Reorg’s Court Opinion Review provides an update on recent noteworthy bankruptcy and creditors’ rights opinions, decisions and issues across courts. We use this space to comment on and discuss emerging trends in the bankruptcy world; our opinions are not necessarily those of Reorg as a whole. Today we consider the implications of Judge Michael Kaplan’s LTL dismissal decision, Judge Colleen MacMahon’s latest reversal of a bankruptcy court decision in the Madoff avoidance litigation and a fight over retention in PWM Property Management.
Reorganizing the Tort System
In a
letter to the Sixth Circuit on Tuesday, March 1, U.S. District Judge Dan Polster, the federal judge overseeing the massive opioid multidistrict litigation proceeding, lamented that “[t]he responsibility to address the long-standing opioid epidemic should rest upon the executive and legislative branches, but they have failed to do their job.” “The judicial branch is not equipped to do so,” Judge Polster continues, “but the nation’s States, cities and counties have nevertheless turned to the courts.” Essentially, the judge pleads that he is doing the best he can with what he’s got.
If the Article I legislative branch of government and the Article II executive branch decline to address a mass tort crisis, and the Article III judiciary cannot effectively do so, then who can? Can Congress or the executive branch create a “new Branch” and give it authority to craft a fair and equitable solution? Or does that new branch already exist - in the form of U.S. bankruptcy courts?
Ostensibly, federal agencies are designed to resolve issues that do not rise to the requisite level of legislative interest, but for better or worse, agency authority has been dramatically curtailed by an increasingly minimalist judiciary intent on curbing executive power. As U.S. District Judge Steven Merryday put it in an
opinion striking down the CDC’s Covid-19 cruising regulations in June 2021, the federal courts have stopped standing by “quiescently” as the unaccountable and anonymous “administrative state” and its “legion of lawyers” extend their “hegemony” to “command and coerce” the citizenry.
Most recently, on Feb. 23, U.S. District Judge Jeremy Kernodle of the Eastern District of Texas
nullified four federal agencies’ effort to steer the outcome of arbitrations over out-of-network provider reimbursement under the federal No Surprises Act, or NSA, which specifically instructed the agencies to set the contours of the dispute resolution process.
Provider groups
challenged the arbitration rule as a resurrection of rejected legislative proposals, while the agencies
defended the rule as necessary to achieve what they view as a key goal of the NSA: bringing out-of-network reimbursement rates closer to in-network contractual rates to correct a “market failure” exploited by private equity-owned provider groups. Judge Kernodle found that the agencies’ proposed rule created a “rebuttable presumption” absent from the NSA and therefore exceeded the agencies’ rulemaking authority.
So perhaps the administrative state cannot be counted on to solve issues the legislature leaves unaddressed in this environment. The days of the EPA or FDA leading from the front are over and likely not coming back anytime soon. I doubt any public policy expert suggested in 2000 that by 2022, individual bankruptcy courts in chapter 11 cases would become the preferred venue for nationwide resolution of policy-heavy mass tort crises, but here we are.
Of course, bankruptcy courts, like federal agencies, have their own jurisdictional limitations, as they are also creations of Congress rather than true Article III “courts” and are still holding powers delegated by Congress, not Article III judicial authority. In the wake of Judge Merryday’s CDC decision, we
wondered whether in the absence of specific authority under the Bankruptcy Code, bankruptcy courts, like federal agencies, have seized the authority to “address the broad-ranging policy issues” now facing them - including mass tort adjudication - “unbound by legislative directive.”
Since we discussed the issue, Article III judges have taken a more active role in reining in bankruptcy courts as well as federal agencies. Most notably, we have the
two recent nondebtor release decisions from U.S. District Judges Colleen MacMahon and David Novak in the
Purdue and
Ascena cases, respectively. Judge Novak held that bankruptcy courts can rely only on their limited “
in rem jurisdiction over the debtors’ property and the disposition of that property,” and have “no
in rem jurisdiction over third-party claims not against the estate or property of the estate.” “Article III simply does not allow third-party non-debtors to bootstrap any and all of their disputes into a bankruptcy case to obtain relief,” the judge concluded.
