Tue 01/04/2022 06:00 AM
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During the Dec. 20, 2021, oral arguments in the consolidated appeals brought by the U.S. Trustee and two securities fraud plaintiffs challenging the release and exculpation provisions in the Ascena Retail debtors’ liquidating plan, U.S. District Judge David Novak offered strong indications that he intends to invalidate the plan’s third-party release provision in a decision he expects to issue “by the early part of January.” As previously reported, public access to the hearing was limited due to technical difficulties. Reorg provides the following summary of the oral arguments based on the transcript of the hearing.

After aggressively questioning George Hicks of Kirkland & Ellis, counsel for the debtors (Ascena is now known as Mahwah Bergen Retail Group), Judge Novak remarked that “it's pretty clear the releases are going to be invalid. That's where that's headed.”

The judge further stated his belief that the Ascena confirmation order violated the Supreme Court’s 2011 Stern v. Marshall decision, which he directed the parties to address in supplemental briefing. “I think there's a Stern v. Marshall violation here,” said the judge, citing a lack of judicial findings by the bankruptcy court and noting that “we really don't know what claims were actually released.”

As to equitable mootness, which the debtors have argued bars appellate review of the confirmation order, the judge said that “there's no way in the world I'm applying equitable mootness here. That's just not going to happen here.”

Judge Novak added that he is “hung up on remedy here” and asked each party for their view on the appropriate remedy in the event he strikes down the releases. Hicks responded that the “only possible remedy” in that case is for the court to invalidate the entire plan, arguing that by its own terms the releases are not severable and so may not be simply “excised” from the plan.

Counsel for the UST suggested that the court treat the confirmation order as “proposed” findings of fact and conclusions of law. In that case, she argued, the “nonseverability provisions haven’t come into effect yet” under the terms of the plan, which provides that such provisions take effect only upon entry of a “final confirmation order.”

She added even if the court were to give effect to the nonseverability provision, “there's really nothing preventing this Court from vacating the Plan and remanding it back to the bankruptcy court for the parties to come up with a new Plan” because “the only thing that happened here was the distribution of money.”

Counsel for the lead securities plaintiffs suggested that the court fashion a remedy “deem[ing] all the [securities] class members to have opted out of the third-party release.”

During the proceedings Judge Novak also expressed concerns over the debtors’ selection of venue in the Richmond bankruptcy court. Although he acknowledged it was permissible under the venue statute, the judge suggested that the debtors selected the Richmond district because of “the releases that are regularly given out down here,” adding that “when you couple” the venue selection “with these releases, I think it looks pretty bad. And that concerns me.” “It is what it is, though,” concluded the judge.

Oral Argument

Judge Novak opened the hearing with a heated line of questioning aimed at Hicks, beginning with asking whether Ascena’s nondebtor releases are “the norm” in the Eastern District of Virginia Bankruptcy Court. The judge then jumped on Hicks’ response - that such releases are approved “with some regularity” in this and other districts - asking, “[D]oesn’t that alone tell you what’s wrong with this?”

Judge Novak asked Hicks to “square” such “regularity” with the Fourth Circuit Behrmann decision, which the judge said warns that third-party releases should be “done cautiously and infrequently.” Judge Novak went on to paraphrase U.S. District Judge Colleen McMahon’s Dec. 16, 2021, decision vacating Purdue Pharma’s plan confirmation as saying that if third-party releases are “unique in all cases,” they are “unique in none.” If this “nonsense” is “going on in our bankruptcy court all the time,” the judge continued, “it needs to end.”

When Hicks responded that the Ascena releases satisfy the Behrmann decision because they are “consensual” as a result of the plan’s opt-out mechanism, the judge interrupted to say “you’re not even in the universe of consensual.”

The confirmed plan provided that the third-party releases applied only to parties who did not submit a form opting out of the releases or who did not object to the plan.

The judge further queried whether the debtors’ argument “rise[s] and fall[s]” on the releases being consensual, highlighting that the bankruptcy court’s findings with respect to the Behrmann factors were limited to a single footnote stating they were satisfied. Hicks responded that the lower court’s finding with respect to the Behrmann factors was “belt and suspenders” given that it had already found the releases to be consensual based on the opt-out provision.

