Chapter VII Settling Fraudulent Transfer Claims

JurisdictionUnited States

Chapter VII Settling Fraudulent Transfer Claims

A. Legal Standard Governing Settlements Under Bankruptcy Rule 9019

Settlements of disputes have long been favored in the bankruptcy arena because they allow for expedited and more efficient administration of the estate.666 Bankruptcy Rule 9019(a) governs the procedural prerequisites for approval of a settlement and provides, in relevant part, that "[o]n motion by the trustee and after notice and a hearing, the court may approve a compromise or settlement."667 Bankruptcy Rule 9019 is silent, however, on what standard the court is to apply in determining whether to approve a settlement. In the absence of statutory guidelines for evaluating settlements, most courts look to the framework articulated by the Supreme Court in TMT Trailer Ferry, which involves determining whether a settlement is fair and equitable.668 The fair and equitable standard is grounded in the court's informed, independent judgment, and courts have devised multi-factor tests to gauge the reasonableness and fairness of settlements. Regardless of whether proposed settlements arise prior to plan confirmation, are incorporated in a plan of reorganization, or arise post-confirmation, the decision to approve a compromise or settlement is subject to the sound discretion of the bankruptcy court.669 Neither the Bankruptcy Code nor the Bankruptcy Rules distinguish between the types of claims and/or causes of action that can be settled under Bankruptcy Rule 9019; therefore, fraudulent transfer claims are often the subject of such settlements.

1. Pre-Plan Settlements

To approve a pre-plan settlement, the bankruptcy court must find that the settlement agreement is "fair and equitable," or as articulated by some courts, "fair and reasonable" and in the best interests of the estate.670 There are two distinct, albeit similar, articulations of the factors to approve a settlement.

Courts in the Second Circuit typically consider the following interrelated factors when determining whether to approve a settlement:

(1) the balance between the likelihood of plaintiff's or defendants' success should the case go to trial vis-a-vis the concrete present and future benefits held forth by the settlement without the expense and delay of a trial and subsequent appellant procedures; (2) the prospect of complex and protracted litigation if the settlement is not approved; (3) the proportion of the class members who do not object or who affirmatively support the proposed settlement; (4) the competency and experience of counsel who support the settlement; (5) the relative benefits to be received by individuals or groups within the class; (6) the nature and breadth of releases to be obtained by the directors and officers as a result of the settlement; (7) the extent to which the settlement is truly the product of "arms-length" bargaining, and not of fraud or collusion.671

The evaluation of settlements in the Third Circuit is substantially similar to that in the Second Circuit because the Third Circuit also "[took] its cue" from TMT Trailer Ferry.672 When considering the best interest of the estate, the Third Circuit holds that the court must "assess and balance the value of the claim that is being compromised against the value to the estate of the acceptance of the compromise proposal"'673 In striking this balance, Third Circuit courts typically consider the following factors: (1) the probability of success in litigation; (2) the likely difficulties in collection; (3) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it; and (4) the paramount interest of creditors.674 Lastly, two courts, under somewhat unique circumstances, held that a court approving a pre-plan settlement should also consider whether the settlement is "fair and equitable" as such term is used in connection with the proposed treatment of classes of claims and interests of a non-consensual plan under § 1129(b).675

A fair and reasonable settlement need not necessarily be the best possible, fairest or most appropriate resolution of a dispute.676 Instead, courts are inclined to review the issues settled and the arguments relating to those issues to ensure that the debtor acted reasonably in reaching a settlement. To that end, although courts typically weigh "all facts necessary for an intelligent and objective opinion of the probabilities of ultimate success should the claim be litigated"677 and make "a fair and full assessment of the wisdom of the proposed compromise,"678 they are not required to conduct a "mini-trial" on the merits of the claims being settled679 or hold an evidentiary hearing prior to approving a settlement.680 The court is obligated, however, to make sufficient evidentiary findings so that any appellate court knows that the lower court considered the appropriate factors and made an informed, independent judgment. A court can evaluate the parties' likelihood of success in litigating the claims being settled by considering the "factual analysis" and the "legal positions" of both sides.681 This analysis, however, is limited in scope. Rather than attempt to decide the numerous issues of law and fact raised by a settlement, courts "must do neither more nor less than canvas the issues and see whether the settlement falls below the lowest point in the range of reasonableness from the perspective of the bankruptcy estate."682 In order to canvas the issues, at least one court has considered an examiner's investigation of fraudulent transfer claims as part of the canvasing exercise regarding fraudulent transfer claims being settled.683

