Sometimes the smallest bankruptcy cases give rise to the most interesting legal questions.  One such case was that of ScripsAmerica, Inc., which gave rise to the question of whether the Office of the United States Trustee (the “UST”) has the statutory authority to disband a committee of unsecured creditors once a committee is appointed, or whether that authority resides with the Bankruptcy Court.

By way of background, ScripsAmerica was a publicly-traded holding company whose primary assets were its ownership interest in a compounding pharmacy known as Main Avenue Pharmacy, Inc., 90% interest in a pharmaceutical wholesaler, and indirect control over another compounding pharmacy.  Substantially all of ScripsAmerica’s revenues, however, were derived from Main Avenue.  Main Avenue was forced to shut down its operations, depriving ScripsAmerica of any meaningful source of revenue.  ScripsAmerica had its own problems as well, including protracted litigation with an entity known as Ironridge Global IV, Ltd., which had paid off certain debts in return for the issuance of shares of ScripsAmerica and the resignation of the CEO and President of the company under a cloud of suspicion.

ScripsAmerica filed for bankruptcy protection on September 7, 2016.  See In re ScripsAmerica, Inc., Case No. 16-11991 (LSS).  On November 3, 2016 the UST appointed a committee (the “Committee”) consisting of two members: the former CEO and Ironridge.  Almost immediately, on November 4, 2016, the debtor filed a motion to disband the Committee, to which both the UST and Committee objected on November 21, 2016.

In its motion to disband the Committee, the debtor relied heavily on the fact that there were only two members of the Committee, one of which was a party against whom the debtor had been engaged in protracted pre-petition litigation and the other being the former CEO (an insider) of the debtor against whom the debtor alleged it had various claims (including, inter alia, claims related to the CEO entering into the Ironridge agreement in the first instance).   The debtor took the position that the Bankruptcy Court had the authority to disband the Committee pursuant to sections 105(a) and 105(d) of the Bankruptcy Code and relied upon case law in which a bankruptcy court had done so, albeit after appointment of a chapter 11 trustee.  See In re Pacific Ave., LLC, 467 B.R. 868, 870 (Bankr. W.D.N.C. 2012).

In their objections, the UST and Committee argued, among other things, that the Bankruptcy Court lacked statutory authority to disband a committee (except where a chapter 11 case is a small business case) because section 1102 is silent on the authority of a Bankruptcy Court to do so and section 105(d) cannot be deployed to expand the Bankruptcy Court’s authority beyond what it is statutorily granted.

The issue of disbandment languished for a time but revved up again when the debtor and Committee could not reach agreement on a plan of reorganization, at which point the debtor re-noticed its motion.  On January 11, 2017, the UST filed a notice of disbandment of the Committee.  The Court directed the Committee to file an adversary proceeding in order to resolve the question of whether the UST had statutory authority to disband the Committee.

In its brief notice of disbandment, the UST asserted that it had the statutory authority to disband the committee under 28 U.S.C. § 586(a)(3)(E), which authorizes the UST to “supervise the administration of cases … under chapter … 11 … of title 11 by, whenever the United States trustee considers it to be appropriate – monitoring creditors’ committees appointed under title 11.”

In its motion for summary judgment, the committee argued in the first instance that the UST’s purported disbandment of the committee violated the careful separation between administrative powers (vested in the UST) and judicial powers (vested with the Bankruptcy Court) inherent in the Bankruptcy Code.  The crux of the Committee’s argument, however, was that the UST simply has no statutory authority to disband a committee.

The committee first looked to section 1102 of the Bankruptcy Code, pursuant to which the UST is directed to appoint a committee and given authority to appoint additional members to a committee.  Nothing in that provision, however, expressly authorizes the UST to disband a committee.  See 11 U.S.C. § 1102.  The committee invoked the doctrine of expression unius est exclusion alterius, noting that Congress’s failure to include within section 1102(a)(1) the power to disband a committee once appointed precluded the UST from doing so.  On the other hand, the committee pointed out that section 1102(a)(4), added by BAPCPA, provides that the Court may order the UST to change the composition of the committee.   With regard to 28 U.S.C. §  586(a)(3)(E), the committee pointed out that the term “monitoring” was consistent with the administrative functions delegated to the UST, but did not encompass the judicial function of disbanding the committee.