However, recent bankruptcy court decisions suggest that bankruptcy judges aren’t heeding this trend. First, on Feb. 4, Judge John Dorsey in Delaware
confirmed Mallinckrodt’s plan, including nonconsensual nondebtor releases of non-opioid claims. Despite the Purdue and Ascena decisions - and growing calls for Congress to
explicitly limit nondebtor releases - Judge Dorsey concluded that there is actually “no debate” over bankruptcy courts’ authority to eradicate nonbankruptcy claims against nondebtors if necessary for a corporate debt reorganization.
Instead of taking the Purdue and Ascena decisions’ logic head-on, Judge Dorsey simply noted that the law of the Third Circuit may be different than the law of the Second or Fourth circuits. Judge Dorsey adds that “although the Third Circuit has not explicitly commented on the propriety of non-debtor releases in these circumstances,” it “has suggested that if they are appropriate anywhere, it would be in a mass tort case like this one.” That’s hardly a ringing endorsement, but it was enough for Judge Dorsey to conclude that the case for nondebtor releases is open and shut.
Then, on Feb. 25, Judge Michael Kaplan in New Jersey went even further in the LTL Management case, openly advocating for bankruptcy courts as the superior venue for mass tort resolution over
Article III judiciary and state courts. LTL does not (yet) involve nonconsensual nondebtor releases, and such releases are specifically contemplated in asbestos cases under section 524(g) of the Bankruptcy Code. However, the core issue - whether nondebtors can take advantage of a debtor’s filing to secure litigation benefits without accepting the burdens of chapter 11 - is the same.
Counsel for the claimants seeking dismissal of LTL’s case explicitly made the connection between LTL and Purdue during
closing arguments. There is an “odor emanating” from this case, counsel argued, and it is the “same smell” that offended Judge MacMahon in Purdue: a “powerful nondebtor testing how far it can go reaching into the cookie jar of another company’s bankruptcy.”
Judge Kaplan was unmoved, and his opinion denying dismissal of LTL’s chapter 11 case provides a rousing defense of the expanding authority of bankruptcy courts questioned by Judge MacMahon and Judge Novak. “There is nothing to fear in the migration of tort litigation out of the tort system and into the bankruptcy system,” Judge Kaplan declared. “[T]he filing of a chapter 11 case with the expressed aim of addressing the present and future liabilities associated with ongoing global personal injury claims to preserve corporate value is unquestionably a proper purpose under the Bankruptcy Code,” added the judge.
In other words, according to Judge Kaplan, not only can Congress create a new branch to resolve mass tort crises, but
it already did so, in the Bankruptcy Code of 1978. You could argue that Judge Kaplan is only referring to asbestos cases, which have that special delegation in section 524(g), but we think Judge Kaplan’s sweeping language goes further.
Judge Kaplan agreed with Judge Polster that the judiciary cannot handle modern mass tort cases, but goes further by proposing that bankruptcy courts can. The judge expressed a “strong conviction that the bankruptcy court is the optimal venue for redressing the harms of both present and future talc claimants in this case - ensuring a meaningful, timely, and equitable recovery.”
Judge Kaplan then wonders why we shouldn’t all
welcome an
opening of the chapter 11 floodgates for solvent companies seeking to resolve their tort liabilities, rescuing those disputes from the unwilling legislative and executive branches and what many view as the inefficient, inequitable landscape offered by the other duly constituted courts of plenary jurisdiction in the country.
In Judge Kaplan’s view, individual tort cases are for the Article III judiciary and state courts, but once they grow to become a threat to an enterprise (and all of its other stakeholders), the bankruptcy courts are best suited to balance interests, allocate fault and set liability.
The judge even seems surprised that counsel for the asbestos claimants - the lawyers those claimants hired and entrusted with prosecuting their legal rights - themselves can’t seem to accept that the bankruptcy court is the superior forum for this policy-making process rather than that pesky jury trial system guaranteed by the Seventh Amendment. Judge Kaplan said he “simply cannot accept the premise that continued litigation in state and federal courts serves best the interest” of plaintiffs, even though “continued litigation in state and federal courts” is exactly what the claimants have repeatedly insisted they prefer.
