Chapter 8 Chapter 11 Plan Confirmation Issues: Settlements, Releases, Gifting and Death Traps

• Jurisdiction: United States

8. Chapter 11 Plan Confirmation Issues: Settlements, Releases, Gifting and Death Traps

Written by:

Douglas E. Deutsch

Chadbourne & Parke LLP; New York

Eric Daucher

Chadbourne & Parke LLP; New York

The requirements set forth in § 1129 of the Bankruptcy Code are not all that one needs to know to understand the chapter 11 confirmation process. This article intends to provide the young or new lawyer with a review of certain important concepts on which practicing lawyers spend incredible amounts of time but cannot simply be found in the statutory language or most basic bankruptcy texts. Such concepts include providing for plan payments to "out of the money" creditors, releasing third parties and methods to encourage parties to vote in favor of a plan. With each discussion topic building on the next, the authors have attempted to address these concepts below.

A. Settlements

Given that parties often recognize that a debtor's finite resources are better spent on a consensual resolution of a litigation issue rather than actual litigation, it is unsurprising that one of the most common issues faced when designing a plan of reorganization is the inclusion of one or more settlements of outstanding claims. Section 1123(b)(3)A) of the Code states that a plan of reorganization may provide for "the settlement or adjustment of any claim or interest belonging to the debtor or to the estate." Such settlements are in fact favored by bankruptcy policy considerations and are a normal part of the reorganization process.¹ However, the Code provides little guidance as to what standard to apply when judging whether a settlement should be approved. Bankruptcy Rule 9019 is, on its face, similarly unavailing. Nevertheless, courts have consistently held that Rule 9019 commits the approval of a settlement to the sound discretion of the bankruptcy court.² Such settlements are incorporated into plans of reorganization and form the framework that allows a plan proponent to use the other plan tools discussed below.

As long as a settlement that is incorporated into a plan falls above the lowest point in the range of reasonableness, it should be approved.³ In evaluating the reasonableness of a settlement, courts generally consider four 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 the creditors.⁴

In evaluating the first factor, likelihood of success on the merits, a bankruptcy court is not to conduct a full trial on the merits. The very purpose of a settlement is to avoid spending the time and money necessary to litigate the underlying issues. The court will review the issues settled and the arguments relating to those issues to ensure that the debtor acted reasonably in reaching a settlement.⁵ The review process is supposed to provide the court with an understanding of the strengths and weaknesses of the debtor's position, as well as the risks posed by an adverse outcome.⁶ It is not entirely clear what level of evidence courts require before deciding that this factor is satisfied, but an utter lack of evidence proffered on the subject is almost invariably fatal to the approval of a settlement.⁷

With respect to the second factor, the court will likewise look for information sufficient to enable it to make an educated estimate of the possible difficulties of collecting on any judgment which might be obtained. For example, if the defendant has little or no ability pay a judgment, the court should be inclined to approve a settlement. That saves the debtor great expense to reach a result that may not have any value for the estate in terms of final recovery.

According to the third factor, courts should favor settlement of a complex case that would otherwise drain substantial resources from the estate. As it is "axiomatic that settlement will almost always reduce the complexity and inconvenience of litigation,"⁸ courts will balance the relative complexity of the case to be settled against the possible gains to the estate from opting not to settle.

The fourth factor requires the seemingly obvious: Courts are obliged to consider the paramount interests of the creditors of the estate. This means that bankruptcy courts will give considerable deference to the views of non-settling parties in deciding whether a settlement is appropriate.⁹ However, out-of-the-money creditors hoping for a recovery based on speculative litigation with little chance of success will generally not be allowed to determine the fate of the reorganization process. It is imperative for settlements to benefit the estate as a whole, even if it may disadvantage a particularly constituency.¹⁰ Therefore, courts tend to grant significant weight to the opinion of in-the-money unsecured creditors, while viewing the objections of other creditors more cautiously.¹¹

Based on the foregoing, we know that a debtor can create a plan of reorganization that settles various matters and that, in general, the bankruptcy court should review the settlement under the Rule 9019 framework. This framework allows us to turn to our other plan concepts.

B. Third-Party Releases

Plans of reorganization may—and routinely do—provide for releases of liability against various parties involved in the reorganization process, such as the debtor's professionals, members of the committee of unsecured creditors, and the committee's professionals. The Bankruptcy Code does not, however, provide any explicit basis for a similar release of claims against non-debtors (except in the case of asbestos claims).¹² Indeed, § 524(e) "makes clear that the bankruptcy discharge of a debtor, by itself, does not operate to relieve non-debtors of their liabilities." Of course, as a practical matter, third parties will often seek a release as part of a settlement of case issues.

Third-party releases initially became prominent in the context of bankruptcies involving asbestos mass-tort claims. Because asbestos injuries often only...