“You know, every piece of information and fact out there is within six degrees of separation of the debtors’ assets and financial affairs. The question is where do you draw the line?”
4/20/17 Transcript of hearing in In Re SunEdison, Inc., et al, Case No. 16-10992-smb (hereinafter “TR”), page 30 lines 6-11.
The Issue. An issue of first impression appears to have arisen recently in a case pending before United States Bankruptcy Judge Stuart Bernstein in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). In the Chapter 11 Case, In re: SunEdison Inc., et al., 16-10922 (SMB) (the “Debtors”), the Bankruptcy Court directed supplemental briefing on the question of whether a debtor is entitled to Bankruptcy Rule 2004 discovery into non-debtor litigation, because the outcome of that litigation may have an effect on the value of a significant asset of the bankruptcy estate of the Debtor. At the hearing where the issue arose, the Bankruptcy Court noted that it had been unable to find a case directly on point, and at the hearing the parties to the matter were not able to identify any such cases. Spoiler alert—as of the date this blog was prepared, the Bankruptcy Court had not yet ruled; an update will be provided when it does so. While we hold our breath waiting for the Bankruptcy Court’s ruling, here is the background and where the six degrees of separation fit in (further spoiler alert: here, the six degrees of separation have nothing to do with Kevin Bacon).
Background: The debtor, SunEdison, Inc. (“SunE”) commenced its chapter 11 case on April 21, 2016, together with twenty-five affiliated co-debtor entities, with additional affiliated co-debtors thereafter filing voluntary petitions (collectively, the “Chapter 11 Cases”). The Chapter 11 Cases have been consolidated for procedural purposes only and are being jointly administered. Notably absent from the Chapter 11 filings were two entities that are referred to in the Chapter 11 Cases as the non-debtor publicly traded “YieldCo” subsidiaries of SunE, TerraForm Power, Inc. (“TERP”), and TerraForm Global, Inc. (“GLBL,” and together with TERP, the “YieldCos”). According to SunE, SunE holds a majority equity stake in TERP and approximately 33% equity stake in GLBL.
In 2014, SunE and TERP, as buyers, had entered into a contract to purchase from D.E. Shaw Composite Holdings, L.L.C. (“DESCO”) and Madison Dearborn Capital Partners IV, L.P. (“MDP” and, together with DESCO, “Plaintiffs”) a company named First Wind, an energy company that owned and developed wind and solar energy. Thereafter a dispute arose and on April 3, 2016, prior to the commencement of the Chapter 11 Cases, Plaintiffs filed a lawsuit in New York Supreme Court against TERP seeking a declaratory judgment as to TERP’s obligations (the “First Wind Litigation”). The Debtors are not a party to that litigation. Upon SunE declaring bankruptcy in April 2016, Plaintiffs asserted that an acceleration event had occurred, and Plaintiffs filed an amended complaint in State Court asserting a claim for breach of contract for TERP’s failure to make what Plaintiffs assert is a $231 million in the aggregate “Accelerated Earnout Payment” as one of the two buyers under the purchase agreement, and for TERP’s failure to comply with its obligations as guarantor.
The Rule 2004 Motion and the Debtors’ Position. In a motion filed jointly by the Debtors and TERP ( the “Rule 2004 Motion”), they sought the entry of an order of the Bankruptcy Court pursuant to Bankruptcy Rule 2004 seeking the production of documents by Plaintiffs and reserving the right to seek depositions[ Docket No. 2692].
According to the Debtors, on March 6, 2017, TERP and Brookfield Asset Management Inc. and its affiliates (“Brookfield”) entered into a definitive agreement under which Brookfield agreed to acquire a controlling interest in TERP (the “Brookfield Acquisition”), with SunE retaining a minority equity interest. Pursuant to this transaction, the Debtors asserted that the Debtors’ estates stood to realize in excess of $800 million in cash and TERP equity and that, accordingly, the disposition of TERP is “critically important” to the formulation of a plan of reorganization of the Debtors, as well as to the proceeds available for distribution to secured and unsecured creditors of the estates. Although the Brookfield Acquisition is not contingent upon resolution of Plaintiff’s claim against TERP, any liability with respect to these claims would, said the Debtors, reduce the value of the equity in TERP retained by SunE after the Brookfield Acquisition. The Debtors further contend that (a) uncertainty about the nature or magnitude of these claims could therefore complicate the financing and implementation of the Debtors’ plan of reorganization, which is premised, in part, on the value of the Debtors’ retained TERP equity; and, in addition, (b) the Brookfield Acquisition is subject to approval by TERP’s public stockholders, and the strength of Plaintiff’s claims against TERP may potentially be important to them.
The discovery is necessary, said the Debtors and TERP, so that SunE and TERP would be able to mitigate any concerns that SunE’s financing sources and TERP’s stockholders may have about the claims of Plaintiffs. Also, contended Debtors and TERP, the discovery would demonstrate that Plaintiff’s claims against TERP were not colorable, on the basis that the First Wind Action depended entirely on Plaintiff’s interpretation of an ambiguous clause of the 2014 purchase agreement that parol evidence would not support. According to the Debtors, without discovery, Plaintiffs would be in a position to interfere with the Brookfield Acquisition and its benefits to SunE and TERP stakeholders.