This is the exact kind of paternalistic bureaucratic impulse that has given Judge Merryday and so many others such a nasty case of Fear For The Future Of The Republic since the rise of strict construction: unelected, nonconstitutional officials - here, bankruptcy judges - imposing their unaccountable “expert” judgment of what is best for individual citizens, businesses and all their constituents - notwithstanding the citizens’ opposition. Judge Kaplan admits that his decision will be “met with much angst and concern” but says that the ruling is “so much more than an academic exercise or public policy debate.”
The judge’s ruling may involve
more than a policy debate, but it unquestionably
answers a policy debate ongoing in Congress
right now: whether bankruptcy courts should be in the business of nonconsensually overriding plaintiffs’ choice of forum, eliminating jury trial rights and eradicating claims against nondebtors in the interest of reorganization. Then there is the broader policy judgment in deciding how the interests of claimants in mass tort cases should be balanced against the interests of enterprises and their other stakeholders.
And there is “no debate” that judges - especially non-Article III bankruptcy judges - should
not be involved in policy decisions, which are reserved to the legislature under the Constitution. Justice Antonin Scalia once warned in a
1989 dissent (which would now likely be a majority opinion) that Congress cannot delegate policymaking responsibility to another government institution as a “new Branch” of government, no matter how sensible or efficient that might appear. “It may well be that, in some circumstances, such a Branch would be desirable,” the dissent acknowledged.
The dissent added, however, that “there are many desirable dispositions that do not accord with the constitutional structure we live under” and, “in the long run, the improvisation of a constitutional structure on the basis of currently perceived utility will be disastrous.”
Of course, it is far from certain that Congress
intended bankruptcy courts to resolve thorny mass tort issues rather than Article III courts when it enacted the Bankruptcy Code (again, putting aside section 524(g)). Even if it did, that might not pass constitutional muster and might lead the bankruptcy courts down a path that ends far from their primary reorganizational purpose.
Putting aside the legalities, do we really want bankruptcy courts to become the forum for fights over the fairness of the U.S. tort system? How many bankruptcy judges want to feel the same
heat applied to Judge Robert Drain in Purdue? We may be better off sticking to sports and staying below the radar.
The Takeaway: So, who’s next? Big pharmacy chains offloading their
opioid liability? Fellow opioid defendants
Endo and
Teva? Companies facing mass tort claims for environmental contamination? The directors of any company facing mass tort liability might breach their fiduciary duty by not at least
considering their own Texas two-step.
The Fine Print: It will be interesting to see if the LTL claimants are able to secure an effective appeal of Judge Kaplan’s decision. In a unanimous 2015 decision on appealability of orders denying plan confirmation, the Supreme Court found that “only plan confirmation - or case dismissal - alters the status quo and fixes the rights and obligations of the parties.” In other words, there may not be any
immediate Article III oversight of Judge Kaplan’s decision here - and if it is later reversed after confirmation, the claimants may have already suffered
years of unwarranted delay in chapter 11 proceedings that should have been dismissed.
Judge MacMahon Strikes Again
Speaking of Article III judges getting snappy with bankruptcy courts, check out Judge MacMahon’s Feb. 17
opinion in one of the never-ending Madoff avoidance actions. Although the district judge ends up affirming Judge Cecilia Morris’ decision below, Judge MacMahon finds that Judge Morris reached the right result for the wrong reasons by employing the “law of the case” doctrine to get around a detailed review of the issues. Squint a bit, and you’ll see the decision could have implications for that grand plan to use bankruptcy cases to centralize and resolve mass tort claims.
The case isn’t anything you haven’t already seen a few hundred times, and that ended up being the problem for Judge Morris. The Madoff trustee sued to recover “fictitious profit” distributions made to several affiliated investors. The key issue was whether the “fictitious profits” were paid out of accounts that qualified as “customer property” under SIPA. If not, then the trustee could not recover the transfers at issue. The question is analogous to the “property of the debtor” element of state law fraudulent conveyance claims and had already been answered many times in prior Madoff adversaries.