When evaluating the reasonableness of a proposed settlement, courts do not need to conduct a full independent investigation and so sometimes defer to the business judgment of the trustee or debtor in possession.684 Courts also consider the paramount interests of the creditors of the estate, often giving considerable deference to the views of the non-settling parties. It is critical that a settlement benefit the estate as a whole, even if it may disadvantage a particular constituency.685 Although courts are reluctant to allow minority creditors hoping for a recovery based on speculative litigation with a low probability of success to determine the fate of the reorganization process, courts tend to grant significant weight to the opinion of majority creditors with reasonable views.686 Ultimately, however, the positions asserted by creditors are not dispositive, and a creditor's objection may be overruled when approval of the settlement is warranted.687

2. Settlements Within a Plan of Reorganization

Whereas Rule 9019 authorizes courts to approve a compromise or settlement, Bankruptcy Code § 1123(b)(3)(A) and (b)(6) permit settlements to be incorporated in, and effected pursuant to, a plan of reorganization.688 Regardless of whether a claim is settled as part of a plan or pursuant to a separate motion, the standards for approval of the settlement tend to be the same.689 It is the "duty of the bankruptcy court to determine that a proposed compromise forming part of a reorganization plan is fair and equitable."690

The Tribune bankruptcy case presents an example of a settlement being incorporated into a plan of reorganization. In Tribune, there were two competing plans of reorganization before the court. The plan proposed by the debtor, the official committee of unsecured creditors and certain senior lenders (the "DCL Plan") incorporated a proposed settlement of certain LBO-related causes of action.691 The proponents of the noteholder plan argued that the proposed settlement amount was unreasonable considering the value of those LBO-related cases of action, including fraudulent transfer claims under §§ 544(b) and 548,692 which, if successful, could provide substantial recoveries to certain noteholders.693 In evaluating whether the DCL Plan was confirmable, the court evaluated, among other things, the reasonableness of the proposed settlements.

The Tribune court's analysis of the reasonableness of settlements incorporated within a plan of reorganization mirrored the analysis applied by the Third Circuit to pre-plan settlements. Specifically, the court evaluated the settlements under the Martin factors.694 The factual record in Tribune included a lengthy examiner's report evaluating the estates' potential causes of action arising out of the LBO and setting forth the examiner's conclusions.695 Ultimately, although the court refused to confirm either plan, the proposed settlements were approved.696

In concluding that the settlements incorporated in the DCL Plan were reasonable, the court noted that "perhaps most importantly ... [the DCL Plan settlement] has been approved by creditors across the Debtors' capital structure."697 The court gave similar consideration to votes in New Century TRS.698 In assessing the paramount interest of creditors, which is the fourth Martin factor, the New Century TRS court concluded that the settlement should be approved where "[t]he voting results show vividly that the Plan is supported broadly by a diverse creditor body. Only one class of the sixteen entitled to vote on the Plan voted against the Plan."699 In the Adel-phia Communications bankruptcy case, Judge Gerber also considered plan votes in determining whether a settlement would meet the third Texaco factor (i.e., the proportion of the class members who do not object to or who affirmatively support the proposed settlement).700

Based on these cases, it appears that although affirmative votes on a plan of reorganization may not be used to circumvent the Rule 9019 settlement review process, courts are inclined to give weight to such votes when deciding whether to approve a settlement incorporated in a plan of reorganization.

B. Standing to Pursue and Settle Claims

1. Applicable Legal Standard

In certain situations, a creditors' committee or other creditor constituency needs the ability to...

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