Plaintiffs’ Initial Objection. In their initial objection to the Rule 2004 Motion, Plaintiffs argued that the Rule 2004 Motion should be denied as a flagrant violation of the “pending proceeding” rule prohibiting the use of Rule 2004 to obtain or circumvent discovery in pending litigation. There was, argued Plaintiffs, no uncertainty about the nature or magnitude of Plaintiffs’ claims as the 2004 Motion alleges, the claims for breach asserted in the First Wind Litigation were unambiguous, and TERP failed to take discovery in the First Wind Litigation in the State Court. Furthermore, according to Plaintiffs, the requested Rule 2004 discovery should also be rejected as wholly unnecessary for plan confirmation in the bankruptcy or in support of the Brookfield Acquisition [Docket No. 2783].
While Plaintiffs acknowledged that generally under Bankruptcy Rule 2004 a Bankruptcy Court may, on a motion, “order the examination of any entity” into “the acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor’s estate,” Fed. R. Bankr. P. 2004(a)-(b), it argued that even Rule 2004 examinations have limits. As argued by Plaintiffs, under the “Pending Proceedings” limitation, parties are precluded from obtaining discovery through Bankruptcy Rule 2004 when proceedings are pending in another forum, and under those circumstances courts have held that discovery should be pursued under the Federal Rules of Civil Procedure or equivalent procedures governing discovery in state court proceedings.
The Bankruptcy Court Hearing. At the Bankruptcy Court hearing on the Rule 2004 Motion conducted on April 20, 2017, the Bankruptcy Court played devil’s advocate with both sides. First, as to the Debtors, the Bankruptcy Court noted that in the Rule 2004 Motion, the Debtors did not really appear to seek discovery regarding the claims filed by the Plaintiffs in the Chapter 11 Cases, but, rather, the discovery was directed at non-debtor TERP’s liability to the Plaintiffs. On this point the Bankruptcy Court queried the Debtors’ counsel:
THE COURT: Let me ask you a question. Suppose that a debtor’s most important customer is involved in litigation outside of bankruptcy, and if it loses that litigation, the customer’s going to go out of business. Would a debtor have the right to get discovery from the other party in that litigation regarding the strength of that claim? Because that’s really what you’re saying.
TR page 26, lines 11-17.
The Court pressed the point by asking Debtors’ Counsel:
THE COURT: Let’s suppose you’re an individual Chapter 11 debtor and your most significant asset is Microsoft stock. Microsoft is involved in a patent litigation in Seattle with some third party, and the outcome of that action would affect the value of your stock. Do you think you could…. insist in bankruptcy court through [Rule] 2004 that that adversary has to turn over information so you can gauge the strength of its patent claim?….
TR page 27, lines 23-25; page 281-2, 8-10.
Six Degrees of Separation. After colloquy with Debtors’ counsel regarding the propriety of a 2004 examination in connection with third party litigation (litigation to which the debtor was not a party) on the basis that the outcome of that litigation could have an effect on the value of the debtor’s assets, with counsel for the Debtors pressing that the examination is appropriate because it concerns the Debtors assets, the Bankruptcy Court made the statement quoted at the beginning of this article: “You know, every piece of information and fact out there is within six degrees of separation of the debtors’ assets and financial affairs. The question is where do you draw the line?”
The Bankruptcy Court likewise played devil’s advocate with Plaintiffs’ counsel and queried why couldn’t the Debtors take Rule 2004 discovery to determine the value of its interest in TERP and on why the transaction with TERP should be approved.
Bankruptcy Court’s Preliminary Ruling and Request for Supplemental Briefing. Ultimately, the Bankruptcy Court denied the Rule 2004 Motion as to TERP on the basis of the Pending Proceeding Rule. As to the Debtors, however, after the Bankruptcy Court noted that it had looked for but had not found any cases on point, the Bankruptcy Court provided the parties with additional time to respond to the Bankruptcy Court’s questions.
The Debtors’ Supplemental Response. In the Debtors’ supplemental response (the supplemental responses were filed simultaneously), they asserted that the broad examination of third parties concerning the value of a debtor’s assets, or to aid in discovery of assets, is permitted under Rule 2004. In support, the Debtors cited several cases that permitted such discovery, including with respect to the value of a debtor’s stock in several third parties, and the value of a debtor’s interest in real property. The Debtors further asserted that Plaintiffs qualified as potential examinees under Rule 2004, citing this language from In re Ionosphere Clubs, Inc., 156 B.R. 414, 432 (Bankr. S.D.N.Y. 1993): “Because the purpose of the Rule 2004 examination is to aid in the discovery of assets, any third party who can be shown to have a relationship with the debtor can be made subject to a Rule 2004 investigation.” The Debtors also pointed out that the Plaintiffs were not just any third parties, as they had filed proofs of claim that were the subject of the First Wind Litigation, and therefore the First Wind Litigation was related to the Chapter 11 Cases [Docket No. 2901].
The Plaintiffs’ Supplemental Response. In the Plaintiffs’ supplemental response, the Plaintiffs contend that Rule 2004 does not support the broad application that the Debtors urge the Bankruptcy Court to adopt, that to the extent courts have permitted Rule 2004 examinations of third parties, the purpose of such examinations was not to assess the potential outcome of a third party litigation, and allowing a Rule 2004 examination in connection with the Third Wind Litigation would be an impermissible interference in a pending litigation to which the Debtors are not a party [Docket No. 2902].
Stay Tuned. Whether the Bankruptcy Court finds the supplemental responses were in fact responsive to the questions posed by the Bankruptcy Court, and were persuasive, remains to be seen. We will follow up once a decision is rendered by the Bankruptcy Court. Ideally, the decision will answer the question, at least in this Bankruptcy Court, of within how many degrees of separation does an issue need to be for it to be subject to examination pursuant to Bankruptcy Rule 2004.