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 Aearo Technologies nondebtor injunction decision, boundary-pushing relief in Carestream and Lumileds and the PG&E postpetition interest decision.
All Ears
Welcome back from a relaxing summer break! We that trust you, like us, are tanned, rested and ready to return to work from a long, muggy month of Hamptons brunches and helicopter rides. Now it’s time to catch up, and your first assignment is a doozy: On Aug. 26, Judge Jeffrey Graham in Indianapolis entered an
order denying Aearo Technologies’ motion for an injunction protecting nondebtor parent 3M Co. from further proceedings in the massive Combat Arms earplugs MDL.
And with that, the
controversial Aearo chapter 11 is over, exactly one month after the case was
filed. Seriously, that’s all, folks. As we’ve
discussed before, the nondebtor affiliate litigation injunction is the cornerstone of every mass tort case. If affiliates and insiders remain subject to continuing litigation in a nonbankruptcy forum, the bankruptcy court becomes an expensive, pointless sideshow. 3M has already appealed the decision and
requested a fast track to the Seventh Circuit, but that could take a while - and during the appeal the jury trials against 3M (in which the company has a
worse record than the Yankees since the All Star break) will continue.
Remember, nobody really cares about the claims against Aearo Technologies. According to the debtors, this company, to the extent it has existed as an independent entity at all after its earplug assets were incorporated into 3M’s Occupational Safety division in 2010, has about $100 million in annual sales. Total Combat Arms MDL claims could exceed $100 billion (according to one plaintiffs’ firm’s
expert - more on that later); we don’t think Aearo can fund its own defense fees, let alone any damages.
Don’t believe us? At the
first day hearing, counsel for Aearo suggested that if the injunction protecting 3M was not granted, 3M might pull the plug on its agreement to fund case expenses and a settlement trust for Combat Arms plaintiffs, notwithstanding the fact that, as 3M later acknowledged, there is no “nondebtor injunction denied” termination trigger in the agreement. Counsel specifically warned Judge Graham that denial of the injunction would tell 3M that the Aearo case “is not going to do anything for you.” “If we’re going to be here,” counsel said, “we are not going to be off someplace else.”
Welcome back to someplace else, then.
Pensacola, Fla., specifically. MDL Judge M. Casey Rodgers, who
deferred to the bankruptcy court on the injunction issue, acted quickly to reassert her authority,
ordering 3M to mediate before her preferred (read:
not a bankruptcy judge) mediator on Aug. 30. Judge Rodgers invited the Aearo debtors to participate and nominate their own co-mediator, and - surprise - on Sept. 2 the debtors filed a
motion asking Judge Graham (
not MDL Judge Rodgers) to appoint a fellow Indianapolis bankruptcy judge as co-mediator.
The Judicial Panel on Multidistrict Litigation
rejected a plaintiff firm’s unorthodox
tag-along transfer strategy, but that’s irrelevant now that 3M must go forward with the MDL. The next Combat Arms trial against 3M is scheduled to begin next month in Pensacola, as Judge Rodgers was careful to remind the parties in her mediation order.
What can future mass tort debtors learn from this decision? We suppose that comes down to figuring out why Judge Graham deemed 3M unworthy of the impartial and equitable protection of our merciful courts of equity, rejecting Judge Michael Kaplan’s
invitation to
open the floodgates in LTL by issuing an injunction protecting nondebtor parent Johnson & Johnson.
Judge Graham’s decision
vibes like an outright rejection of the LTL decision. After all, the two cases are very similar: Both involved extremely solvent companies using an affiliate’s chapter 11 to deal with an allegedly unmanageable tort “lottery” that produced wide-ranging verdicts in individual cases but no magical “global settlement.” In both cases, the nondebtor parent offered up a non-recourse eve-of-filing funding and indemnification agreement as consideration and cudgel justifying protection by the bankruptcy court.
