We resume our ongoing coverage of the Report of the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 as it relates to exiting the chapter 11 case. A prior post highlighted key proposals about plan voting, and today’s post discusses key proposals about plan settlements, exculpation and release provisions, and exit orders.


Uniform Standard for Approving Settlements and Compromises in a Plan

Settlements and compromises are an important (and, as a general policy matter, favored) aspect of the plan process, but courts do not employ a uniform standard for reviewing and approving settlements incorporated into a chapter 11 plan. As the Commissioners acknowledge, a plan typically proposes a treatment of creditors’ claims, which can include compromises of creditors’ rights, and creditors then vote to accept or reject the plan. A plan may also include substantive settlements that do not relate to the resolution of claims or interests asserted against the estate but nonetheless will affect the debtor’s exit from chapter 11, such as the settlement of claims or causes of action held by the estate. With respect to the latter type of settlements, the Commissioners note that some courts evaluate these settlements as part of the plan process under section 1129 without requiring separate evidence in support of the appropriateness of such settlements. Other courts require separate motions under Bankruptcy Rule 9019 – or, at least, separate evidence – on the proposed settlement as part of the confirmation hearing.

The Commissioners generally agreed that courts should separately approve any settlement or compromise of a material dispute affecting property of the estate, including matters in pending or threatened litigation or regulatory review, but excluding those integrated into the claims allowance process and addressed by creditors’ votes and related provisions in section 1129. The Commissioners propose amending section 1129(a) to include a hybrid standard for approval of settlements and compromises included in, or related to, the plan: Based on evidence presented by a plan proponent or debtor at the confirmation hearing, a settlement or compromise incorporated into a chapter 11 plan must be “reasonable and in the best interests of the estate.” The debtor will not need to file a separate motion or schedule a separate hearing to approve settlements or compromises under the plan; however, as part of the confirmation process, the court must make a specific finding that all plan-related settlements and compromises are reasonable and in the best interests of the estate.

The proposed standard is a middle road – it is a more rigorous examination of settlements than the “lowest point of reasonableness” (the standard generally applied by courts under Bankruptcy Rule 9019) but something less than “fair and equitable” (the standard the U.S. Supreme Court applied to compromises forming a part of a reorganization plan in its Bankruptcy Act-era holding in TMT Trailer Ferry ). It is the same standard that the Commissioners would apply to approval of settlements and compromises outside the chapter 11 process.

Clarifications on the Standards for Approving Exculpation and Releases

The Commissioners also tackled what they view as courts’ inconsistent treatment of exculpation and release provisions in plans. As aptly explained by the Commissioners, exculpation is akin to limited immunity for conduct during the chapter 11 case; releases, on the other hand, are a relinquishment of claims that the debtor or third parties may have against certain non-debtor parties. These provisions are usually intended to protect parties that aided the estate in the chapter 11 process. The Commissioners determined that these provisions should be permissible, if they meet certain standards and are adequately disclosed in the disclosure statement and plan.

For exculpation provisions, the Commissioners advocate that permissible provisions cover conduct that amounts to simple negligence by parties participating in the case and identified in the chapter 11 plan with respect to acts or omissions during the case or prior to the effective date of the plan.

For third-party releases, the Commissioners suggest adopting the standard set forth in In re Master Mortgage Investment Fund, Inc., 168 B.R. 930 (Bankr. W.D. Mo. 1994). This requires that courts consider and balance the following five factors, with emphasis on the last factor:

(i) the identity of interests between the debtor and the third party, including any indemnity relationship; (ii) any value (monetary or otherwise) contributed by the third party to the chapter 11 case or plan; (iii) the need for the proposed release in terms of facilitating the plan or the debtor’s reorganization efforts; (iv) the level of creditor support for the plan; and (v) the payments and protections otherwise available to creditors affected by the release.

The Commissioners further determined that the Master Mortgage factors “adequately captured the careful review required” and they omit any requirement to justify such releases on the basis of unique or unusual circumstances.

Exit Orders: No Structured Dismissals

The Commissioners recommend that chapter 11 cases only be resolved by confirming a plan under section 1129, converting a case under section 1112, or dismissing the case subject to section 349. This means no “structured dismissals” – that is, dismissal of a chapter 11 proceeding that includes some aspects of a confirmation order, like provisions for third party releases and distributions to creditors. Liquidating chapter 11 debtors with de minimis funds may seek a structured dismissal to expedite final cash distributions after a sale of substantially all assets pursuant to a section 363 of the Bankruptcy Code because they think a structured dismissal can save some of the costs associated with the plan process or converting to a chapter 7 case, and, as a result, increase distributions to creditors.

The Commissioners generally view structured dismissals as “short-circuiting” the creditor protections under the disclosure and soliciting provisions of the Bankruptcy Code. They highlight certain components of structured dismissals as particularly problematic in this respect: provisions that violate the absolute priority rule by “gifting” a portion of sale proceeds for lower priority creditors, third-party releases, and alternative claims-allowances processes. The Commissioners argue that their 363x sales proposals (discussed here) incorporate appropriate creditor protections from the confirmation process and, if adopted, would render the use of structured dismissals unnecessary.

Conclusions

The ABI Commission’s plan-related proposals, if adopted, will surely impact the strategies of the various stakeholders in a chapter 11 plan process, and, in certain circumstances, could increase the amount of time necessary to exit a chapter 11 case. They could also make exiting a chapter 11 case costlier for debtors.
The proposed amendments to the voting provisions, discussed in our last post on this topic, would also take away leverage in plan negotiations from creditors who may hold (or who would seek to acquire) a blocking position, and would increase negotiating leverage for debtors. In addition, strategic claims trading by creditors would likely decline.
As the Commissioners have reiterated, the ABI Report was several years in the making, and the numerous proposals provide much to consider and debate, which we will continue to do on this blog in upcoming posts.