Judge Morris had granted summary judgment for the trustee in reliance on those prior decisions. “Noting that these exact same claims had been litigated over and over again in other avoidance proceedings,” Judge MacMahon recounts in her opinion on appeal, Judge Morris granted summary judgment “on the ground that the transfers were, in fact, transfers of BLMIS' customer property and must be turned over to the Trustee.”
To get to an easy, no-brainer summary judgment decision using prior rulings rather than a detailed review of the evidence, Judge Morris relied on the “law of the case” doctrine, which provides that legal decisions in a particular case are binding on all parties to that case. This allowed Judge Morris to avoid conducting a detailed analysis on the customer property issue in the instant case - something bankruptcy judges do all the time to quickly dispose of common issues in hundreds of claims objections or avoidance actions in a particular case. In the right circumstances, this is perfectly legitimate.
The law of the case doctrine makes intuitive sense in traditional litigation cases, where the same parties are involved at all stages. If you sue someone for breach of contract, the trial court enters a partial summary judgment finding that a binding contract exists as a matter of law and an appellate court affirms, the defendant can’t later argue to the contrary at trial.
In a bankruptcy case with multiple adversary proceedings, the doctrine seems a bit less obvious, since the same parties are not involved in every adversary. Nevertheless, Judge MacMahon agreed with Judge Morris that the “law of the case” applies to all adversary proceedings related to a single SIPA liquidation like the Madoff case. “This means that legal rulings reached by appellate courts in earlier clawback/fraudulent transfer cases can be treated as law of the case in this one,” the district judge concluded.
Where Judge Morris erred, Judge MacMahon found, was in using the “law of the case” to evade a detailed analysis of
factual issues - like the customer property question. “Because law of the case applies to legal, not factual, conclusions,” Judge MacMahon said, the earlier factual finding “that BLMIS owned, and so has an interest in, the property transferred to Appellants from the JPMorgan Accounts, cannot possibly be ‘law of the case.’”
Judge MacMahon then gives Judge Morris the benefit of the doubt: “The learned Bankruptcy Judge - who has presided” over “multiple trials and other proceedings in which the evidence overwhelmingly demonstrated that the Trustee's position is factually true - can be certainly forgiven for trying to come up with a reason not to prolong the wasteful re-litigation of this issue,” Judge MacMahon wrote. “But the solution Chief Judge Morris found is not the correct solution,” concluded Judge MacMahon.
“[D]espite the unitary nature of adversary proceedings in a single SIPA liquidation, like this one, factual findings made in one litigated proceeding cannot simply be grafted onto separate adversary proceedings involving different parties - even though the issues are identical,” Judge MacMahon explained. “[T]he results in the earlier cases are not ‘binding’ on subsequent litigants because each case involves different defendants,” Judge MacMahon added in her analysis on collateral estoppel, a similar shortcut for trial judges looking to avoid taking factual issues head-on. “[T]he repeated, unanimous factual findings in favor of the Trustee” on one issue “do not collaterally estop the next net winner in the queue.”
The district judge then proceeded to conduct her own analysis and concluded that Judge Morris reached the right result on summary judgment - and could have done so without being questioned on appeal had she not chosen to use inapplicable preclusive doctrines to push another Madoff avoidance decision down the assembly line.
The Takeaway: There is a practical, commonsense allure to deciding issues just once in a bankruptcy case or adversary proceeding and applying that decision to all related matters to save time, energy and expenses. This approach definitely plays into Judge Kaplan’s idea of bankruptcy courts as a more
efficient way to handle mass tort cases by using preclusive tools to prevent inconsistent outcomes and lower the cost of litigation. Again, however, the interests of expediency must yield to legal standards - at least so long as bankruptcy courts purport to be courts of law.
The Fine Print: We can’t wait for a bankruptcy judge to cite this decision in granting a motion to estimate mass tort claims in some future Texas two-step case. Well, the judge might imply, I can’t use law of the case or collateral estoppel to resolve these thousands of claims efficiently, so we have to estimate them in a summary proceeding using sampling and statistical models rather than particularized evidence, and then use that to cap the claimants’ recovery. Look what you made me do, Judge MacMahon!