What’s important to remember is that,
if anything, the debtors in LTL had the tougher lift - the whole Texas two-step issue didn’t come into play in Aearo. Aearo - a separate legal entity - at least plausibly was the source of the 3M claims; LTL came into existence only after a tortured Texas two-step. Moreover, unlike J&J, 3M never floated a $2 billion cap on the funding agreement as an “opening offer” to claimants.
Why did Aearo fail where LTL succeeded? Could be nothing more than a different judge feeling a different way at a different time. However, we can’t help but posit that the difference was 3M’s refusal to suggest and present evidence that the continuing Combat Arms litigation presented a financial threat to 3M itself.
In the LTL case, the debtors presented evidence that the talc MDL had tangible economic effects on J&J’s business. Check out section II(B)(2) of Judge Kaplan’s LTL
dismissal opinion, titled “Debtor’s Financial Distress.” Yes, we know the debtor is LTL, and that this is the dismissal opinion and not the injunction decision. However, the dismissal and injunction issues went hand in hand in LTL, and the Aearo debtors’ alleged bad faith was very much at issue in their injunction fight.
According to Judge Kaplan’s LTL dismissal decision, “As Debtor’s expert, Dr. Gregory Bell testified, and as reflected in J&J’s public filings, talc-related litigation was the ‘primary driver’ that caused J&J’s entire Consumer Health segment ‘to drop from a $2.1 billion profit (14.8 percent of sales) in 2019 to a $1.1 billion loss (-7.6 percent of sales) in 2020.’”
Judge Kaplan continues: “It is true that Debtor, under the Funding Agreement, could compel J&J to deplete its available cash (amounting to nearly 7% of its entire market cap) or pursue a forced liquidation of New JJCI [the consumer products business spun out of the Texas divisional merger] to tap into its enterprise value of $61 billion. Needless to say,
such actions would have a horrific impact on these companies, with attendant commercial disruptions and economic harm to thousands of employees, customers, vendors, and shareholders, and threaten their continued viability” (emphasis added).
Now THAT is something a bankruptcy judge can sink their teeth into - saving jobs! Protecting small businesses and individual investors whose mutual funds own J&J stock! Judge Kaplan suggested that by virtue of the funding agreement, allowing the talc MDL to go forward against J&J could seriously strain J&J’s own finances.
This is not something 3M conceded in the Aearo case. Judge Graham calls the existential threat to 3M from the MDL the “elephant in the room,” but not because 3M raised the issue. In fact, it was the
plaintiffs that presented evidence the Combat Arms litigation could bankrupt 3M via the funding agreement. The evidence that
Aearo presented, Judge Graham points out, “emphasizes that 3M is more than able to honor the Funding Agreement, even if the Pending Actions proceed,” and the judge “accepts that evidence at face value.” 3M actually sought to
exclude the plaintiffs’ evidence that damages in the MDL could top $100 billion.
Judge Graham notes that 3M counsel did raise the specter of injury to 3M in closing arguments, but he reiterates that 3M presented no evidence to that effect. In other words, that argument was a day late and $100 billion short.
Because 3M elected not to provide evidence that its employees, vendors and shareholders were at risk in the MDL - for what Judge Graham suggested in a footnote were “tactical” reasons - Aearo had only one big-picture argument: the alleged failure of the Combat Arms MDL judge to properly manage that case and handle bellwether trials.
Thus, as we
discussed last time, the Aearo
first day hearing featured a
full-throated denunciation of Judge Rodgers. Counsel asserted that the “heart” of the debtors’ “problem” arises from Judge Rodgers’ case management decisions. The MDL docket and case are “broken,” counsel added, suggesting that Judge Graham, an Article I bankruptcy judge,
had an obligation to address this.
Counsel also pointed to “terrible verdicts” from bellwether juries, presenting a demonstrative slide attacking the 16 bellwether verdicts against 3M as “emotional” and suggested Judge Graham should “solve” this “problem” by taking the claims away from juries entirely and estimating everything himself.
From the beginning, LTL’s strategy was to ask Judge Kaplan to protect LTL and J&J from the MDL, whereas Aearo’s strategy was to ask Judge Graham to protect Aearo and 3M from
a particular MDL judge and juries whose decisions they didn’t like.
