  Judge Drain noted that such treatment in a plan of reorganization clearly qualified as impairment.  The Debtors, in response, clarified that these intercompany claims were not being altered through the Plan, but through private contractual arrangements among the RSA parties—the language in the Plan merely memorialized these arrangements.  Id. at p. 78, ln. 6 – p. 80, ln. 5.  A similar exchange occurred over the treatment of executory contracts, Id. at p. 77, ln. 17 – p. 78, ln. 2.

Step 6.  Provide a Mechanism of Review for All Post-Petition Professional Fees and Expenses Being Paid under the Plan

The Trustee did, however, unequivocally win one of its objections, although not in the way the Trustee hoped.  Although the Debtors professional were to be compensated through the normal process of § 327 and § 330 of the Code, the Debtors proposed, under Article I(A)(64) and (110) of the Plan, to allow as administrative claims the professional fees and expenses of the RSA Parties and the Notes Trustees without any need for those professionals to apply to the Bankruptcy Court for compensation.  The Trustee argued that the Court’s previous holding in In re Lehman Bros. Holdings Inc., 487 B.R. 181 (Bankr. S.D.N.Y. 2013), vacated and remanded on other grounds, 508 B.R. 283 (S.D.N.Y. 2014) established that that Sections 1123(b)(6) and 1129(a)(4) of the Code could not serve as a basis for paying the professional fees and expenses of creditors without the necessity of filing an application and meeting their evidentiary burden for payment under Section 503(b) of the Code.  Trustee’s Objection at p. 17-20.

Judge Drain disagreed with the Trustee’s arguments, and held that Lehman Brothers should be read narrowly to apply to the professional fees and expenses of official creditors’ committee’s members, and not broadly to all creditors.  Confirmation Transcript at p. 67, ln. 24 – p. 70, ln. 4.  Nonetheless, the Court held that § 1129(a)(4) requires that any fees being paid under that provision be reasonable and be subject to court review” and therefore an objective third party was needed “to make the type of objection that objective third parties make.”  Id. at p. 70, ln. 17-22.  Thus, the Court simply required that Notes Trustees and RSA Parties submit a copy of their professional fees and expenses claims; if the Trustee objected, the Court would determine whether the claims were reasonable, but if the Trustee did not object, the professional claims would be allowed.  Id. at p. 67, ln. 17-19.

Step 7.  Be Flexible and Willing to Compromise

Finally, and perhaps most importantly, Roust demonstrates the importance of flexibility.  A prepack, by its nature, heightens a number of judicial concerns, and those concerns skyrocket when confirmation is sought only seven days after filing.  The Debtors in Roust succeeded in confirming precisely because they were willing to bend on every peripheral issue that was raised.  The Debtors added language to the Plan to resolve nascent objections from White & Case, the largest unsecured creditor, and the IRS.  Judge Drain required at least a dozen clarifications be made in the Plan, all of which the Debtors assented to.  And most notably, the Debtors, in response to Judge Drain’s concerns, volunteered to carve the unsecured creditors entirely out of the third-party releases in the Plan, in order to ensure that the unimpaired status of the unsecured creditors was clear.  Id. at p. 84, ln. 3-8.  Any practitioner wishing to confirm a plan in only seven days must know exactly what the core terms of her Plan are and being willing to concede on everything else.

Conclusions

Ultimately, every case is confirmed on its facts.  In re Roust presents a unique set of facts that may not be widely generalizable.  And although the vast majority of cases will not share the unique facts of In re Roust, those facts were important because they mitigated specific concerns the Court had in confirming a plan shortly after the Petition Date.  Those concerns will be important in any prepack that seeks a speedy confirmation, and the Seven Steps above merely illustrate how these Debtors met them.  It will be interesting to see what creative solutions other debtors craft in the future to address these concerns.

On January 18, 2017, the U.S. Court of Appeals for the Second Circuit issued an opinion in the case of Trikona Advisers Limited v. Chugh, No. 14-975-cv, 2017 WL 191936 (2d Cir. Jan. 18, 2017), thwarting an attempt to expand the scope of Chapter 15 of Title 11 of the United States Code (the “Bankruptcy Code”).  Specifically, the Second Circuit held, among other things, that Chapter 15 does not prevent a U.S. District Court from giving preclusive effect to the findings of a foreign court presiding over an insolvency proceeding where the action pending in the U.S. is not connected to the foreign insolvency proceeding.

Facts

Trikona involved the demise of Trikona Advisers, Ltd. (“TAL”), an investment advisory company formed in the Cayman Islands in 2006 by Rakshitt Chugh (“Chugh”) and Aashish Kalra (“Kalra”) to assist foreign investors seeking to invest in Indian real estate and infrastructure.  2017 WL 191936, at *1.  Chugh and Kalra each held a fifty percent (50%) equity stake in TAL through entities owned by them: (i) Chugh through ARC Capital LLC (“ARC”) and Haida Investments (“Haida”); and (ii) Kalra through Asia Pacific Investments, Ltd. (“Asia Pacific”).  Id.  The 2008 economic crisis took its toll on TAL, however, and as a result of pressure from shareholders to sell TAL’s assets and a series of failed transactions with a German fund manager, among other things, the relationship between Chugh and Kalra soured.  Id., at *1-*2.  Eventually, TAL ceased to function as a going concern, Chugh was removed as a director without notice and Kalra proceeded to treat TAL and its assets as his own.  Id., at *2.

Procedural History

On February 13, 2012, ARC and Haida filed a petition in the Grand Court of the Cayman Islands, seeking to “wind up” TAL under the Cayman Islands Companies Law.  2017 WL 191936, at *2.  Asia Pacific opposed the petition by asserting affirmative defenses that Chugh had breached his fiduciary duty to TAL in several ways and that his removal from TAL’s board was justified.  Id.  After seven days of trial in January of 2013, the Cayman court granted Chugh’s petition and rejected each of Kalra’s affirmative defenses, finding that they had “no merit whatsoever.”  Id., at *3.  Kalra appealed the judgment to two separate courts in the Cayman Islands, each of which affirmed the original judgment.  Id.

Two months before the commencement of the Cayman wind-up proceeding, Kalra, through Asia Pacific, had sued Chugh, ARC, and other related corporate entities (collectively, the “Chugh Defendants”) in the U.S. District Court for the District of Connecticut (the “District Court”) alleging, among other things, breach of fiduciary duty and aiding and abetting breach of fiduciary duty.  2017 WL 191936, at *3.  The claims “substantially reprised the allegations” that Kalra had asserted as affirmative defenses in the Cayman proceeding.  Id.

In January of 2013, the Chugh Defendants moved for summary judgment in the District Court under the theory of collateral estoppel based on the Cayman judgment.  2017 WL 191936, at *3.  Specifically, the Chugh Defendants argued that because the Cayman court already had made findings of fact in Chugh’s favor with respect to TAL’s collapse, Kalra was collaterally estopped from relitigating those factual disputes.  Id.  On March 6, 2014, the District Court granted the Chugh Defendants’ motion for summary judgment.  Id.  The District Court also denied a motion for reconsideration filed by TAL (which eventually replaced Asia Pacific as plaintiff), stating that because the affirmative defenses made by Kalra in defending the wind-up petition were “fundamentally the same” as the factual assertions made in the underlying complaint in the District Court, collateral estoppel applied and summary judgment was appropriate.  Id.

Insolvency Principles

Although TAL made five separate arguments on appeal, its assertion regarding Chapter 15 of the Bankruptcy Code is relevant for bankruptcy practitioners to note.  Specifically, TAL asserted that Chapter 15 precluded the District Court from applying collateral estoppel to the findings of fact from the wind-up proceeding.  2017 WL 191936, at *4.  In other words, TAL argued that because an application for recognition of the “foreign proceeding” (i.e., the Cayman proceeding) was not made or pending in the U.S., it was impermissible for the District Court to “recognize” the judgment of the Cayman court.  Id.  The Second Circuit disposed of this argument swiftly, stating that “the requirements of Chapter 15 do not apply here.”  Id.