The debtors—who had originally argued that the Bankruptcy Court had the authority to disband the committee in their motion requesting that it do so—argued in their opposition that the power to disband a committee is “inherent” in the UST’s authority under section 1102(a)(1) to form a committee, in conjunction with the UST’s power to “monitor” the committee under 28 U.S.C. § 586(a)(3)(E).  The debtors claimed that, prior to BAPCPA and the addition of section 1102(a)(4), the UST’s ability to remove committee members was not subject to Court review, although the debtor never actually pointed to any basis upon which that unfettered authority existed.  The debtors then relied heavily upon the case of In re VentureLink Holdings, Inc., 299 B.R. 420 (Bankr. N.D. Tex. 2003).  While VentureLink did contain similar facts to those in ScripsAmerica, the opinion largely proved the Committee’s point: the composition of the committee in VentureLink was modified, not by an edict of the UST (which had refused to remove the member in question), but by an order of the Bankruptcy Court.  See 299 B.R. at 424.  The VentureLink decision suggests that the UST has the authority to remove members of a committee in the first instance, but final authority rests with the Bankruptcy Court.

The UST never submitted a brief in support of its notice of disbandment because, before it was required to do so, ScripsAmerica’s chapter 11 proceeding was converted to a chapter 7, largely because the estate was administratively insolvent, in no small part because of the litigation over disbandment of the Committee.

Predicting where the Bankruptcy Court might have come out on the issue is impossible because, in the end, neither the Bankruptcy Code nor title 28 clearly grant anybody—either the Court or the UST—the authority to disband a committee.  Logic would seem to dictate that some mechanism for eliminating a committee under the right circumstances should exist, but Congress does not appear to have given statutory expression to that logical observation.

Nor does the case law provide clear guidance.  In a relatively recent decision, a Bankruptcy Court concluded that it lacked statutory authority to disband a committee once appointed, but did not find that the UST had the authority to disband a committee.  See, e.g., In re Caesars Entm’t Operating Co, Inc., 526 B.R. 265 (Bankr N.D. Ill. 2015) (in fact, the UST shared the moving debtors’ concern that the committee in question would engage in duplicative activities that would increase fees, yet the court did not suggest the UST had the power to disband the committee); cf. Credit Suisse AG v. Appaloosa Inv. L.P., 2015 WL 52570003 at *5 (S.D.N.Y. Sep. 9, 2015) (discussing court’s earlier order denying motion to disband on grounds that court lacked statutory authority).  In another case, the Bankruptcy Court declined to rule on whether it had the authority to disband a committee because it concluded on the facts that doing so was not appropriate, though the court also did not conclude that only the UST had the authority to disband a committee.  See In re Dewey & Leboeuf LLP, 2012 WL 5985325 (Bankr. S.D.N.Y. Nov. 29, 2012).  However, counsel seeking to have a committee disbanded may take heart in the fact that in at least one case a court allowed the fees of the movant.  See In re Keene Corp., 205 B.R. 690, 704-05 (Bankr. S.D.N.Y. 1997).

Unfortunately for those seeking clarity on the scope of the UST’s authority, the conversion of the ScripsAmerica case mooted the issue of the disbandment of the committee.  Thus, the bankruptcy bar will have to wait until the next time the UST seeks to disband a committee for case law on whether the UST has that authority.

Disclosure:  Cole Schotz P.C. represents a significant unsecured creditor of ScripsAmerica, Inc. and advocated for the conversion of the case to a chapter 7 proceeding.  Neither Cole Schotz P.C. nor its client took any position on the authority of the UST to disband the Committee.