In hindsight, maybe Aearo took the wrong message from Judge Kaplan’s suggestion in LTL that the mass tort system is a “lottery” that bankruptcy judges can take over and mold into an equitable global settlement using the “tools” of chapter 11, including judicial estimation. We don’t think Judge Kaplan intended to suggest that bankruptcy courts should take MDL cases away from Article III judges with constitutional and statutory jurisdiction because of alleged evidentiary issues in specific jury trials.
Put aside the sweeping policy conclusions in Judge Kaplan’s LTL opinion, and focus on what the debtors put forward. During
closing arguments on the nondebtor injunction on Feb. 18, counsel for LTL focused on the
number of cases in the talc MDL, the massive cost of defending individual trials on each of those claims and the
variance in trial results, rather than attacking the MDL judge for allowing those cases to pile up or improperly allowing unfairly prejudicial evidence that led to those verdicts. Counsel for LTL then brought it all back to the threat to J&J, which she said would spend $76 billion to $190 billion to try all of the remaining cases.
Long story short: In selling a mass tort case to a bankruptcy judge, these two cases suggest strategy matters. Do: present evidence regarding the potential danger of the MDL to the nondebtors you want to protect and focus on the number of claims and the cost of defending them all to trial. Don’t: attack the MDL judge for allowing the number of claims to grow “out of control” and question the validity of specific jury verdicts. To get that sweet nondebtor injunctive relief, you have to at least concede that the mass tort exposure presents some financial risk to the nondebtor.
The Takeaway: To be fair, we are not suggesting that counsel for Aearo made a foreseeable mistake by crafting their chapter 11 strategy around mistakes in the MDL rather than the danger to 3M. Again, they had Judge Kaplan’s opinion in front of them, and that opinion was much more sweeping than the straightforward nondebtor injunction arguments LTL actually made. And 3M may have very good non-litigation reasons for declining to put its own solvency even tangentially at issue. Finally, LTL seems to have benefited from having the injunction and the dismissal motion heard at the same time, which made financial stress more explicitly relevant.
The Fine Print: Interesting question: Can Aearo now dismiss the chapter 11 case? Certainly 3M might want the debtors out of bankruptcy if 3M is paying the bills but not getting a stay of the MDL - as mentioned above, debtors’ counsel admitted as much at the first day hearing. Would Judge Graham allow the debtors to extract their heads from the lion’s mouth at this point? Or does he take the debtors at their word - that they are truly independent entities with their own interests and independent directors - and force them to proceed with what could be a complete charade, at 3M’s expense?
More: Assuming the case has to continue, is there something to salvage for 3M? The debtors have said they will seek estimation of the Combat Arms claims. It’s hard for us to see how the cost and expense of that exercise could foster settlement discussions when the plaintiffs have recourse to an MDL court committed to the MDL process (sample cases actually litigated versus a global approach to estimation).
First Time for Everything
There have been two novel requests for relief in prepacks worth discussing in the last few weeks. First, the
Carestream Health debtors asked Judge J. Kate Stickles to approve exit financing commitment fees - not DIP fees, exit fees - at the first day hearing. Second, the
Lumileds debtors asked Judge Lisa Beckerman to approve the distribution of a controlling reorganized equity stake via DIP and backstop fees. You will not be surprised to learn that both judges ended up granting the requested relief, though not without expressing some skepticism over the proposals.
Carestream filed its prepack on Aug. 23 with a plan to hand reorganized equity over to a cross-holder group of DIP lenders via a rights offering. The debtors’ exit financing includes an $85 million ABL facility to be syndicated by JP Morgan Chase Bank. Nothing really interesting here, except that the debtors filed a “first day”
motion for final approval of about $6.9 million commitment fees for the prospective exit ABL lenders along with the usual requests for first day relief.
You know what those quotes mean. “This is not a first day motion,” the U.S. Trustee argued at the otherwise peaceful
first day hearing on Aug. 24. To their credit, counsel for the debtors did not disagree, calling the relief “unprecedented.” Counsel for the crossover group/DIP lenders also admitted that it is “not the norm” for prepack debtors to seek final approval of exit facility commitment fees at the first day hearing.