The Second Circuit’s discussion of Chapter 15 began by explaining that the “primary purpose” of Chapter 15 is to “facilitate the consolidation of multinational bankruptcy into one single proceeding.”  2017 WL 191936, at *4 (citing In re ABC Learning Centres Ltd., 728 F.3d 301, 305-06 (3d Cir. 2013)).  It then identified the four circumstances under which Chapter 15 applies, which are specifically set forth in section 1501(b) of the Bankruptcy Code: (i) assistance sought in the U.S. by a foreign court or a foreign representative in connection with a foreign proceeding; (ii) assistance sought in a foreign country in connection with a case under the Bankruptcy Code; (iii) a foreign proceeding and a case under the Bankruptcy Code with respect to the same debtor are pending concurrently; or (iv) creditors or other interested persons in a foreign country have an interest in requesting the commencement of, or participating in, a case or proceeding under the Bankruptcy Code.  The Second Circuit noted that inherent in those scenarios, however, is the assumption that (i) the U.S. court is being asked either to assist in the administration of a foreign liquidation proceeding itself; or (ii) a foreign court is being asked to assist in administration of a liquidation proceeding in the U.S.  Id., at *5 (citing 11 U.S.C. § 1501(b)).  Moreover, the court noted that a Chapter 15 case must be initiated by a “foreign representative” (as defined in section 101(24) of the Bankruptcy Code).  2017 WL 191936, at *5; see also 11 U.S.C. § 101(24).

In Trikona, however, the proceeding in the District Court did not stem from any of the enumerated circumstances set forth in section 1501(b) of the Bankruptcy Code, and the action was not commenced by a “foreign representative” of a foreign proceeding.  2017 WL 191936, at *5.  Accordingly, the Second Circuit held that “Chapter 15 does not apply when a court in the U.S. simply gives preclusive effect to factual findings from an otherwise unrelated foreign liquidation proceeding,” especially because the District Court proceeding was a “non-bankruptcy action, brought in the District of Connecticut and governed by Connecticut law.”  Id.

Notably, the Second Circuit stated in a footnote that if the case involved an attempt to enforce an order entered in a foreign insolvency proceeding, rather than simply to give such an order a preclusive effect, as was done in the District Court, arguably Chapter 15 would have been implicated.  2017 WL 191936, at *5 n.2.  Moreover, in response to TAL’s argument that Chapter 15 of the Bankruptcy Code preempts the state law doctrine of comity, the Second Circuit explained that such a conclusion could not have been the intent of Congress given “the very narrow purpose of Chapter 15.”  Id., at *8.

Implications

Although the Second Circuit declined to expand the scope of Chapter 15 beyond its intended purpose, it did create some uncertainty by stating in a footnote that Chapter 15’s precepts may apply in situations where a party to a U.S. proceeding seeks to enforce an order entered by a foreign court presiding over an insolvency proceeding.  Parties involved in U.S. litigation should be reminded, however, that the court strictly applied the language of Chapter 15 by stating that an application for recognition under section 1515 of the Bankruptcy Code must be brought by a “foreign representative,” and that the section does not apply “generally to parties.”  2017 WL 191936, at *5.  TAL, therefore, acted inappropriately by attempting to invoke Chapter 15 in a “non-bankruptcy action . . . unconnected to any foreign or United States bankruptcy proceeding.”  Id.

A topic that receives relatively little attention is the practice of plan proponents to include “death trap” provisions in chapter 11 plans.  A death trap provision can provide for a distribution, or a larger distribution, to an impaired class in exchange for a favorable vote on the plan.  Although such a provision can be an extremely useful tool in achieving confirmation of a Chapter 11 plan, courts are reluctant to approve such provisions if they deviate from a certain standard, forcing the parties back to the drawing board and causing them to incur significant costs and delays in connection with the plan confirmation process.

Pursuant to 11 U.S.C § 1129 of the Bankruptcy Code, a court may only confirm a plan if, among other things, each class of claims or interests (a) accepts the plan or (b) is not impaired under the plan. § 1129(a)(8).  If the requirements of § 1129(a)(8) are not met, the plan may be “crammed down” on an impaired class that does not accept the plan, but only under the condition that the plan does not “discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.” § 1129(b).

Cramdown hearings can be costly and time-consuming.  In order to prevent a cramdown fight, a plan proponent may include in the plan a “death trap” provision that will incentivize an impaired class to vote for the plan by providing a distribution, or a larger distribution than it otherwise would receive.  Courts tend to approve disclosure statements and plans that contain such provisions if certain criteria are met.

For example, in In re Zenith Elecs. Corp., Judge Walrath overruled the objection of the equity committee with respect to the treatment of certain bondholders under the plan. 241 B.R. 92, 105 (Bankr. D. Del. 1999).  The plan contained a provision that provided for bondholders to receive nothing if they voted against the plan, but for a pro rata distribution of $50 million of new 8.19% Senior Debentures if they voted for the plan.  Id.  The equity committee asserted that such a treatment was unfair because, under the valuation conducted in that case, if correct, bondholders would not receive anything.  Id.  In addition, the equity committee argued that the plan was unfair because it did not provide for a similar treatment of shareholders.  Id.  Judge Walrath disagreed holding that “[t]here is no prohibition in the Code against a Plan proponent offering different treatment to a class depending on whether it votes to accept or reject the Plan.”  Id. (citing In re Drexel Burnham Lambert Group, Inc., 140 B.R. 347, 350 (Bankr. S.D.N.Y. 1992).  The Court continued explaining that such a disparate treatment can be justified in that it can save the plan proponent the “expense and uncertainty of a cramdown fight” which, in turn, furthers the Bankruptcy Code’s overall policy of “fostering consensual plans of reorganization . . . .”  Id.;  see also In re MPM Silicones, LLC, No. 14-22503-RDD, 2014 WL 4637175 (Bankr. S.D.N.Y. Sept. 17, 2014) (explaining that “[s]uch fish-or-cut-bait, death-trap, or toggle provisions have long been customary in Chapter 11 plans . . . [they] offer a choice to avoid the expense and, more importantly, the uncertainty of a contested cramdown hearing.”).

Courts, however, tend to disapprove death trap provisions if they deviate from the standard articulated by Zenith and other courts.  For example, in In re Mcorp Fin., Inc., the court rejected a “death trap” provision that not only implicated the treatment of one class under the plan, but also the treatment of other classes.  137 B.R. 219, 236 (Bankr. S.D. Tex. 1992).  In that case, the plan provided for a possible distribution to all equity classes (Classes 15, 16, and 17) in the event Class 15 voted for the plan.  Id.  However, Class 15 voted against the plan.  Id.  The Court held that the inclusion of the provision resulted in the plan not being confirmable because it was unfair, not equitable, and resulted in unfair discrimination, especially because “Classes 16 and 17 not only lost any possible distributions, but also the right to vote effectively, since they could not know until after [class 15] had cast its vote (due on the same date as that of all other claimants) . . . what their own status was.”  Id.

More recently, the issue arose during the disclosure statement hearing in the Molycorp bankruptcy.  Molycorp, the United States’ only rare earth miner, filed for bankruptcy protection in 2015 and sought approval of its disclosure statement.  The disclosure statement and the proposed plan contained broad releases of current and former directors and officers of Molycorp and also a “death trap” provision that provided as follows:

If the Entire Company Sale Trigger does not occur, the [Accepting GUC Distribution, will] be shared Pro Rata among the Holders of General Unsecured Claims in Class 5A who do not opt out of the Third Party Releases, if (a) Class 5A votes to accept the Plan and (b) none of (1) the Creditors’ Committee or any of its members, (ii) the Ad Hoc Group of 10% Noteholders or any of its members or (iii) the 10% Notes Indenture Trustee objects to the Plan.