Real Estate Expenses
Here’s something you don’t see often in big chapter 11 cases: On Jan. 21, Judge Mary Walrath in Delaware
rejected the PWM Property Management debtors’ application to retain Houlihan Lokey as their investment banker. It all
worked out in the end for the banker, though Houlihan had to take some deep fee cuts to get through on the second attempt. As is usually the case with retention and fee fights, the dispute had less to do with Houlihan than with the debtors and a litigious creditor’s fundamentally differing views on the nature of the case and the best reorganization strategy.
The debtors, affiliates of HNA Group, are shell companies that own two office buildings - one in New York at 245 Park Ave. with a $1.2 billion mortgage and another in Chicago that guaranteed the New York mortgage. The debtors
filed for chapter 11 on Oct. 31, 2021, to forestall a cash dominion event that might have forced a sale and to get rid of the property manager at 245 Park Ave., an S.L. Green affiliate.
The catch? SLG also holds the debtors’ mezzanine debt and a big chunk of preferred equity and claimed the right to veto any filing under the debtors’ organizational documents. Prior to filing, the debtors pulled the typical maneuver to get around that veto right: appointing new “independent” managers who, unsurprisingly, agreed to endorse the petition. We won’t delve too deeply into that tactic right now, except to say that in this case, as in virtually all others, it worked; bankruptcy courts virtually never dismiss cases on corporate authority grounds.
Back to the main event: The debtors suggested in their first day pleadings that SLG, as property manager, had slow-pedaled finding a replacement tenant for Major League Baseball at 245 Park so that the mortgage lenders could seize the building’s cash, and the mezzanine lenders, including SLG, could force a sale of the building at an advantageous price.
As you can imagine, SLG didn’t take this lying down. At a heated
first day hearing on Nov. 2, SLG accused the debtors of bad faith and said they were using SLG as a “scapegoat” for the failure to find a new tenant and failing to pay HNA’s rent for space at 245 Park “for years,” among other things. The debtors in turn accused SLG of allowing $11 million to be paid out of operating accounts (including $3.7 million in prepetition interest to first lien lenders and $3 million in prepetition interest to mezzanine lenders which, again, include SLG) after the case was filed, in violation of the automatic stay.
On Nov. 12, SLG
asked Judge Mary Walrath to dismiss the chapter 11, arguing, among other things, that the debtors “are not financially distressed,” have no intention to reorganize and filed the case solely to gain a litigation advantage in a two-party dispute between HNA and SLG and avoid triggering SLG’s preferred equity redemption rights. Other mezzanine lenders eventually
joined this request and added that the debtors “never approached” any of their secured creditors to discuss a restructuring prior to filing. This, the lenders hinted, evidenced that the debtors weren’t really interested in reorganizing.
At a
hearing on Nov. 22, counsel for the debtors insisted that they really intended to restructure their debt, pointing to “inquiries” from “potential third party investors, financing sources and other interested parties.” In the debtors’ Dec. 8
response to the dismissal motion, they argued that they were in financial distress because the potential cash seizure at 245 Park could “foreseeably set in motion a chain of events that would ultimately trigger defaults and the right to exercise competing remedies across the Debtors’ capital structure.” While admitting that they are essentially shell real estate holding companies, the debtors denied that this alone justified dismissal.
One day later, on Dec. 9, the debtors filed an application to retain Houlihan Lokey as their investment banker, possibly to bolster their case for reorganization against dismissal. Again, the debtors had an interest in shoring up their reorganization bona fides, and the retention of an investment banker specializing in restructuring might help with that. At the
evidentiary hearing on Dec. 13, the debtors’ chief restructuring officer cited the Houlihan retention as evidence of an ongoing restructuring effort.