The debtors’ case was made more difficult by the fact that they could not invoke any “parade of horribles” should the commitment fees be approved at a
slightly later date. As Judge Stickles herself noted, the exit ABL commitment letter gave the debtors 10 days after filing to secure court approval. The U.S. Trustee pointed out that this meant the debtors could not show sufficient “irreparable harm” to secure final relief on 24 hours’ notice.
Counsel for JPMorgan tried their best, arguing that potential lenders would not start work on their participation in the ABL until the fees were rubber-stamped. Debtors’ counsel added that with a confirmation hearing set for Sept. 28, any delay could result in the exit ABL not being syndicated and documented by the time the plan was confirmed. Every day the fees were not approved, debtors’ counsel said, would be a day “not spent working on the exit facility ABL.”
Debtors’ counsel also told the judge that this was a really, really
prepackaged prepack. In 26 years of practice, counsel said, he had never seen “a prepack as buttoned up as this one.” Nash assured Judge Stickles that none of the “sophisticated” holders of $159 million in first lien debt that declined to vote to accept the plan
really objected; they just didn’t vote, for whatever reason.
Perhaps more convincing, counsel for the crossover group pointed out the fees would come out of their DIP financing, which would be equitized at confirmation - meaning the fee would basically be paid from an equity contribution, rather than new debt.
The judge suggested holding a hearing on the commitment fees a week later, on Aug. 31. After considering the arguments, however, she decided to compromise and set a hearing on the commitment fees for two days after the first day hearing, on Aug. 26. Turned out, the debtors were right - no one objected, and Judge Stickles
approved the commitment fees at that hearing, subject to a clarification that she was not approving the exit ABL itself on a final basis.
Lumileds filed on Aug. 29 with a plan for $1.7 billion in first lien loan claims to receive $125 million of exit first lien take-back term loans and “100%” of reorganized equity, with the latter subject to
a lot of dilution, with most of that dilution coming from first lien lenders themselves. Given that the debtors’ capital stack is almost exclusively the first liens, some of this feels like complexity for complexity’s sake, but here we go: The debtors also sought approval of a $275 million DIP facility backstopped by an
ad hoc group of the lenders, with the DIP facility itself open to all lenders and split into a $175 million term loan available upon interim approval and a $100 million delayed-draw loan. Not
very delayed-draw, considering the debtors hope to emerge within 60 days of filing and a confirmation hearing is
set for Oct. 14. But that financing would not come cheap!
The debtors explained that the delayed-draw facility is intended to safeguard “against the further liquidity crisis that would result in the event that either the Court does not grant the Debtors authority to maintain” an €80 million receivables factoring facility with Crédit Agricole, or CA “fails to continue fully performing under the Factoring Facility.” As of the petition date, €80 million equaled approximately $79 million (no, that’s not a typo, for those of you born
after December 2002 - we live in interesting times). That’s about $20 million less than the delayed-draw facility meant to cover for any loss of the factoring facility. Hmm.
Anyway, the debtors filed a
motion to approve the factoring facility along with their other first day papers, and Judge Beckerman granted the motion on an interim basis at the Aug. 30
first day hearing. Crisis averted!
But there was another problem: The debtors asked Judge Beckerman to approve a real doozy of a DIP fee package. The debtors proposed to give DIP backstoppers 10.5% of new common equity subject to dilution by a management incentive plan (up to 10% of reorganized common shares), plus 36.7% of reorganized equity as a participation fee (also subject to the MIP) and 10.5% of reorganized equity as an exit commitment fee, again subject to the MIP (any of the $175 million term facility due on the effective date will be rolled up into the exit facility).