Calling the inclusion of the provision “unprecedented and impermissible,” the Creditors’ Committee argued that this issue is “not only a confirmation issue, [but also] a voting issue [that] must be addressed at the disclosure statement hearing.”  The Creditors’ Committee asserted that the provision deviates from the standard set forth by Zenith and other courts because the provisions that have passed muster in those cases “have been conditioned solely on a class voting to reject, not on whether a fiduciary or a creditor in a different class filed an objection to a plan.”  In addition, the Creditors’ Committee asserted that the provision “attempts to shield the D&O Releases from any objections.”  The United States Trustee argued that “this plan is patently non-confirmable because the collective effect of the deathtrap and the third-party release provisions is to muzzle the creditors and the fiduciaries from exercising their rights, and it should not be approved.”  The United States Trustee noted that “[t]here is no democratic process involved” and that “[n]othing could be more fundamentally unfair or inequitable than provisions like this, that tell the creditors, you better vote for the plan or you get nothing.”  At the disclosure statement hearing in January 2016, Judge Sontchi agreed ruling that the “deathtrap based on the objection is unacceptable.” Calling the proposal “ridiculous,” Judge Sontchi said to Oaktree’s attorney “I’d rather you not give them anything than you squash the rights of fiduciaries . . . [y]ou are trying to shut the committee — you’re trying to put the committee in an impossible situation, where they have — if they object to — on a legitimate basis, [where] everybody has voted yes, they are robbing their constituency of a recovery.”  With respect to the releases, the Court noted that they are a “confirmation issue” and that “they’re fine for disclosure statement purposes.”

While a “death trap” provision can be, and often is, an important and useful tool in preventing time consuming and expensive cramdown fights, practitioners should be cautious in proposing provisions that deviate from the standards articulated by Zenith and other courts.  In particular, courts have shown hostility to death trap provisions that (1) condition the recovery of multiple classes upon the vote of one class and (2) that limit the proper exercise of fiduciary duties.

The Barton doctrine, which has been imposed in “an unbroken line of cases … as a matter of federal common law,” In re Linton, 136 F.3d 544, 545 (7th Cir. 1998) (Posner, J.), requires that plaintiffs “obtain authorization from the bankruptcy court before initiating an action in another forum against certain officers appointed by the bankruptcy court for actions the officers have taken in their official capacities.”  In re Yellowstone Mountain Club, LLC, No. 14-35363, ___ F.3d ___, 2016 WL 6936595, at *2 (9th Cir. Nov. 28, 2016) (internal quotations omitted).  In Yellowstone, the Ninth Circuit (Judge Kozinski writing on behalf of a unanimous panel) became the first Circuit Court to hold that the Barton doctrine applied to claims against a member of the Official Committee of Unsecured Creditors (the “Committee”).  This blog post examines Yellowstone and the status of the Barton doctrine in the Third Circuit, with a focus on a potentially significantly difference in how the doctrine is applied in the two circuits.

In Barton v. Barbour, 104 U.S. 126, 128 (1881), the Supreme Court held that  “before suit is brought against a receiver leave of the court by which he was appointed must be obtained,” because “[t]he evident purpose of a suitor who brings his action without leave is to obtain some advantage over the other claimants upon the assets in the receiver’s hands.”  The Court further held that it was irrelevant that the receiver was “conducting the business of, a railroad as a common carrier,” id. at 131, and that, without leave, the court in which the claims were brought lacked jurisdiction to hear the claims.  Id.  The Court’s second holding was superseded by statute in 28 U.S.C. § 959(a), which states that “[t]rustees, receivers or managers of any property, including debtors in possession, may be sued, without leave of the court appointing them, with respect to any of their acts or transactions in carrying on business connected with such property.

The Barton doctrine, however, has remained part of federal common law.  It was expanded to include bankruptcy trustees in Vass v. Conron Bros. Co., 59 F.2d 969 (2d Cir. 1932) (Learned Hand, J.)  (applying doctrine to trustee because the “trustee is equally an officer of the court,” and bringing claims against him will equally interfere with his duties to the court as trustee).  Multiple circuits have since expanded the doctrine to include officers appointed by the bankruptcy court and their functional equivalents.  See, e.g., Lowenbraun v. Canary (In re Lowenbraun), 453 F.3d 314, 321 (6th Cir. 2006) (applying doctrine to suit against trustee’s counsel); Lawrence v. Goldberg, 573 F.3d 1265, 1270 (11th Cir. 2009) (applying doctrine to suit against creditors and their counsel who advanced funds to the estate to fund estate litigation, because they “functioned as the equivalent of court appointed officers”).

As the Ninth Circuit described it, their decision was “but the latest chapter in the long-running saga of the Yellowstone Mountain Club bankruptcy litigation.”  2016 WL 6936595, at *1.  The bankruptcy court had confirmed a plan of liquidation in the case on March 12, 2012; that confirmation was appealed by Blixseth, the Club’s former co-founder, and affirmed by the Ninth Circuit in In re BLX Grp., Inc., 584 F. App’x 684 (9th Cir. 2014).  Blixseth, however, did not give up; in 2015, he sued his former counsel, Brown, who was “[o]ne of the UCC members—the chairman, no less” in the district court, alleging that Brown used confidential information in the bankruptcy proceedings to Blixseth’s detriment.  2016 WL 6936595, at *2.  The district court, applying Barton, held that Blixseth was required to request leave from the bankruptcy and dismissed his claims without prejudice.  Id.  Blixseth appealed that decision and the Ninth Circuit dismissed his appeal because it was not based on a final order.  Id.  Finally, Blixseth went before the bankruptcy court for permission to bring his claims in the district court.  Id.  The bankruptcy court denied permission and dismissed the claims on the merits.  Id.  The district court affirmed and, in Yellowstone, the Ninth Circuit held that the Barton doctrine applied to Blixseth’s post-petition claims.  Id. at *3-5.

Ultimately, the Court in Yellowstone found three reasons for applying the Barton doctrine to claims against a Committee member.  First, the Court found that the Committee’s interests align with the estates’ interests because the Committee “can only maximize recovery for the creditors by increasing the size of the estate.”  2016 WL 6936595, at *3.  Second, Committee members “are statutorily obliged to perform tasks related to the administration of the estate.”  Id.  Finally, lawsuits challenging actions taken in furtherance of those statutory obligations “could seriously interfere with already complicated bankruptcy proceedings.”  Id.  The Court noted that “[e]ven the fear that such a lawsuit could be filed… may cause UCC members to be timid in discharging their duties.”  Id.

The Barton doctrine was only officially embraced by the Third Circuit in In re VistaCare Grp., LLC, 678 F.3d 218, 232 (3d Cir. 2012).  Despite embracing the doctrine far later than other circuits, the Third Circuit’s holding in VistaCare fully endorsed the Barton doctrine.  Id. at 228-232 (holding that the Barton doctrine applied to state law claims against a Chapter 7 trustee, but affirming the bankruptcy court’s decision to allow the claims to be brought in state court).  The VistaCare Court rejected multiple statutory and policy arguments for finding that the Barton doctrine was no longer good law, and specifically overturned In re Lambert, 438 B.R. 523 (Bankr. M.D. Pa. 2010), in which the bankruptcy court held that the Bankruptcy Code had superseded the common law Barton doctrine.  Finally, the only reported case in the Bankruptcy Court for the District of Delaware applying the Barton doctrine is In re Summit Metals, Inc., 477 B.R. 484 (Bankr. D. Del. 2012), in which Judge Carey held that the Barton doctrine applied to a suit brought by the former chairman of the committee against the Chapter 11 trustee of Summit Metals, Inc., and the Trustee’s counsel.

Neither Vistacare or Summit contain language that expresses reservation about extending the Barton doctrine beyond bankruptcy trustees—and in fact, Summit held that the doctrine covered a chapter 11 trustee, his former counsel and his current counsel.  Summit, however, applied a harsher version of the doctrine than Yellowstone, and held that a plaintiff’s failure to request leave from the bankruptcy court warranted dismissal with prejudice of the plaintiff’s claims.  Whether this reflects a circuit split is unclear, but practitioners should certainly be aware of how Summit applied the Barton doctrine.

The Court in Summit held that the committee member’s failure to request leave of the bankruptcy court prior to bringing his claims in New York state court warranted dismissal of the claims.  477 B.R. at 497-98.  As the Court saw it, “[a]llowing the unauthorized case to proceed would be contrary to the policies that the Barton doctrine is intended to advance.”  Id. at 497.  Quoting from In re Herrera, 472 B.R. 839, 853–54 (Bankr. D. N.M. 2012), the Court explained that removal to the bankruptcy court cannot cure all problems under the Barton doctrine—when the doctrine is violated, the Trustee is forced to expend resources to remove the action and to demonstrate the applicability of the Barton doctrine to the non-bankruptcy forum.  Moreover, if the Trustee is not properly served but the action moves forward, the Trustee might be found liable and be forced to later defend against that liability.