When the Dec. 13 hearing wrapped, Judge Walrath denied the motion to dismiss. Although it was a “close decision,” the judge found that the chapter 11 filing had a valid reorganizational purpose beyond any dispute between SLG and HNA: preventing an imminent cash dominion event and forced sale that could have impacted creditors’ rights. On Dec. 20, Judge Walrath
granted the debtors’ motion to terminate the 245 Park management agreement with SLG, an easy decision once the motion to dismiss was denied.
The movants then
appealed the judge’s denial of their motion to dismiss (see above re: difficulty of appealing orders
denying dismissal). Pending relief from the district court, SLG started searching for targets elsewhere in the case to push their “no reorganizational purpose” narrative, and eventually settled on, among other things, that Houlihan application.
On Jan. 6, SLG
objected to the Houlihan application on the basis that the debtors needed a real estate broker, not an investment banker. Instead of paying Houlihan a $2 million base fee, a $7.5 million restructuring fee and “the opportunity to earn millions more” through a 0.6% sale fee, SLG kindly suggested that the debtors bring in a commercial real estate broker at a “significantly lower” cost.
According to SLG, there was no need for a high-priced investment bank because “[u]nlike many chapter 11 cases, where investment bankers are critical to facilitating intricate restructuring or sale transactions involving complex capital structures and a multitude of assets, these Chapter 11 Cases are ‘two single asset cases that are linked only through a guarantee triggered by the bankruptcy.’”
The debtors cheekily pointed out in a
response on Jan. 14 that SLG had itself tried to retain Houlihan in connection with the matter “only a few weeks” earlier. The debtors also reiterated that they “intend to consider and pursue
all possibilities for a value-maximizing transaction, and the retention of an experienced investment banker such as Houlihan Lokey is critical to that effort.”
At a
hearing on Jan. 21, Judge Walrath rejected the retention, citing cost concerns. The judge essentially found that although the debtors had sufficient reorganizational intent to stay in chapter 11, as real estate shell companies, they had insufficient reorganizational complexity to justify the cost of an investment banker. Judge Walrath said she saw a role for a real estate broker to sell or refinance the property for customary fees and expressed concern that professional fees not “eat up” the estates.
On Feb. 4, the debtors
asked to retain Houlihan again on improved terms. Much of the renewed request was dedicated to attacking SLG’s “obstructionist behavior,” which, yes, of course, but the debtors also highlighted reductions in Houlihan’s proposed fees to bring them closer in line to those of a commercial real estate broker. Houlihan “agreed to eliminate its $2 million base fee, reduce its restructuring fee from $7.5 million to $3 million, its sale commission from 0.6% to 0.4%, its mortgage financing fee from 0.5% to 0.275%, its mezzanine debt financing fee from 1.5% to 0.275%, and its unsecured debt financing fee from 1.5% to 0.275%.”
SLG duly
objected again, and like the debtors, focused more on perceived failures to negotiate than on retention issues. On Feb. 15, the debtors filed another
defense of the retention, this time helpfully laying out for Judge Walrath all of the various reorganization possibilities available to them (and literally every other chapter 11 debtor) should they retain an investment banker, including such novel strategies as finding “attractive new financing” or “attractive” sale opportunities and locating “an equity investor that wants to reinstate some or all” of their indebtedness.
Alas, peace broke out before SLG could call a witness on the wonderful world of commercial real estate brokerage or the debtors could call a witness from Houlihan to provide a Bankruptcy 101 primer on every single reorganization structure ever used in a chapter 11 case. Just before a
hearing on Feb. 17, the debtors reached a deal with SLG on Houlihan’s proposed fees, and Judge Walrath duly approved the modified retention, noting that she had been prepared to send the parties to mediation if they didn’t reach a deal over the retention. The detente on Houlihan’s hiring after two months of litigation “is cause for some degree of cautious optimism,” debtors’ counsel told the judge. Hope springs eternal.
The Takeaway: Fortunately, no dissenting creditor has, to our knowledge, objected to the retention of specialized bankruptcy and restructuring
counsel as unnecessary in a relatively simple chapter 11 case involving shell companies.
The Fine Print: Check out MLB’s new headquarters in New York,
here. You’ll have better luck getting a cup of coffee at “Field of Beans” than Mike Trout
right now.
--Kevin Eckhardt