Relying on the plain language of Section 502(b), a bankruptcy court refused to approve a settlement proposed by a debtor because it would have compromised a claim objection that a creditor was prosecuting against a secured lender.
“When a party files an objection to a claim, their rights to be heard on the claim objection should not be abridged or modified by a settlement,” Bankruptcy Judge William T. Thurman of Salt Lake City said in his July 27 opinion.
Judge Thurman based his decision on the plain language of Section 502(b), which provides that the court “shall determine the amount of such claim” once an objection has been filed. [Emphasis added.]
Judge Thurman conceded that the Tenth Circuit had not reached the issue, but, he said, the appeals court has clearly said “there is no need to venture into policy interpretations” when the “language of the Code is unambiguous.”
As a result of his holding, Judge Thurman said that bankruptcy courts might “be required to resolve claim objections before approving a settlement.” To conclude otherwise, he said, “would strip creditors of their claim objection rights under the clear language of the Code.”
The breadth of Judge Thurman’s holding may be limited by a footnote where he conjectured that a debtor may be able to compromise a creditor’s claim if it were property of the estate or derivative in nature.
In the case before him, the claims were not entirely derivative. The judge said that the creditor was asserting “some direct claims” against the lender that were “its primary contention in this case.” Therefore, Judge Thurman’s opinion might be distinguished from cases where debtors propose settlements of claims that are estate property.
The opinion might also be viewed as the court’s refusal to approve a settlement containing a so-called third party release, which occurs when creditors are barred from asserting claims they otherwise could prosecute against the proposed recipient of the release.
When it comes to third party releases, the courts are split, with some circuits, like the Ninth, barring them altogether. In that regard, click here to read ABI’s discussion of In re Grove Instruments Inc., where Bankruptcy Judge Christopher J. Panos of Worcester, Mass., declined last month to approve a settlement in a chapter 7 case containing a bar order precluding creditors from bringing suit on independent, non-derivative claims against the corporate debtor’s officers and directors.
The issue came to Judge Thurman in a messy case fraught with conflicts of interest suggesting that the debtor’s board members proposed a settlement that was not in the best interests of the estate. Further, the board had neutered the company’s chief restructuring officer, in substance compelling him to support a settlement that he initially opposed.
Had the settlement been approved, it would have allowed insiders to purchase the assets, in the process freezing out an offer from another prospective buyer that the restructuring officer preferred.