Hicks continued to stress the plan’s opt-out mechanism as supporting a conclusion that the third-party releases were consensual, drawing an analogy to opt-out provisions in class-action settlements. Judge Novaks resisted Hicks’ analogy, saying that class actions typically provide class members with “some consideration” if they do not opt out of a class settlement, whereas the release notice and opt-out form in these cases make “not one mention” of what releasing parties would receive in exchange for the releases.

When the judge suggested that the only consideration for releasing parties who did not opt out was “mutual releases,” Hicks responded that that was the case for interest-holders, while claimholders would also receive an avoidance action waiver.

Judge Novak pressed Hicks on the universe of potential claims to be “mutually released” against the releasing parties. With the exception of the securities fraud claims asserted by appellants Patterson and Michaella Corp. against former directors, Hicks was unable to identify any such claims, saying they are “as concrete” as the types of claims subject to the third-party releases.

He added that the purpose of the “comprehensive releases” is to cover all possible claims that could be asserted against the plan’s released parties in order to “get the stakeholders to the table” to facilitate a consensual restructuring. The judge responded that the debtors’ inability to identify any potential claims against the released parties leads him to believe the “mutual releases” are “illusory” and designed to “make up some consideration for these releases.”

Expressing concern about the scope of released claims, Judge Novak told Hicks, “Just tell me how many types of claims are released. Is it 10? Is it 100? Is it 1,000? Because I can't figure it out.” Hicks was unable to give a specific number but stressed that the bankruptcy court found “over and over and over” in its “uncontested findings” that the releases were “essential, integral, instrumental, and necessary” to the plan.

The judge countered that the bankruptcy court’s findings “seemed” to be “boilerplate,” or “just accepting whatever was put in front of” the court. “To me,” the judge continued, “there's a complete abdication of what are supposed to be judicial findings. Just rubber-stamped it.” Elaborating on the lack of judicial findings, the judge added that “there's no way for an appellate judge like me, and ultimately the Fourth Circuit when you appeal me,” to be able to “tell what's been released and what's not.”

Hicks pushed back, asserting that it is not “fully accurate” to say the bankruptcy court “just breezed through it.” According to Hicks, the bankruptcy court made numerous findings from the bench, in the confirmation order and in its “very lengthy opinion” supporting confirmation. “You and I have vastly different views of what our bankruptcy judge did here,” responded the judge. “The record speaks for itself. You can talk to the Fourth Circuit about that.”

Judge Novak then turned to Stern v. Marshall. “I think we have a Stern issue here,” said the judge, “since we really don't know what claims were actually released” and because the bankruptcy court made no findings regarding which released claims were “core” or “noncore” claims. Looking at the record, added the judge, “I just find a generic, boilerplate conclusion that it's all part of” plan confirmation.

When Hicks pointed out that the UST had not challenged the bankruptcy court’s “constitutional authority” to “do what it did,” Judge Novak said, “I’m looking at it now though.” “I think there's a Stern v. Marshall violation here,” he continued. “I think it requires detailed findings by the bankruptcy court. They did none.”

Hicks countered that “whether something is core or noncore is a matter of law” and therefore specific factual findings by the bankruptcy court were not needed. He added that the confirmation hearing was the “operative proceeding” for Stern purposes, rather than any “adjudication” of the released claims.

Turning to the debtors’ argument that the releases were “consensual” based on the plan’s “opt-out” mechanism, the judge asked Hicks to explain “how it is that silence can be used for folks that consent to release of their claims.” “Because basic contract principles say the opposite,” the judge continued. “Unless you're in a unique position, silence is never consent.”

Returning to his class-action comparison, Hicks asserted that in that context “a lack of affirmative opt-in can be material.” Again rejecting the analogy, Judge Novak pointed out that a class has counsel “advocating for them all the time. We don’t have that here.”

Moreover, said the judge, the bankruptcy notices did not communicate the consideration being offered in exchange for the releases, namely the “mutual release,” which the judge reiterated he believes to be “illusory.” “Even if it wasn’t [illusory],” he added, “it wasn’t communicated to folks.” According to Judge Novak, Ascena’s notices merely communicated that “if you don't respond, you release your claims. Have a nice life.”

During a colloquy regarding equitable mootness, which the debtors have argued applies to bar the appeals, the judge indicated he intends to exercise his discretion to not apply the doctrine. “I think you're using equitable mootness here to avoid review of really troublesome releases. And I don't think that's what the law is about,” said the judge. “I think if these releases were proper, we should say it. If they were not proper, we should say it. That's what judges do, and I think that's what my job is now.” As noted above, the judge said there is “no way” he would apply equitable mootness in this case.