On the other hand, although the district court in Yellowstone dismissed Blixseth’s claims because of his failure to first request leave from the bankruptcy court, it did so without prejudice, despite the fact that Brown, the Committee chairman, had been forced to expend resources defending himself in the non-bankruptcy forum.  2016 WL 6936595, at *2.  And after Blixseth refiled his claims with the bankruptcy court and requested leave to bring those claims in the district court, the bankruptcy court merely refused leave and adjudicated Blixseth’s claims on the merit.  Id.  The Ninth Circuit’s decision in Yellowstone, however, does not indicate whether Brown had requested dismissal with prejudice based on the Barton doctrine.

The outcome in Yellowstone may have resulted from a circuit split or from Brown sleeping on his rights.  The bankruptcy court, cognizant that it was applying the doctrine to a Committee member for the first time, may have felt that dismissal with prejudice was unwarranted under those circumstances.  Regardless, it is clear that practitioners should be cognizant of the holding in Summit.  In Delaware, failure to first request leave from the bankruptcy court may result in final dismissal of the plaintiff’s claims.  Parties should carefully examine whether the Barton doctrine applies to their claims, and if uncertain, err on the side of caution and request leave from the bankruptcy court.  And parties defending against claims relating to their actions in a bankruptcy case should keep the doctrine in mind; the Barton doctrine may provide a quick resolution in their favor.

In a decision released on November 17, 2016, the Third Circuit Court of Appeals reversed the holding of the Delaware Bankruptcy Court, affirmed by the District Court, that EFIH is not required to pay make-whole payments. In re Energy Future Holdings Corp., 16-1351, _ F.3d _ (3d Cir. Nov. 17, 2016).

Summary of Facts

In 2010, Energy Future Intermediate Holding Company LLC and EFIH Finance Inc. (together “EFIH”) borrowed approximately $4 billion. In return, EFIH issued notes secured by a first priority lien on their assets. The indenture governing the loan (the “First Lien Indenture”) allowed an early redemption prior to December 1, 2015 provided that EFIH paid a “redemption price equal to 100% of the principal amount of the Notes redeemed plus the Applicable Premium [i.e., the make-whole] . . . and accrued and unpaid interest” (the “Optional Redemption Provision”). The First Lien Indenture also provided for an immediate acceleration of “all outstanding Notes” in the event EFIH filed for bankruptcy (the “Acceleration Provision”). The Acceleration Provision provided the First Lien Noteholders the right to “rescind any acceleration [of] the Notes and its consequences[.]”

In 2011 and 2012, EFIH borrowed additional funds and issued Notes secured by a second priority lien on their assets. The indenture governing the Notes (the “Second Lien Indenture”) contained a redemption provision similar to the one described above. The Second Lien Indenture, however, contained an acceleration provision providing that “all principal of and premium, if any, interest . . . [,] and any other monetary obligations on the outstanding Notes shall be due and payable immediately” if EFIH filed for bankruptcy.

The Bankruptcy and District Court Decisions

On April 29, 2014, EFIH and certain affiliates filed for bankruptcy in the Delaware Bankruptcy Court. EFIH sought, among other things, to refinance the Notes, at a lower interest rate, without incurring the obligation to pay the make-whole. The bankruptcy filings caused the debt to accelerate and, by definition, triggered the right of the Noteholders to rescind the acceleration. The indenture trustees for the First and Second Lien Noteholders, Delaware Trust Company and Computershare Trust Company, N.A. and Computershare Trust Company of Canada respectively, commenced separate adversary proceedings seeking, among other things, a declaration that EFIH’s refinancing of the Notes would entitle the Noteholders to make-whole payments.

In 2015, the Bankruptcy Court, in two separate opinions,held that the Noteholders were not entitled to make-whole payments. In re Energy Future Holdings Corp., 527 B.R. 178 (Bankr. D. Del. 2015), aff’d, No. CV 15-620 RGA, 2016 WL 627343 (D. Del. Feb. 16, 2016); In re Energy Future Holdings Corp., 539 B.R. 723 (Bankr. D. Del. 2015), aff’d, No. CV 15-1011 RGA, 2016 WL 1451045 (D. Del. Apr. 12, 2016). Specifically, the Bankruptcy Court found that when EFIH filed for bankruptcy, the Notes automatically accelerated and became due immediately. Because the Notes became due and payable upon acceleration, EFIH’s refinancing could not constitute an “optional redemption” and, therefore, did not trigger the obligation for make-whole payments under the Indentures. The Bankruptcy Court further held that the automatic stay prevented the Noteholders from rescinding the acceleration of the Notes. The First Lien Noteholders then sought relief from the automatic stay, which the Bankruptcy Court denied.In re Energy Future Holdings Corp., 533 B.R. 106, 116 (Bankr. D. Del. 2015). The District Court affirmed the decisions of the Bankruptcy Court and the indenture trustees each appealed to the Third Circuit and the appeals were subsequently consolidated.

The Third Circuit Decision

The Third Circuit, in analyzing whether a make-whole payment was due, focused on the following questions: (1) was there a redemption, and (2) if so, was the redemption optional?

With respect to the first question, the Court rejected EFIH’s argument that the term “redemption” only entailed “repayments of debt that pre-date the debt’s maturity” as the Bankruptcy Court had concluded. The Third Circuit, relying on rulings of New York and federal courts, concluded that the term encompasses both pre- and post-maturity repayments of debt. The Court further concluded that the redemption was “optional,” because the Debtors voluntarily filed for chapter 11 protection intending to “refinance the Notes without paying any make-whole amount” and had opposed the Noteholders’ attempt to lift the automatic stay and rescind the acceleration of the Notes. Finding that the refinancing of the Notes constituted “optional redemptions” that occurred prior to December 1, 2015; the Court concluded that EFIH was obligated to pay the make-whole payments.

Next, the Court addressed the relationship between the Optional Redemption and the Acceleration Provisions and concluded that both provisions “address different things . . . [that they] provide the map to guide the parties through a post-acceleration redemption.” The Third Circuit specifically rejected EFIH’s reliance on In re AMR Corp.,which held that no make-whole payment was due because the text of AMR’s acceleration provision specifically stated that no make-whole was due upon acceleration. 730 F.3d  88 (2d Cir. 2013). After taking a closer look at the additional language contained in the acceleration provision in the Second Lien Indenture, i.e., “premium, if any,” the Court found that it “leaves no doubt that [the Optional Redemption Provision] and [the Acceleration Provision] work together.” EFIH had further argued, relying on a recent Southern District of New York decision, Momentive, currently on appeal before the Second Circuit, that the language – “premium, if any” – is not specific enough to require a make-whole payment. In re MPM Silicones, LLC, No. 14-22503-RDD, 2014 WL 4436335 (Bankr. S.D.N.Y. Sept. 9, 2014), aff’d, 531 B.R. 321 (S.D.N.Y. 2015) (“Momentive”). The Third Circuit seized the opportunity to criticize Momentive finding it “unpersuasive” and noting it “conflicts with that indenture’s text and fails to honor the parties’ bargain.”

EFIH further argued that “courts must close their eyes to make-whole provisions once a debt’s maturity has accelerated.” The Third Circuit disagreed and concluded that  the Optional Redemption “applies no less following acceleration of the Notes’ maturity than it would to a pre-acceleration redemption.”

Finally, the Court rejected EFIH’s reliance on Northwestern, a New York state court decision, that stands for the proposition that “prepayment premiums” can only arise before a debt’s maturity date. Nw. Mut. Life Ins. Co. v. Uniondale Realty Assocs., 816 N.Y.S.2d 831, 836 (N.Y. Sup. Ct. 2006) (“Northwestern”). Noting that EFIH and the lower courts “stretch Northwestern beyond its language and appl[y] its clear-statement rule to yield-protection payments not styled as prepayment premiums,” the Court observed that the indentures at issue did not use the word “prepayment,” but instead the term “redemption,” which, as the court earlier explained, can occur “at or before maturity.” The Court concluded that when the term redemption is properly understood, the Optional Redemption Provision and the Acceleration Provision have no “linguistic tension to resolve.”