That’s right - the debtors wanted Judge Beckerman to approve DIP “fees” equal to 57.7% of reorganized equity
at the first day hearing. If that’s not a
sub rosa plan, brother, there’s
no such thing. The judge pointed out that under the debtors’ enterprise valuation, the DIP lenders would receive $184 million in reorganized equity as a fee for providing $275 million in financing (and, as discussed above re: the delayed-draw facility, that seems much more likely to be $175 million in financing). Of that value, $117 million would be paid as a participation fee
for a DIP that is fully backstopped.
Although the judge admitted she is new to the bench, she dryly noted that, given her past experience in both finance and legal practice, she “can do math” and is “very aware of what is market and what is unusual.” Our collective pack of Reorg dogs, though not particularly bright, have enough finance and legal experience to see this package is
not market and very unusual. Kind of puts the “unprecedented” $6.9 million in Carestream fees in perspective, though.
Nevertheless, Judge Beckerman agreed to the DIP incentives package - really, to the distribution of a controlling stake in reorganized equity to a select group of lenders - on about one day’s notice. The judge accepted the debtors’ position that the fees were part of an integrated restructuring package, and expressed concern that general unsecured creditors would not be paid in full if the deal were renegotiated. The judge also seemed to credit the debtors’ position that the fees could at least plausibly pass muster when compared with equity allocations to parties providing a new-money exit facility in other cases.
According to the debtors’
petition, their two largest unsecured creditors hold claims of about $2.3 million and $1.8 million. The rest of the 28 unsecured creditors on the top-30 list each hold claims of less than $1 million. Unlike Judge Beckerman, we are not former investment bankers and cannot “do math,” but our humble phone calculator can - and it gives us a total of about $12.7 million in unsecured claims on that top-30 list. Seems unlikely a renegotiated (or even just delayed) deal to own the provider of lighting for “one in three cars globally” would result in impairment of that amount, but again, we’re
only lawyers.
The Takeaway: Expect more unusual goodies for DIP and exit lenders to get approved at prepack first day hearings going forward. If this kind of relief gets ubiquitous enough, heck, expect more prepacks. Probably a good thing. Here’s our question, though: Where is the market test? A
lot can get wrapped into exit financing, but that’s almost always supported by the argument that the debtor has tried and failed to secure a better deal. This is a prepack, so any such test was entirely prepetition.
The Fine Print: These are the kinds of pragmatic relief that might be compromised by the Plain Language Police discussed below. Not sure the Bankruptcy Code says anything about distributing control of a large multinational corporation via
fees at a first day hearing with essentially zero notice.
Winter Is Coming
Over the life of this column, we have
warned you
many times of the creeping danger to our pragmatic, problem-solving bankruptcy system posed by what we are now calling the Plain Language Police. The Aearo filing itself suggests that some of you simply aren’t listening and intend to keep pushing the envelope to the edge of the equity table heedless of the inevitable reaction from these, well, reactionaries. But we don’t intend to give up!
Our latest example of What You Need to Worry About: Judge Sandra Ikuta’s incredible dissent in the Ninth Circuit’s PG&E postpetition interest
decision from Aug. 29. Yes, there is a
Federalist Society judge on the Ninth Circuit, though you won’t be surprised to learn she has largely practiced her trade in dissents. That only makes Judge Ikuta’s PG&E dissent more troublesome: On other circuits it might not be as difficult to find a second judge to turn an insane statutory reading like “unimpaired creditors should never get postpetition interest, ever, even if impaired creditors do” into law.
Before diving into Judge Ikuta’s dissent, a little background on the majority opinion: Judge Carlos Lucero (on loan from the Tenth Circuit) and Judge Lawrence VanDyke agree that in order to render a nonconsenting creditor unimpaired and thus deprive them of the chance to vote to reject and trigger a cramdown, a debtor must, absent “compelling” equitable circumstances, pay them postpetition interest at the contractual rate (if one applies) or the state law statutory rate rather than the very low federal judgment rate approved by the bankruptcy court.
Sure, some people might suggest this conclusion is bonkers, but they’re all working on plans that unimpair a group of dissenting creditors to keep them from voting and now face weeks of interest calculations and testy phone calls with ad hoc groups. This holding is not some left-field Ninth Circuit nuttiness; the majority basically adopts Judge Marvin Isgur’s most recent postpetition interest rate
decision in the
Ultra Petroleum case (currently
under advisement at the Fifth Circuit), and no one has suggested that decision was crazypants. The Fifth Circuit might well go the same way.
