The confirmation of a contentious chapter 11 plan prompted District Judge Sidney A. Fitzwater of Dallas to write an 85-page opinion dealing with Fifth Circuit law on a multitude of issues including standing to appeal, arbitration, breakup fees and plan injunctions.
A registered investment advisor managed almost $15 billion in assets through a network of some 2,000 entities. One segment of the business, operated by several related companies, invested in collateralized loan obligations, or CLOs.
The CLO companies fired their portfolio manager, who had become a 25% owner of the business segment. In arbitration, he won a judgment for almost $8 million that was confirmed in state court in Texas. Believing that the CLO companies were denuding themselves of assets to avoid the judgment, the former portfolio manager first sought injunctions and finally filed an involuntary chapter 11 petition against his former employer.
Judge Jernigan’s Rulings
The debtor corporation filed a motion asking Bankruptcy Judge Stacey G.C. Jernigan of Dallas to dismiss the involuntary petition based on a contention that the disputes were subject to an arbitration agreement with the former executive. Judge Jernigan denied the arbitration motion and entered an order for relief in chapter 11. Later, she appointed a chapter 11 trustee, Robin Phelan.
The trustee confirmed a chapter 11 plan where the former executive purchased the equity in the reorganized company in return for reduction of his claim by $1 million. The plan called for paying all claims, including the former executive’s claim.
The confirmation order included an injunction barring the debtor’s affiliates from exercising rights they otherwise would have to compel liquidation of the CLOs and effectively put the reorganized company out of business.
An affiliate of the debtor appealed. The affiliate, in substance, was a shareholder of the debtor.
Judge Fitzwater upheld Judge Jernigan in all respects, in the process synthesizing several developing issues in Fifth Circuit bankruptcy law.
Standing to Appeal
Judge Fitzwater first dealt with the appellant’s standing to appeal. He recited the familiar notion that the “person aggrieved” requirement for appellate standing is more rigorous than the test for Article III standing. For appellate standing, the appellant must be directly and adversely affected in a pecuniary sense by the order on appeal.
Finding no binding precedent, Judge Fitzwater adopted the so-called shareholder standing rule from the First and Eighth Circuits. The rule stands for the principle that a shareholder has only an indirect financial stake and therefore lacks standing to appeal an order that is adverse to the corporation. He therefore dismissed the shareholder’s appeal from the order for relief.
Were the rule otherwise, Judge Fitzwater said that “any one of a debtor’s numerous shareholders could separately appeal bankruptcy court orders affecting the value of the debtor — thus resulting in ‘umpteen appeals raising umpteen issues.’”
The trustee also contended that the shareholder lacked standing to appeal the order of the bankruptcy court denying the shareholder’s motion for leave to intervene in the litigation over the involuntary petition. Because the denial of intervention could have affected the shareholder’s standing, Judge Fitzwater examined the merits of the intervention motion.
Intervention under Rule 24(a), Judge Fitzwater said, likewise requires a direct and substantial interest in the proceedings, thus bringing the shareholder standing rule in through the back door. For the same reason as the lack of standing to appeal the order for relief, he ruled that the bankruptcy court properly denied the shareholder’s intervention motion.
Arbitrating an Involuntary Petition
Next, the shareholder argued that the bankruptcy court improperly denied the motion to compel arbitration. The shareholder reasoned that the bankruptcy court lacked subject matter jurisdiction because the arbitration motion should have been granted.
Judge Fitzwater found loose language in prior Fifth Circuit opinions suggesting that the court lacks subject matter jurisdiction when a dispute is subject to arbitration. Later Fifth Circuit authority, he said, “supports the conclusion that a dismissal based on an arbitration agreement does not implicate the court’s subject matter jurisdiction.” [Emphasis in original.]
Since denial of the arbitration motion does not implicate the court’s subject matter jurisdiction, Judge Fitzwater dismissed the appeal from the denial of arbitration because it could only be brought by a party with appellate standing.
The Breakup Fee
The shareholder also appealed the bankruptcy court’s approval of a $2.5 million breakup fee.
The shareholder first argued that the transaction was so unlikely to close that the bankruptcy court abused its discretion in approving the breakup fee in the first place.
Judge Fitzwater responded by saying that weighing the benefits of the breakup fee was not for the court to decide on appeal. He said there was no evidence that the bankruptcy court abused its discretion.
Next, the shareholder contended that the breakup fee was so large as to be unreasonable. Although the fee was 2.3% of the total sale price, it was 26% of the amount the reorganized company would retain after paying claims.
Judge Fitzwater first noted that 2.3% was “in line with breakup fees authorized by other courts.” With regard to the argument based on 26%, he said there “is no principled reason to compare the breakup fee to the amount of money retained [by the debtor] after paying off” claims.
Third-Party Releases
Based on the Fifth Circuit’s prohibition of plans with non-debtor, third-party releases, the shareholder attacked the plan injunction that enjoined affiliates from compelling the liquidation of CLOs and effectively putting the debtor out of business.
Parsing In re Zale Corp., 62 F.3d 746 (5th Cir. 1995), Judge Fitzwater found that the Fifth Circuit prohibited “permanent” releases of nonparties’ claims. He quoted Zale’s statement that the prohibition “does not necessarily extend to temporary injunctions of third-party actions.” Id. at 761. The Zale court went on to list several “unusual circumstances” that could justify an injunction.
One exception, Judge Fitzwater said, allows temporary injunctions that are a “critical component” of a plan. He said that the bankruptcy court’s findings of fact were “sufficient to satisfy” the unusual-circumstances requirement. He also noted how compelling redemption of the CLOs would be an “economically ‘irrational’ transaction that would serve as the last step in [the affiliates’] ‘intentional scheme to keep assets away from [the former executive] as a creditor.’”
The shareholder is appealing to the Fifth Circuit.
The confirmation of a contentious chapter 11 plan prompted District Judge Sidney A. Fitzwater of Dallas to write an 85-page opinion dealing with Fifth Circuit law on a multitude of issues including standing to appeal, arbitration, breakup fees and plan injunctions.
A registered investment advisor managed almost $15 billion in assets through a network of some 2,000 entities. One segment of the business, operated by several related companies, invested in collateralized loan obligations, or CLOs.
The CLO companies fired their portfolio manager, who had become a 25% owner of the business segment. In arbitration, he won a judgment for almost $8 million that was confirmed in state court in Texas. Believing that the CLO companies were denuding themselves of assets to avoid the judgment, the former portfolio manager first sought injunctions and finally filed an involuntary chapter 11 petition against his former employer.