Conclusion and Practice Pointer

The Third Circuit repeatedly emphasized its duty to “give full meaning and effect to all of [the Indenture’s] provisions” and that “adherence to these principles is particularly appropriate in a case like this involving interpretation of documents drafted by sophisticated, counseled parties and involving the loan of substantial sums of money.” In re Energy Future Holdings Corp., 16-1351, _ F.3d _ (3d Cir. Nov. 17, 2016) (quoting NML Capital v. Republic of Argentina, 952 N.E.2d 482, 489-90 (N.Y. 2011)).

Practitioners drafting indenture agreements should insist on clear and unambiguous terms governing make-whole obligations.

The Third Circuit’s decision also reflects a departure from recent make-whole decisions in bankruptcy and federal courts. As discussed, the Third Circuit disagreed with the New York bankruptcy and district courts’ holding in Momentive, finding it inconsistent with the text of the indenture. We await the Second Circuit’s decision in Momentive and whether it will present a split in the circuits. Stay tuned!

On November 28, 2016, the Supreme Court is scheduled to hear oral arguments in the appeal of Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. 2015), as amended (Aug. 18, 2015), cert. granted sub nom. Czyzewski v. Jevic Holding Corp., 136 S. Ct. 2541 (2016). The question before the Court is whether a bankruptcy court may authorize the distribution of settlement proceeds in derogation of the absolute priority rule; the issue is the subject of a circuit split. Notably, the parties to the case did not ask the Court to consider whether structured dismissals are an appropriate exit vehicle from bankruptcy in spite of the fact that that issue was also discussed by the Third Circuit.

In Jevic, the Third Circuit affirmed a bankruptcy court’s approval of a settlement agreement that skirted the Bankruptcy Code’s priority scheme and brought about the structured dismissal of the debtors’ cases.¹ Although the Third Circuit made apparent its reluctance to affirm Jevic’s class-skipping settlement agreement, it found that, unlike plans, settlement agreements are not required to comply with the absolute priority rule. Nevertheless, it opined that “[i]f the ‘fair and equitable’ standard is to have any teeth, it must mean that bankruptcy courts cannot approve settlements and structured dismissals devised by certain creditors in order to increase their shares of the estate at the expense of other creditors.” Accordingly, it held that the absolute priority rule may be circumvented in the context of a settlement agreement if a court has “specific and credible grounds to justify [the] deviation.” In Jevic, the Third Circuit found that the structured dismissal at issue did, in fact, justify a deviation from the absolute priority rule in light of the fact that the debtor was facing administrative insolvency and had no viable means to exit bankruptcy absent the structured dismissal route and, most importantly, the structured dismissal was not “contrived to evade the procedural protections and safeguards of the plan confirmation or conversion processes.”

While at odds with the Fifth Circuit’s decision in U.S. v. AWECO, Inc. (In re AWECO, Inc.), 725 F.2d 293 (5th Cir. 1984), the Third Circuit noted that its approach aligns with that of the Second Circuit, which has found that although compliance with the absolute priority rule is the most important factor in determining if a settlement is “fair and equitable,” a settlement that does not adhere to the priority scheme may be approved if other factors weigh heavily in its favor. Motorola, Inc. v. Official Committee of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007) (expressing approval for one deviation from the priority scheme but remanding for more information to justify a different deviation). But cf. AWECO, 725 F.2d 293 (a settlement is “fair and equitable” only if it complies with the Bankruptcy Code’s priority scheme).

The case has garnered significant interest from third parties. For example, numerous scholars have submitted amicus briefs in support of the Third Circuit’s decision, arguing that imposing the absolute priority rule’s requirements on settlement agreements would expand existing law and limit debtors’ chapter 11 exit strategies. See generally, Brief for Amici Curiae Law Professors David Gray Carlson et al. Supporting Respondents, Czyzewski v. Jevic Holding Corp. (No. 15-649); Brief for Amici Curiae Law Professors Jagdeep S. Bhandari et al. Supporting Respondents, Czyzewski v. Jevic Holding Corp. (No. 15-649). These scholars emphasize the importance of flexibility in the bankruptcy process and the longstanding tradition of allowing parties-in-interest to craft unique, if imperfect, solutions for the benefit of the greater good. They caution that rigid application of the absolute priority rule would hamper the efforts of bankruptcy courts and all of their constituencies in fashioning constructive solutions to complicated problems.

On the other hand, Acting Solicitor General Ian Heath Gershengorn filed an amicus brief advocating for Jevic’s reversal, arguing that the absolute priority rule does indeed apply to settlements. Brief for the United States as Amicus Curiae Supporting Petitioners, Czyzewski v. Jevic Holding Corp. (No. 15-649). The United States was motivated by a desire to prevent non-consenting creditors (such as the United States itself) from being denied the benefit of their priority claim status. A group of 35 states and the District of Columbia also submitted an amicus brief advocating for the reversal of the Third Circuit opinion, noting the effect that a disruption of the priority scheme could have on tax claims, domestic support obligations, certain pre-petition wage claims, and consumer deposits. Brief for Illinois et al. as Amici Curiae Supporting Petitioners, Czyzewski v. Jevic Holding Corp. (No. 15-649). The states argued that in the absence of a reversal such class-skipping settlements will “become the norm” as non-priority creditors, secured lenders, potential buyers, and debtors will increasingly enlist the bankruptcy system to augment their coffers at the expense of the interests of priority creditors.

Regardless of the outcome, the Court’s decision on this matter will significantly affect the trajectory of American bankruptcies for years to come. Stay tuned for more information on this momentous case!

¹ For a more detailed description of the underlying Third Circuit decision, see Jacob S. Frumkin, U.S. Supreme Court to Weigh in on Structured Dismissals and Settlements Circumventing the Bankruptcy Code’s Priority Scheme (July 12, 2016).

Last month, the United States Bankruptcy Court for the Southern District of New York published proposed amendments to its local rules effective December 1, 2016 (the “Proposed Amendments”).  Links to the Bankruptcy Court’s notice to the bar with respect to the Proposed Amendments and the full text of the Proposed Amendments are provided below.  The Proposed Amendments are currently open for public comment.  The comment deadline is November 14, 2016 by 5:00 p.m.

Below is summary of substantive changes effected by the Proposed Amendments which may be of interest to practitioners:

  • Local Rule 1002-1 (Filing of Petition): the amended rule will require, to the extent practicable, that when a prospective chapter 11 debtor or chapter 15 petitioner anticipates the need to seek orders for immediate relief, counsel must contact the United States Trustee’s office and the Clerk’s office prior to filing the petition to advise them of the anticipated filing and the matters on which the debtor or petitioner intend to seek immediate relief.
    • The proposed amendment aligns the SDNY with a similar local rule that is already in effect in Delaware.
  • Local Rule 2002-1 (Notice of Proposed Action or Order When Not Proceeding by Motion): the current rule – which provides a procedure for presenting orders to the court when the Bankruptcy Code requires “notice and a hearing” but a motion is not mandatory – will be moved and combined with current Local Rule 9074-1, discussed below.
  • Local Rule 3011-1 (Disposition of Unclaimed Funds Under a Confirmed Chapter 11 Plan): this will be a new rule.  In summary, it will require a chapter 11 plan to provide for the distribution of unclaimed property that cannot be distributed pursuant to 11 U.S.C. § 347(b) by either reallocating the property pursuant to the absolute priority rule, or pursuant to the plan’s distribution scheme, or donating it to a designated not-for-profit, non-religious organization.
    • Pursuant to section 347(b) of the Bankruptcy Code, unclaimed funds revert to the debtor or the entity acquiring assets to a plan. The proposed official comment to the rule explains that the rule is designed to address a seeming infirmity of § 347(b) in the context of liquidating chapter 11 plans in which no entity acquires most of the debtor’s assets and the debtor essentially ceases to exist.
  • Local Rule 3018-1 (Certification of Acceptance or Rejection of Plans in Chapter 9 and Chapter 11 Cases): The current rule requires the submission of certified ballot reports, certifying the amounts and numbers of accepting or rejecting classes to the court seven days in advance of a confirmation hearing.  The proposed amendment will require that the ballot report also certify as to the amount and number of any ballots not counted.
  • Local Rule 3021-1 (Post-Confirmation Requirements in Chapter 11 Cases): The proposed amendment will add a subsection to the existing rule, requiring that, “as a condition to serving as a liquidating trustee or a successor trustee to a post confirmation liquidating, or similar trust, the liquidating plan shall specify what steps the trustee shall take to monitor and ensure the safety of the trusts’ assets.”
  • Local Rule 5075-1 (Clerk’s Use of Outside Services and Agents; Claims and Noticing Agents): the current rule governs the use of claims agents.  In addition to the rule’s existing provisions, the proposed amendment will revise subsection (c) and add a new subsection (d) to provide, respectively, that:  (1) “Upon the request of the Clerk, the agent must provide public access to the Claims Registers, including complete proofs of claim with attachments, if any, without charge” and (2) the order providing for the retention of a claims agent must provide for “(i) the discharge of the agent at the conclusion of the case, or as otherwise provided by entry of an additional order by the Court; and (ii) the disposition of any records, documents and the like, that have been provided or delivered to such agent, whether in paper or electronic form in accordance with the Protocol for the Employment of Claims Agents.”
  • Local Rule 7052-1 (Proposed Findings of Facts and Conclusions of Law): the current rule governs the submission of proposed finding of fact and conclusions of law.  The proposed amendment effects two substantive changes:  (1) Whereas previously, parties were allowed by right to submit counter-findings and conclusions (unless the Court ordered simultaneous submissions), the amendment requires parties to request the Court’s permission to submit such counter-findings and conclusions.  (2) The amendment strikes the portion of the rule that prohibited proposed findings and conclusions from forming any part of the record on appeal (unless otherwise ordered by the Court).  Accordingly, the content of the record on appeal will no longer be limited by the rule.
  • Local Rule 8010-1 (Notice to the Bankruptcy Court of the Filing of Preliminary Motion with an Appellate Court): this will be a new rule.  It requires a party filing a preliminary motion (as defined in Bankruptcy Rule 8010(c)) in the district court or the court of appeals, to also file that motion and notice thereof on the bankruptcy court’s docket.
  • Local Rule 9006-1 (Time for Service and Filing of Motions and Answering Papers): the current rule addresses the notice period and objection deadline for motions for which the notice period is not otherwise prescribed in the Bankruptcy Rules.  The existing rule is silent as to the right to submit reply papers.  The proposed amendment addresses the silence by providing that:  “reply papers shall be served so as to ensure actual receipt not later than 4:00 p.m. three (3) days before the return date.”
    • The proposed amendment aligns the SDNY with the rule already in effect in EDNY.
  • Local Rule 9018-1 (Motions to Publicly File Redacted Documents and to File Unredacted Documents Under Seal): this will be a new rule.  It provides a uniform procedure for the submission of sealing motions, including the substantive content that must be asserted in and the documents which must be included with the sealing motion.
    • The submission of sealing motions is currently governed by each Judge’s individualized Chambers’ rules.
  • Local Rule 9037-1 (Redaction of Personal Identifiers): this will be a new rule.  The rule will provide guidance and procedure with respect to the redaction of personal data identifiers, placing that responsibility solely on counsel, parties in interest and non-parties (e., not the Clerk or claim agent if one has been appointed).  If a party seeks to redact personal data from a document or proof of claim already filed with the Court, such party must contact the Clerk’s office to request that the data be restricted from public view and file a motion and pay the associated fee.
  • Local Rule 9074-1 (Submission, Settlement or Presentment of Order, Judgment, or Decree): as noted above, current rule 2002-2 will be moved and combined, in toto, to this rule.  Aside from certain stylistic revisions and reformatting resulting from combining the two rules, the amendment adds two provisions:  (1) In the circumstances addressed by current Rule 2002-2 in which Bankruptcy Code requires “notice and hearing” but a motion is not mandatory and a party presents an order to the Court following the procedure outlined in the local rule, the amendment makes clear that no hearing will be held by the court unless timely objection is filed.  (2) The amendment makes clear that in the case of a motion, application or any pleading submitted by notice of presentment (as opposed to notice of hearing), such pleading must include a copy of the proposed order and the moving party must promptly submit a copy of the proposed order to chambers after the presentment date if there has been no objection or hearing date scheduled.
  • The Proposed Amendments also will repeal Local Rules 7008-1, 7012-1, 9027-1, and 9027-2 in light of the revisions to National Bankruptcy Rules 7008, 7012 and 9027 that were effected since their enactment in April of 2012. These local rules were all enacted to address issues raised by the Supreme Court’s decision in Stern v. Marshal.

Notice to the Bar Regarding Proposed Amendments to Local Bankruptcy Rules.

Proposed Amendments to the Local Bankruptcy Rules for the Southern District of New York.

Prepetition, Millennium Lab Holdings II, LLC, Millennium Health, LLC, and RxAnte, LLC (the Debtors) reached a settlement with various government entities (the USA Settling Parties) relating to, among other things, claims against the Debtors for violations of the Stark law, Anti-Kickback Statute and False Claims Act (FCA). The Debtors also negotiated a restructuring support agreement with an ad hoc group of lenders (the Ad Hoc Group) holding debt under a 2014 existing credit agreement in the original principal amount of $1.825 billion (the Credit Agreement). In re Millennium Lab Holdings II, LLC, 543 B.R. 703, 705 (Bankr. D. Del. 2016).

The terms of the settlements included: 1) a $325 million payment from the equity holders to the Debtors; 2) conversion of the Credit Agreement into a $600 million new term loan; 3) transfer of the Debtors’ equity interests to the lenders under the Credit Agreement (the Lenders); 4) creation of two trusts; 5) a $206 million payment to the USA Settling Parties; 6) full recovery for all creditors except the Lenders; and 7) non-debtor third-party releases (the Releases) of the Debtors’ equity holders and their officers and directors. Id. at 706.

Since the Debtors did not receive sufficient votes from the Lenders for an out-of-court restructuring, on Nov. 10, 2015, the Debtors filed petitions for Chapter 11 relief together with a proposed prepackaged plan (the Plan) in the United States Bankruptcy Court for the District of Delaware (the bankruptcy court). The Plan incorporated all of the terms of the prepetition settlements with the USA Settling Parties and the Ad Hoc Group, including the Releases. Id.

The Debtors provided disclosure of the Releases as follows: 1) including all Plan release provisions verbatim in bold typeface as an exhibit to the notice of hearing on confirmation of the Plan. In re Millennium Lab Holdings II, LLC, Case No. 15-12284, Dkt. No. 91, Ex. 2 (Bankr. D. Del. Dec. 10, 2015); 2) including the release provisions in the Lenders’ class 2 ballots (the “Class 2 Ballots”), id., Dkt. No. 16, Ex. A; and 3) using fully capitalized typeface in the Plan itself. Id., Dkt. No. 182-1, at 66-67. The Lenders were the only class entitled to vote on the Plan, id. at 27, and the Class 2 Ballots did not include an option to opt-out of the Releases. Id., Dkt. No. 16, Ex. A.

Some of the Lenders with claims against the Debtors’ equity holders and directors and officers voted against the Plan and objected to the Releases (the Opt-Out Lenders). On Dec. 10, 2015, an evidentiary hearing was held by the bankruptcy court to consider confirmation of the Plan. Id., Dkt. No. 190. The next day, the bankruptcy court made a lengthy oral ruling from the bench confirming the Plan and overruling the objections of the Opt-Out Lenders and the United States Trustee. Id., Dkt. No. 206 (the Hearing).

Oral Ruling

During Judge Laurie Selber Silverstein’s oral ruling, she first addressed the Opt-Out Parties’ assertion that the bankruptcy court did not have jurisdiction to approve the Releases. Judge Silverstein stated that bankruptcy courts have at least related to jurisdiction over third-party claims that could have an impact on the estate. Id. at 13:1-15. Here, the released parties had contractual indemnification claims and litigation advancement rights against the Debtors, which was a sufficient nexus to the Debtors’ estates, for the bankruptcy court to have jurisdiction to consider the Releases.