After all, it seems intuitively fair that under the absolute priority rule creditors should get the
full benefit of their state law bargain before shareholders take anything home. That’s how it would happen
outside of chapter 11, and isn’t the point that bankruptcy doesn’t alter nonbankruptcy rules unless specifically provided otherwise in the Bankruptcy Code? As the majority recognizes, that was also the rule before enactment of the Bankruptcy Code - the “solvent-debtor exception” - and there’s no evidence that Congress intended to toss that long-established rule in the dumpster.
Yes, other bankruptcy courts have
held to the contrary, but there are at least reasonable arguments regarding the practical effect of the ruling on either side. The “solvent-debtor exception” relied upon by the majority failed to tear apart the pre-Code system, and the Bankruptcy Code should likewise survive the exception’s survival.
The dissent, however, demands that plain language prevail though the heavens fall. According to Judge Ikuta, the phrasing of section 502(b)(2) of the Bankruptcy Code dictates the outcome without any consideration of bankruptcy practice, economic reality or plain common sense.
Section 502(b)(2) provides that a claim should be allowed unless it is a claim “for unmatured interest.” According to Judge Ikuta, this means that “a claim stops accruing interest at the time the petition in bankruptcy is filed,” and thus section 502(b)(2) requires disallowance of all claims for postpetition interest
unless explicitly provided somewhere in the text of the Bankruptcy Code. The Bankruptcy Code does not include any phrasing specifically requiring payment of postpetition interest for unimpaired creditors, the judge concludes, so unimpaired creditors are not entitled to postpetition interest. Q.E.D.
Here we will note, like the majority, that the debtors never even
asked for disallowance of all of the postpetition interest sought via this absolutist position; they merely argued that postpetition interest should accrue at the lower federal judgment rate. This is Judge Ikuta going out of her way to champion the fundamental rights of a few words Congress threw into the Bankruptcy Code - words that, the majority points out, were already present in the pre-Code Bankruptcy Act, under which it was well established that unimpaired creditors were entitled to postpetition interest in solvent cases.
Judge Ikuta acknowledges that the Bankruptcy Code requires consideration of postpetition interest due on
impaired claims via the section 1129(a)(7) best interests test, but deems the apparent inequity of giving postpetition interest to impaired creditors while giving none to supposedly
unimpaired creditors irrelevant. If the PG&E trade creditors wanted postpetition interest, she hints, they should have simply asked to be
declared impaired. But: that’s
exactly what they were asking for, should they be denied postpetition interest at the contractual or state law rate.
Rather than trying to justify this incongruity, Judge Ikuta turns it into
support for her strict textualist position, which should tell you all you need to know about the value of the strict textualist position. The provision making postpetition interest a relevant part of impaired creditors’ claim is not a problem for her conclusion, she maintains, but
proof she is
correct in her interpretation. “Congress knew how to draft the kind of statutory language that petitioner seeks to read into [the Code],” the judge says, but “chose not to make a similar exception authorizing an award of post-petition interest to unsecured creditors holding unimpaired claims, regardless of whether the debtor ends up solvent.”
The idea that the phrasing chosen for two different Bankruptcy Code provisions in different titles of the statute evidences some legislative choice is extremely elegant and makes a judge’s job very easy, but - we cannot say this enough - has
nothing to do with reality.
As the majority details in its opinion, there is no evidence Congress actually
chose not to provide unimpaired creditors with postpetition interest in solvent cases, which was a long-standing bankruptcy practice for decades. In drafting section 502(b)(2), Congress just restated an old Bankruptcy Act provision, and the solvent-debtor exception was regularly applied under that provision
And there is ample evidence that Congress very much intended to provide unimpaired creditors with postpetition interest of some sort - that’s probably why PG&E never bothered to make the absolutist argument. As the majority points out, Congress amended section 1124(3) of the Bankruptcy Code in 1994 with the specific intent of overruling a 1994 bankruptcy court decision which, as Judge Ikuta herself puts it, “ruled that unimpaired creditors were not entitled to post-petition interest when the debtor was solvent.” That’s right - Congress reacted almost immediately to overrule this decision and amended the Bankruptcy Code
exclusively to prevent the outcome Judge Ikuta says is mandated by the words Congress “chose” for section 502(b)(2) 16 years earlier.
