U.S. Bankruptcy Rule 9019 provides that on a motion brought by a trustee (and thus a chapter 11 debtor-in-possession as well) the court may approve a settlement. The prevailing view is that due to the court’s approval requirement, pre-court approval settlement agreements are enforceable by the debtor but not against the debtor. The District Court for the Eastern District of New York recently disagreed. It held that the statutory approval requirement is not an opportunity for the debtor to repudiate the settlement. Rather, the court held that settlements requiring court approval are binding on all parties to the extent allowable under state law until the court considers and rejects the settlement. Liberty Towers Realty, LLC v. Richmond Liberty, LLC, 569 B.R. 534 (E.D.N.Y. 2017).

In the case, chapter 11 debtors reached a global settlement agreement with creditors who foreclosed on their real property (the “Settlement Agreement”). The Settlement Agreement provided that the creditors were allowed to sell the property to a third party, and the creditors entered into a contract of sale with a third-party purchaser. The third-party purchaser, in turn, as it was required to do pursuant to the terms of the Settlement Agreement, moved for bankruptcy court approval pursuant to Bankruptcy Rule 9019.

At a hearing on the third-party purchaser’s motion, however, the debtors withdrew their support for the Settlement Agreement due to a purportedly better post-settlement offer. The Bankruptcy Court nonetheless granted the third-party purchaser’s motion and approved the Settlement Agreement. The debtors appealed.

On appeal, the debtors argued that they were entitled to rescind unilaterally the Settlement Agreement before it was approved by the bankruptcy court and that the third-party purchaser had no authority to submit the Settlement Agreement for approval.

The Court denied the debtors’ arguments altogether. Acknowledging that the Second Circuit has not spoken on this issue and rejecting persuasive authority to the contrary, the Court held that “[t]he better view of the law is that settlements requiring court approval are binding on all parties to the extent allowable under state law until the court considers and rejects the settlement.” The Court reasoned that this rule “better promotes settlement” and “advantages the estate because it gives creditors more incentive to engage in serious settlement negotiations and abide by any settlement agreement reached in the time before it is approved by the bankruptcy court.” Generally, the Court found, a post-settlement offer will have no bearing on the enforceability of a settlement agreement. Instead, bankruptcy settlements are governed by state contract law, and in this case the Settlement Agreement is binding under New York law. The Court therefore rejected the debtors’ argument that “the requirement of court approval provides a mechanism by which [the debtors] can act on [their] buyer’s remorse.” The court also rejected the argument that Rule 9019 allows standing only to the trustee/debtor-in-possession to seek approval of settlements. Since the Settlement Agreement specifically required the purchaser to seek approval of the agreement, the Court held that the debtors delegated to the purchaser their authority to seek court approval.

That said, the Court did not deem a potentially better post-settlement offer meaningless. Instead, it found that such offer should be a factor in the bankruptcy court’s decision on whether to approve the settlement or not. That is, the post-settlement offer should be presented to the bankruptcy court in connection with the Rule 9019 motion. The court will then “have the opportunity to evaluate whether this better offer warrants rejecting the settlement agreement.” Based on the above, the Court concluded that the Settlement Agreement was validly presented to the bankruptcy court for approval, and that given the facts of the case the debtors failed to show that the court’s decision was clearly erroneous.

Chapter 11 debtors in the Eastern District of New York, and elsewhere to the extent Liberty Towers is followed, should be aware that settlement agreements in bankruptcy may be binding, even before approval by the bankruptcy court. Accordingly, the approval stage may not be an “escape route” from previously signed settlements even when a seemingly better offer is on the table.