Second, Judge Silverstein addressed whether the Releases were appropriate under the circumstances. The Judge cited to In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000), which “set forth what it called the ‘hallmarks’ of permissible, non-consensual releases; namely: Fairness, necessity to the reorganization, and specific factual findings to support the conclusions.” Judge Silverstein considered the following factors in analyzing the Continental hallmarks:

[1] An identity of interest between the debtor and the third party, such that a … suit against the non-debtor is, in essence, a suit against the debtor, or will deplete assets of the estate. [2] Substantial contribution by the non-debtor of assets to the reorganization. [3] The essential nature of the injunction to the reorganization, to the extent that, without the injunction, there is little likelihood of success. [4] An agreement by a substantial majority of creditors to support the injunction; specifically, if the impacted class or classes overwhelmingly votes to accept the plan. And [5] a provision in the plan for payment of all or substantially all of the claims of the … class or classes affected by the injunction. Hearing Tr. at 17:14-18:4.

Here, Judge Silverstein found that: 1) there was an identity of interest between the Debtors and the released parties due to the indemnification and advancement obligations owed by the Debtors should a nondebtor pursue a claim against the released parties; 2) the equity interest holders made substantial contributions by paying $325 million to the Debtors and relinquishing their equity interests in the Debtors, and the directors’ and officers’ sweat equity from their prior and future work for the Debtors was also a substantial contribution under the circumstances; 3) the Releases were essential to the Plan; 4) the support of 93.02% in number and 93.74% in amount of Class 2 Lenders was a substantial majority of creditors supporting the injunction; and 5) the $600 million new term loan, all the equity in the Debtors and recoveries under two trusts was reasonable compensation for Class 2 Lenders in exchange for the Releases, which is all that needs to be shown to satisfy the final factor.

Judge Silverstein stated that she was “not rejecting the argument that sweat equity alone may not be sufficient to constitute a substantial contribution in a given case. But in this case, where the record is unrebutted that the efforts of management successfully resulted in a viable plan that garnered support from all parties other than [the Opt-Out Lenders], and results in 100 percent payment to all creditors other than the [Lenders]; and that management, in the [Lenders’] view, is critical to unlocking the reorganized debtors’ total enterprise value, I find that the directors and officers have made a substantial contribution.”

After reviewing the relevant factors, Judge Silverstein approved the Releases, stating that “[t]aking into consideration the facts of this case, I find the releases and injunctions to all parties to be fair and necessary to the reorganization … . It is clear that the releases are necessary to both obtaining the funding and consummating a plan. In these cases, the funding does not merely enhance creditor recoveries; it is necessary for the [Debtors] to confirm the plan.”

The United States Trustee argued that there must be an ability to optout of releases contained in the Plan. In response, Judge Silverstein stated:

Here, the notice of non-voting status was served on all known non-voting classes … . That notice contained the full text, in bold, of the plan releases; thus, nonvoting creditors, including unsecured creditors, were on notice of the releases being granted and chose not to object. [G]iven the 100 percent payment on claims in this case, I find that the nonvoting parties have consented. Hearing Tr. at 27:22-28:5.

While Judge Silverstein confirmed the Plan without an opt-out mechanism, she stated that she could reevaluate this issue in future cases. Id. at 27:20-22.

Certification to the Third Circuit

Judge Silverstein certified the Opt-Out Lenders’ direct appeal to the U.S. Court of Appeals for the Third Circuit on the issue of what standard of law governs approval of “a non-debtor’s direct claims against other non-debtors for fraud and other willful misconduct without the consent of the releasing non-debtor … .”Millennium Lab, 543 B.R. at 709, 717. This issue met the requirements of direct certification because Judge Silverstein’s holding conflicts with Washington Mutual, 442 B.R. 314 (Bankr. D. Del. 2011). Id. at 714.

Unlike Judge Silverstein’s holding in Millennium Lab, Judge Mary F. Walrath stated in Washington Mutualthat a bankruptcy court “does not have the power to grant a third party release of a non-debtor. Rather, any such release must be based on consent of the releasing party (by contract or the mechanism of voting in favor of the plan).” Millennium Lab, 543 B.R. at 714-15 (quoting Washington Mutual, 442 B.R. at 352). While both cases recognized Continental, Judge Silverstein’s “interpretation of what is meant by Continental’s hallmarks — fairness and necessity to the reorganization — differs from that of theWashington Mutual court.” Millennium Lab, 543 B.R. at 715. However, the Third Circuit denied the petition for permission to appeal. In re Millennium Lab Holdings, No. 16-8017, Doc. No. 003112215428 (3d Cir. Feb. 22, 2016). Therefore, the Opt-Out Lenders were forced to file their appeal with the United States District Court.

Appeal to the District Court

The Opt-Out Lenders raised numerous issues on appeal of confirmation of the Plan, which is still pending before the district court. In re Millennium Lab Holdings II, LLC, Case No. 1:16-cv-00110(LPS), Dkt. No. 13, at 27-42 (D. Del. April 15, 2016). One of the issues on appeal is that the bankruptcy court erred in approving the Releases based on the facts of the case. The OptOut Lenders argue that the Plan does not provide for payment of all or substantially all of the Lenders’ claims, there is no identity of interest between the released parties and the Debtors because the released parties have no right to seek indemnification against the Debtors for willful misconduct claims, and the released parties are not contributing substantial assets. Id. at 45-58.

It is uncertain whether the issues raised on appeal by the OptOut Lenders will be decided by the district court. The Debtors filed a motion to dismiss the appeal on the grounds that the appeal is equitably and constitutionally moot, which the Opt-Out Lenders have opposed. In re Millennium Lab Holdings II, LLC, Case No. 1:16-cv-00110(LPS), Dkt. No. 7, 28 (D. Del. 2016). The district court scheduled a hearing on the Motion to Dismiss for Oct. 7, 2016. Id., Dkt. No. 41.

Practical Pointers

Prior to Millennium Lab, Washington Mutual provided precedent within the Third Circuit that a nondebtor third-party release could only be granted by a bankruptcy court based upon the affirmative consent of the releasing party. See Washington Mutual, 442 B.R. at 352. Millennium Lab now provides some authority for the position that bankruptcy courts can approve non-consensual third-party releases. Millennium Lab also provides new precedent for the proposition that directors’ and officers’ sweat equity alone could be enough to meet the substantial contribution factor in support of a nondebtor third party release.

However, practitioners should be careful in citing Judge Silverstein’s oral ruling as precedent in future cases. In fact, Judge Silverstein stated that “this ruling is not to be cited back to me. It may not even be persuasive in other cases, we’ll see.” Hearing Tr. at 5:3-4. The oral ruling needs to be considered in light of the circumstances that the bankruptcy court was faced with to confirm a plan prior to the expiration of a settlement deadline.

Judge Silverstein made it clear that she could reevaluate many of the issues decided in Millennium Lab, such as whether creditors must be given the ability to opt-out of non-debtor third-party releases contained in a plan, and whether sweat equity alone by directors and officers could be enough to weigh in favor of releases. Therefore, practitioners should carefully consider whether providing a mechanism for opting out of non-debtor third party releases is necessary and what consideration must be provided by officers and directors to support such a release in future cases. If nothing else, Millennium Lab provides a good example to debtors’ counsel of the notice that should be provided to all creditors should a plan provide for a non-debtor third-party release.

Reprinted with permission from the Volume 33, Number 12: October 2016 edition of the The Bankruptcy Strategist© 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.

On June 28, 2016, the U.S. Supreme Court agreed to hear a challenge to a Third Circuit-affirmed settlement and dismissal of the chapter 11 cases of Jevic Transportation, Inc. (“Jevic”) and certain of its affiliates.  See Official Comm. of Unsecured Creditors v. CIT Grp./Bus. Credit Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. 2015), cert. granted Czyzewski v. Jevic Holding Corp., No. 15-649, 2016 WL 3496769 (U.S. 2016).  Specifically, the Supreme Court will determine whether a settlement Jevic made with its secured lenders and the official committee of unsecured creditors (the “Committee”), which included a “structured dismissal” of Jevic’s bankruptcy cases, runs afoul of the payment priority scheme set forth in title 11 of the United States Code (the “Bankruptcy Code”).