And literally every bankruptcy decision since that amendment has concluded that the amendment had the desired effect: Unimpaired creditors are entitled to some postpetition interest in solvent cases. The only dispute is the appropriate interest rate.
In advancing her strict reading, Judge Ikuta also disregards the
plain phrasing of several Supreme Court decisions relied on by the majority for the proposition that courts should not “read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.” This conclusion, the judge writes, ignores important “context” to those Supreme Court decisions - a richly ironic statement from a judge whose position is based on reading a statute without considering the context.
“[I]n context,” Judge Ikuda says, these Supreme Court decisions “faithfully followed” a “textualist approach.” “Once the majority’s erroneous approach is eliminated, there is no support for the majority’s conclusion,” the judge contends.
Judge Ikuta seems to think that the PG&E trade creditors
wanted to be classified as unimpaired because they would get some component of their claim as unimpaired creditors they would not get as impaired creditors - that the trade creditors wanted to be unimpaired and
also have their claim include postpetition interest like those lucky impaired creditors. But, as the majority notes, the trade creditors wanted to be deemed
impaired, and thus allowed to vote on the plan, exclusively on the basis of the treatment the debtors offered. They weren’t
trying to be unimpaired
and get postpetition interest, they simply wanted the debtors to treat them as impaired if they were only getting the federal judgment rate of postpetition interest.
The question of whether a claim is unimpaired or impaired, the majority points out,
depends on whether creditors are entitled to postpetition interest; it is not
independent of that classification, which is in the first place dictated by the debtors when they propose a plan. The failure to provide for postpetition interest at the contract or state law rate, the majority continues, actually
causes the impairment of a purportedly unimpaired creditor.
By framing the issue as whether unimpaired creditors are entitled to postpetition interest, the dissent simply accepts the debtors’ classification of the trade vendors as unimpaired, and then attaches dispositive legal importance to that unilateral classification.
“[T]he sole function of the courts is to enforce [the Code’s plain language] according to its terms,” Judge Ikuta responds to these criticisms, “even if that ‘may produce inequitable results for trustees and creditors.’” “Moreover,” the judge continues, “even if policy considerations were relevant, Congress could have chosen to give impaired creditors greater protections than unimpaired creditors, because impaired creditors (such as classes of wildfire victims here) may not receive payment of their claims in full.”
We are fully through the looking glass here. The trade creditors are saying they are impaired on the basis of the postpetition interest treatment afforded to them under PG&E’s plan. They very clearly argue they are not receiving payment of their claims in full.
Politics aside, this kind of thinking could have serious ramifications for bankruptcy courts. As debtors’ counsel often point out, ours are courts of equity with a flexible remit - able to grant all kinds of relief not explicitly provided for in the Code. Just take nondebtor releases: Under Judge Ikuta’s logic, Congress “chose” to provide for nondebtor releases in asbestos cases by enacting section 524(g), and, by leaving other debtors out, “chose” not to allow releases for non-asbestos nondebtors.
Bankruptcy courts suspended payment of retail debtors’ rent during Covid-19 shutdowns, even though the Bankruptcy Code clearly entitles landlords to rent starting 60 days after filing. Bankruptcy courts allow debtors to pay “critical vendors” ahead of other prepetition creditors. Bankruptcy courts allow debtors to pay their attorneys and advisors ahead of other administrative creditors of equal priority, and maintain bank accounts that are not compliant with section 345. These are all questionable practices under the plain language of the Bankruptcy Code.