Since February 2016, the Local Rules for the United States Bankruptcy Court for the District of Delaware provide for combined hearings on approval of disclosure statements and confirmation of plans and for the use of combined disclosure statement and plans in liquidating chapter 11 cases.

Although combined hearings in such cases occurred prior to the enactment of the new rule, they were relatively rare and often subject to objection.  Such objections were largely based upon the limitations in section 1125(f) of the Bankruptcy Code that provides, among other things, that “the court may determine that the plan itself provides adequate information and that a separate disclosure statement is not necessary” and that “the hearing on the disclosure statement may be combined with the hearing on confirmation of a plan” in a small business case.  The Code is silent on the process as it relates to non-small business chapter 11 cases.

For example, in In re Corinthian Colleges, Inc., No. 15-10952 (KJC), the Department of Education objected to a combined process arguing that “[a]n integrated plan and disclosure statement is permitted for small business bankruptcies . . . [and] [b]y authorizing a combined disclosure statement and plan for chapter 11 bankruptcies of small businesses, Congress implicitly prohibited them for other chapter 11 bankruptcies.”  [D.I. 580].  Similarly in In re Old FOH, Inc., No. 15-10836 (KG), the debtors submitted a combined plan and disclosure statement.  In that case, the United States Trustee objected arguing, among other things, that a combined document is ordinarily only appropriate in small business cases.  [D.I. 421].  In each case, the court overruled the objections.

Other Judges in the District of Delaware have approved combined hearings on the approval of disclosure statements and the confirmation of chapter 11 plans in non-small business and non-prepacked cases prior to the enactment of the rule.  See, e.g., In re Hipcricket, Inc., Case No. 15-10104 (LSS) (Bankr. D. Del. Mar. 31, 2015); In re AFA Investment Inc., Case No. 12-11127 (MFW) (Bankr. D. Del. January 16, 2014); In re Devonshire PGA Holdings, LLC, Case No. 13-12460 (CSS) (Bankr. D. Del. Oct. 16, 2013); In re Rubicon US REIT, Inc., Case No. 10-10160 (BLS) (Bankr. D. Del. June 21, 2010).

Now a combined process, including the use of a combined document containing the plan and disclosure statement, is expressly contemplated by Local Rule 3017-2 which provides as follows:

(a)   Applicability. This Local Rule shall be applicable to all cases arising under chapter 11 of the Code where the following requirements are met:

(i)  All or substantially all of the assets of the debtor[s] were or will be liquidated pursuant to a sale under 11 S.C. § 363; and

(ii)  The plan of liquidation proposes to comply with section 1129(a)(9) of the Code; and

(iii)  The plan of liquidation does not seek non-consensual releases/injunctions with respect to claims creditors may hold against non-debtor parties; and

(iv)  The debtor’s combined assets to be distributed pursuant to the proposed plan of liquidation are estimated, in good faith, to be worth less than $25 million (excluding causes of action).

(b)  Combined Disclosure Statement and Plan of Liquidation. A plan proponent may combine the disclosure statement and plan of liquidation into one document.

Since the enactment of Local Rule 3017-2, the use of combined plan and disclosure statements and/or combined hearings appear to have increased, particularly in liquidating cases with assets less than $25 million.  See, e.g., In re SDI Solutions LLC, Case No. 16-10627 (CSS) (Bankr. D. Del. May 24, 2016); DNIB Unwind, Inc. (f/k/a BIND Therapeutics, Inc., et al., Case No. 16-11084 (BLS) (Bankr. D. Del. Sept. 26, 2016).

Proponents of the combined process contend that it is more streamlined, less expensive, and quicker.  See, e.g., In re JMO Wind Down, Inc., Case No. 16-10682 (BLS) [D.I. 320].  The author predicts that practioners in the District of Delaware will continue to increasingly take advantage of the combined process in the right cases due to the enactment of Local Rule 3017-2.

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.