Jevic and certain of its affiliates filed chapter 11 petitions in May 2008 in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”), and the Committee was formed shortly thereafter.  Jevic, 787 F.3d at 176.  At the time of filing, Jevic owed approximately $53 million to several secured creditors, including CIT Group/Business Credit Inc. (“CIT”) and a subsidiary of the private equity firm Sun Capital Partners (“Sun Capital”), and more than $20 million to its tax and general unsecured creditors.  Id.  Two years prior to Jevic’s bankruptcy filing Sun Capital acquired Jevic in a leveraged buyout financed by a group of lenders led by CIT, and at the time of the bankruptcy filings Sun Capital and CIT each held first-priority liens over substantially all of Jevic’s assets.  Id. at 175-76.

The legal issues surrounding the settlement and dismissal made their way to the Third Circuit as a result of two lawsuits that were filed in the Bankruptcy Court during the chapter 11 proceedings.  Jevic, 787 F.3d at 176.  The first was a class action lawsuit filed by a group of Jevic’s terminated truck drivers (collectively, the “Drivers”) against Jevic and Sun Captial alleging violations of federal and state Worker Adjustment and Retraining Notification (WARN) Acts, “under which Jevic was required to provide 60 days’ written notice to its employees before laying them off” (the “WARN Lawsuit”).  Id.; see also 29 U.S.C. § 2101; N.J. Stat. Ann. § 34:21-2.  The Drivers’ estimated claim in the bankruptcy cases was $12.4 million, of which $8.3 million likely was entitled to priority of payment under section 507(a)(4) of the Bankruptcy Code as employee wages.  Id. at 177; see also In re Powermate Holding Corp., 394 B.R. 765, 773 (Bankr. D. Del. 2008) (“Courts have consistently held that WARN Act damages are within the ‘the nature of wages’ for which § 507(a)(4) provides [a priority of payment].”).   The second lawsuit, brought by the Committee against CIT and Sun Capital, alleged, among other things, that the leveraged buyout saddled Jevic with excessive debt while requiring it to operate with minimal capital (the “LBO Lawsuit”).  Id.

In March of 2012, representatives of the Committee, Sun Capital, CIT, Jevic and the Drivers convened to negotiate a settlement of the LBO Lawsuit.  Jevic, 787 F.3d at 176.  By that time, however, Jevic’s only remaining assets were $1.7 million in cash (which was subject to Sun’s Capital’s lien) and the LBO Lawsuit, because all of Jevic’s tangible assets had been liquidated to repay CIT Group.  Id.  As a result of those discussions, all parties other than the Drivers reached a settlement pursuant to which, among other things, (i) mutual releases would be executed, (ii) Sun Capital’s lien on Jevic’s $1.7 million in cash would be assigned to a trust that would pay tax and administrative creditors first and then general unsecured creditors on a pro rata basis, (iii) CIT would pay $2 million into an account earmarked to pay Jevic’s and the Committee’s legal fees and other administrative expenses; and (iv) Jevic’s chapter 11 cases would be dismissed.  Id. at 177.  As described by the Third Circuit, “[t]he parties’ settlement thus contemplated a structured dismissal, a disposition that winds up the bankruptcy with certain conditions attached instead of simply dismissing the case and restoring the status quo ante.”  Id. at 177.

Notably absent as parties to the settlement agreement were the Drivers who, the Third Circuit surmises, were not able to reach an agreement with the other parties in large part because Sun Capital was a defendant in the WARN Lawsuit and was unwilling to fund litigation against itself.  Jevic, 787 F.3d at 179.  Moreover, the settling parties effectively acknowledged that the Committee only would negotiate a deal under which the Drivers were excluded because a settlement that paid the Drivers’ wage priority claim would have left the Committee’s constituents “with nothing.”  Id. at 178.  In the end, the Drivers were left completely out of the settlement, and “never got the chance to present [their] damages case in the Bankruptcy Court” due to the structured dismissal.  Id. at 177.  Consequently, both the Drivers and the United States Trustee objected to the proposed settlement and dismissal “mainly because it distributed property of the estate to creditors of lower priority than the Drivers under § 507 of the Bankruptcy Code.”  Id. at 178.  The Bankruptcy Court rejected the objections and approved the proposed settlement and dismissal.  Id.  The Drivers appealed to the U.S. District Court for the District of Delaware, which subsequently affirmed the Bankruptcy Court’s approval of the settlement and dismissal.  Id. at 179.

On appeal, the Third Circuit answered the question of whether “a case arising under Chapter 11 [may] ever be resolved in a ‘structured dismissal’ that deviates from the Bankruptcy Code’s priority system” by finding that “in a rare case, it may.”  Jevic, 787 F.3d at 175.  The Third Circuit “admit[ted] that it [was] a close call,” but stated that approval of the settlement agreement and structured dismissal “remained the least bad alternative since there was ‘no prospect’ of a plan being confirmed and conversion to Chapter 7 would have resulted in the secured creditors taking all that remained of the estate . . . .” Id. at 184-185.  Indeed, the court stated that the Drivers proved only that the Bankruptcy Code forbids structured dismissals when they are used to circumvent the plan confirmation process or conversation to chapter 7.  Id.at 181.

In affirming the appeal of the settlement and dismissal, the Third Circuit reinforced a circuit split with the Fifth Circuit, which held in U.S. v. Aweco Inc. (In re Aweco, Inc.), 725 F.2d 293 (5th Cir. 1984), that a bankruptcy court cannot approve a settlement agreement between a debtor and a junior creditor if the objections of senior creditors regarding priority are not respected.  Id. at 298.  Nevertheless, the result in Jevic is not without support, as the Second Circuit similarly held in the case of Iridium Capital Corp. v. Official Committee of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 451 (2d Cir. 2007), that a settlement may deviate from the Bankruptcy Code’s priority scheme in certain circumstances.  Id. at 464-465.  The more recent decisions in the Second and Third Circuits, therefore, reflect the notion that approval of a settlement violating the Bankruptcy Code’s priority rules may be favorable to no settlement at all.  This conflict, however, creates uncertainty regarding the scope of settlement agreements and structured dismissals, and bankruptcy practitioners, bankruptcy courts and parties in interest in bankruptcy cases hopefully will gain valuable guidance from the Supreme Court’s decision, once rendered.

The author would like to thank Adam Morsy, a summer associate at Cole Schotz P.C., who assisted in drafting this blog post.

 

 

Thomas Edison famously said that “opportunity is missed by most people because it is dressed in overalls and looks like work.”  Consistent with Edison’s musings, companies in an acquisition mode often overlook opportunities that arise in the bankruptcy arena because they lack knowledge of the system and think bankruptcy is an unruly beast dressed in extra-large overalls.  For companies seeking to acquire going concern businesses, real estate assets, liquidated equipment and rolling stock, or distressed debt, however, bankruptcy purchase opportunities are plentiful, usually at below market prices with potential high margin rewards.  Chapter 11 creates a buyer-friendly market for asset sales because (i) assets can be sold free and clear of liens, claims and encumbrances; (ii) going concern value can be preserved during the sale process; (iii) sales can proceed on an expedited basis without the kind of full marketing efforts of a solvent owner; and (iv) initial bidders can obtain protections such as break-up fees and expense reimbursement to protect them from being overbid.  Opportunistic companies can improve their market share by acquiring the business or strategic assets of a failing competitor, or simply add a new line of business to their enterprise, by purchasing through a bankruptcy sale.  Over the last five years, Maryland bankruptcy courts have overseen the disposition of assets ranging from residential real estate lots, shopping centers, apartment complexes, banks, loan portfolios and warehouses, to turn-key retail and wholesale businesses, manufacturers, nursing homes and service companies.  Interested parties can also purchase the debt of a bankrupt company in a “loan to own” strategy, or invest in a reorganization plan and obtain the equity in a reorganized business.  So remember, there is usually opportunity behind every perceived difficulty, and the bankruptcy market may be your next big one.