All this useful relief is not so unassailable as we might assume, if federal judges are willing to sacrifice useful reorganization tools without any consideration for legislative intent, longstanding practice or sound policy.
The Takeaway: We have suggested that in some cases some kinds of extra-Code relief is inappropriate, or at least needs to be based on a fuller evidentiary record - especially nondebtor releases. We don’t care what benefits or damage these kinds of relief bring in any particular case; that’s none of our business. Nor do we mean to criticize debtors’ counsel for pushing these forms of relief in a particular case - that’s their job. The problem arises when the routine granting of such relief on spurious grounds or thin evidence threatens the bankruptcy system by provoking an
angry legislature and the plain language posse always looking to trim our sails and tow us back to port.
The Fine Print: This all assumes that the Federalist Society folks mean what they say and care most about limiting judicial “activism” and strapping judges to the specific language Congress used. Cynics might say these principles tend to flex quite a bit in cases with clear partisan implications, but we struggle to see how PPI fits into a
red-versus-blue fractured polity.
Other Matters:
- Xclaim Examination: More trouble on the claims agent front! On Aug. 18, Judge Sean Lane issued an opinion in the Madison Square Boys & Girls Club case denying the debtors’ application to retain Epiq as claims agent to the extent the retention is subject to a data-sharing arrangement with Xclaim, a third-party-claims-trading website. Judge Lane pointed out that claims agents essentially serve as an outsourcing agent for the court’s own clerk’s office (which generally acts as claims agent in the vast majority of non-mega cases). Because the clerk would not be permitted to enter into a similar business relationship or receive fees from Xclaim, Epiq also cannot do so, the judge concluded. Judge Lane also noted that the claims data Xclaim seeks to obtain from Epiq is not Epiq’s property but belongs to the U.S. courts, as the clerk of court is the “official custodian of court records.” Epiq attempted to remedy the issue by removing an exclusivity provision in the Xclaim agreement, but the judge was not mollified: Even without exclusivity, the arrangement with Xclaim was improper, he said. On Sept. 2, Xclaim took steps to appeal the decision, meaning we could soon get some appellate guidance on this issue (assuming Xclaim has standing to appeal a court’s denial of the debtors’ application to retain someone else).
Putting aside Judge Lane’s decision, on Aug. 25 Judge Martin Glenn opened an unusual “miscellaneous proceeding” to consider the Xclaim issue globally (you can track the docket HERE). In his order opening the matter, Judge Glenn directs all of the New York bankruptcy court’s authorized claims agents to disclose any arrangements with Xclaim and any compensation received from the platform in any case. On review of this information and subsequent briefing, the judge ominously says, the court may “impose sanctions on the Approved Claims Agents who have performed under a Synchronization Agreement and received unauthorized Fees, including possible suspension from the Clerk of Court’s list of Approved Claims Agents and/or disgorgement of Fees received.”
- Exculpation Vacation: On Aug. 19, the Fifth Circuit issued an opinion in the Highland Capital case dramatically narrowing the scope of exculpation provisions in chapter 11 cases (the Fifth Circuit issued a superseding opinion clarifying its opinion on other issues on Sept. 7 after the appellants asked for clarification). As you no doubt know, the Fifth Circuit prohibits nonconsensual nondebtor releases, though this prohibition has not deterred the growth of Houston as a mega-chapter 11 destination, thanks to a number of potential workarounds (usually revolving some form of opt-out and implied consent). The application of this rule to bar exculpation provisions protecting the CEO, general partners, claimant trusts and their trustees, members of the trust oversight board and, most importantly, debtor and committee professionals - basically, everyone but the postpetition independent directors - could actually be more troublesome.
In a double whammy, the Fifth Circuit also rejected the debtors’ argument that the appeal was equitably moot. The panel flatly rejected the debtors’ warning that “clawing back” the plan “‘would generate untold chaos,’” calling this parade of horribles “farfetched” and “speculation.” Equitable mootness should be wielded as a “scalpel rather than an axe,” the panel suggested, raising one more potential issue: The Fifth Circuit has lost its grasp on metaphors.
--Kevin Eckhardt