Turning to the debtor’s argument that the plan releases are “nonseverable” from the rest of the plan, Judge Novak then asked Hicks whether a holding that the releases are severable would “undermine” the equitable mootness argument. The judge pointed out that “everything was done” by December 2020, referring to the debtors’ sale of various brands, and that by the confirmation hearing in February 2021, “nothing need[ed] to be done other than paying the money” to creditors.

Hicks responded that if the releases were “excise[d]” from the plan, “you are basically creating a situation where the parties to the Plan don't have the bargain that they agreed to.” According to Hicks, “It's the lenders who made this possible,” and “according to the uncontroverted findings of the bankruptcy court,” they “wouldn't do it without these releases.” That point “can't be emphasized enough,” said Hicks.

“Why would I not just excise the releases and let this phenomenal deal go forward?” asked the judge. “Because it seems to me the releases, under the testimony that was given, are really no longer necessary.” Hicks answered that would be “setting a very imprudent precedent going forward,” suggesting that “to look at it ex-post and to strike something because you think it's no longer necessary” would be problematic for “the next time one of these comes about and the parties are trying to figure out … what are we going to do to get the parties to the table to agree on how we're going to bring about another one of these successful restructurings.”

“The answer is easy,” countered the judge. “It is to ensure that the bankruptcy court makes detailed findings about what the releases are, the nature of the releases, who's being released, and why they are integral to the deal.” But, the judge continued, “the absence of judicial findings here has allowed everybody to have a giant guessing game as to what the impact is.”

Regarding the plan’s exculpation provision, Judge Novak pressed Hicks on the proper remedy if he were to agree with the UST that it is impermissibly broad. Hicks responded that the exculpation provision is, like the releases, nonseverable from the plan and cannot be modified without invalidating the entire plan. “So what you're saying is if I find the releases and/or the exculpation clause to be invalid, I have to necessarily throw the whole Plan out. That's what you're telling me?” asked the judge, with Hicks responding in the affirmative.

UST attorney Sumi Sakata told the judge that if he concludes that Stern v. Marshall was violated, then the court should treat the confirmation order as “proposed” findings of fact and conclusions of law - “essentially a report and recommendation” to the district court - in which case, according to Sakata, the “nonseverability provisions haven’t come into effect yet” under the terms of the plan, which provides that such provisions take effect only upon entry of a “final confirmation order.” That would be the case for both the release and exculpation provisions, said Sakata.

Stern was violated, continued Sakata, because entry of the confirmation order “terminat[ed]” the claims at issue regardless of whether the bankruptcy court “actually went through and determined the merits of the claim[s].” Sakata added that the plan’s nonseverability provision is a “legal fiction” that was “purely there just to protect” against an “appeal based on equitable mootness grounds.” Even if the court chose to give effect to that provision, she continued, “there's really nothing preventing this Court from vacating the Plan and remanding it back to the bankruptcy court for the parties to come up with a new Plan” because “the only thing that happened here was the distribution of money.”

Andrew Behlmann of Lowenstein Sandler, on behalf of securities fraud lead plaintiffs Joel Patterson and Michaella Corp., challenged the debtors’ argument that the plaintiffs lack standing on appeal because they opted out of the third-party releases by virtue of their objection to the releases. Behlmann, who said his clients did not submit an opt-out form, characterized the plan’s construct on this point as a “death trap,” saying they were left with a “Hobson’s choice” of objecting and losing standing or having to defend against an argument that they “waive[d] every issue on appeal.”

Judge Novak acknowledged the “conundrum,” but pointed out that the plaintiffs still need a “direct and pecuniary injury” to have standing. The judge also asked why, “in practical terms,” he should “go through the mental gymnastics to figure out whether or not you've got standing when the trustee does have standing” and has also challenged the releases. Behlmann responded that his clients are the only parties “with an actual economic interest in the outcome.”

Behlmann suggested that if the court finds the releases to be impermissible, the proper remedy as to his clients is for the court to “deem all the class members to have opted out of the third-party release.”

The judge voiced additional concerns over professional fees approved in the case, saying that “when you choose the venue, the case law says you choose the rates of the locale,” but “the rates that have been used here are not Richmond rates.” “It's clear I can't claw it back,” the judge continued, “but I want to make it clear for any of the bankruptcy folks that are here, we're using Richmond rates going forward because I am very troubled about the fee rates here.”
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