In confirming a chapter 11 plan containing third-party releases, Bankruptcy Judge Gregory L. Taddonio of Pittsburgh declined to guess how the Supreme Court will resolve the split of circuits when it rules on Merit Management Group LP v. FTI Consulting Inc., 16-784 (Sup. Ct.), and decides whether the safe harbor in Section 546(e) applies if a financial institution only serves as a “mere conduit.”
Retailer Rue21 Inc. proposed a chapter 11 plan containing a broad release in favor of third parties. Although 93% of unsecured creditors supported the plan, the official creditors’ committee wanted Judge Taddonio to excise a sliver of the release while still confirming the plan.
The committee sought to narrow the release by permitting creditors to mount a fraudulent transfer suit against a selling shareholder in a 2013 leveraged buyout. The debtor responded by commissioning an investigation where the independent committee concluded, on advice of counsel, that the selling shareholder had a complete defense under the safe harbor, even though the financial institution in the LBO was a mere conduit.
The independent committee’s conclusion was based on In re Resorts International Inc., 181 F.3d 505 (3d Cir. 1999), where the Third Circuit is aligned with four other circuits by invoking the safe harbor even though the financial institution is a mere conduit. The Supreme Court granted certiorari to the Seventh Circuit in Merit Management to resolve a split of circuits because the Chicago-based appeals court held, along with the Eleventh Circuit, that the safe harbor does not apply unless the financial institution had a beneficial interest in the transaction. Oral argument in Merit Management will be held on Nov. 6.
In his Sept. 8 opinion, Judge Taddonio first had to pick the standard for ruling on the propriety of the release. Was it part of a settlement implicating the looser business-judgment test, or should the court employ the more exacting Master Mortgage factors invoked by the Delaware bankruptcy courts in passing on non-debtor releases?
Judge Taddonio chose Master Mortgage because there was “insufficient proof” that the release “was intended to be a settlement of a claim.” He said the release was “given little thought” when it was included in the pre-bankruptcy restructuring support agreement.
Because the five Master Mortgage factors are not exhaustive, Judge Taddonio added a sixth test: whether the creditors could establish a colorable claim. On that question, he said, the “court must apply the law as it exists today.” Since Resorts is currently binding law in the Third Circuit, it gives the former shareholder a complete defense, Judge Taddonio said.
Consequently, Judge Taddonio found justification for the release because there was “no utility in preserving a claim when there are no viable means to prosecute it.”
The committee wanted Judge Taddonio to await the outcome of Merit Management. To that, the judge said the court would “not speculate on the outcome of future rulings, nor is it required to do so.”
Although he said that Master Mortgage would be “largely irrelevant” if “the released claims have no value,” Judge Taddonio nonetheless examined all five of them. Notably, he said that the shareholder made a substantial contribution to the reorganization by agreeing not to sell its stock and thereby preserve tax losses for the reorganized company. He also said that the releases were a “critical component of the multi-party” restructuring agreement. It was “foreseeable that unraveling one aspect of that agreement could lead to an unwinding of the entire enterprise.”
In sum, Master Mortgage also counseled for approval of the releases.
Chapter 11 mavens should read Judge Taddonio’s opinion in full text, especially with respect to the discussion of third-party releases. For discussion of Merit Management, click here.