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Disclosure Statements and Plan Confirmation           


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JOSEPH SAMET: Thank you. We do learn from the evaluations. We listen to new subjects that you want to hear, the leading subjects you don't want to hear or have heard enough of. And so we do make modifications, including on scheduling. So we're going to continue on with Martin and Ana.

MARTIN BIENENSTOCK: OK thanks, and thank you for coming back from the break. So one more item that's a little bit within the theme of what people are doing as substitutes for Chapter 11 are using rules outside of Chapter 11 to restructure debt. A big thing for the last two years had been a new interpretation of section 316(b) of the Trust Indenture Act.

When I started practicing in 1977, I remember reading the Trust Indenture Act. And what popped out at me was if you want to reduce the amount of principal owed or the amount of interest owed, or you want to give up collateral, you need a unanimous vote of every holder of the debt. If you want to do other things like waive a default, or waive covenants, or things like that, the indenture itself could set forth the voting requirements as to whether you need half, or 2/3, or 80%. It could set those limits. But principal interest and collateral were off-limits.

And I think most people had a similar take on the Trust Indenture Act. I never really heard a controversy about it. In the last couple of years, there have been several situations where you had a bond issued by a debtor, whether at the operating company or a holding company, and guaranteed by another entity, usually an affiliate. And some of these bonds provide for the guarantees to be eliminated under certain circumstances.

So in a few situations-- one was Caesar's, another's Marblegate-- the debtors basically went to some of the bondholders and said, we'll buy you out or we will restructure your existing debt as long as you give us a vote to release the guarantee from the rest of the debt. And anyone who doesn't play ends up having debt that's no longer guaranteed. And so that was done in Marblegate and that was done in Caesar's.

And the bondholders who found themselves without the guarantee went to court under section 316(b) of the Trust Indenture Act. And they pointed to the language that the court is not supposed to-- or the debtor is not supposed to take steps to impair the collection of the claim period. And the court started finding in favor of the bondholders that essentially the release of the guarantee needed to be treated the same as principal interest and collateral, and you needed unanimity to have it released.

Suffice it to say that not the day before, but the morning of the confirmation hearing in Caesar's where this was like a major, major issue in the case, the Second Circuit decided in favor of the issuer in Marblegate and said, no, these guarantee releases can be done by less than all. They don't come within the protection of principal interest and collateral. And we were all wondering whether the control entities at Caesar's were going to pull the whole plan and do it all over again because this had been one of the big weapons the bondholders had been using against them.

So to my knowledge, this use of the release provisions for guarantees is now pretty much a given. And people just have to be careful with the bonds-- the indentures they buy, to read them and make sure they understand how they can lose their guarantees if the issuer wants to go in that direction.

OK, I thought that would spark some discussion, it didn't. [LAUGHTER] So let me go to A really big issue that's been an issue that I've covered over the years. And I call it a big issue both because it has such a humongous impact on value. And it's amazing that in the year 2018 we don't have an answer. And this year we have a Second Circuit decision addressing the question and we still don't have a real answer, although the answer maybe is a little more certain or less unpredictable than it was before.

So the issue I'm talking about is when a debtor's chapter 11 plan crams down secured debt by issuing a new note for the value of the collateral or the amount of the claim, whichever is less. What interest rate must the plan proponent put on that new debt instrument to cram it down and be confirmable under section 1129 B of the bankruptcy code?

Until the Second Circuit rendered its decision in Momentive several months ago, everyone started this discussion by referencing the US Supreme Court's decision in Till, T-I-L-L, which was rendered 15, 20 years ago. And Till was actually a chapter 13 case where the issue was in the chapter 13 plan that was a cram down on the lender who loaned against the value of a truck. What interest rate does the lender have to be given on that crammed-down truck loan?

And there were basically four alternatives that the litigants were teeing up. Of course, the lender said, you have to give me the rate I would charge on a new loan. If you don't give me that, at least give me the rate in my existing contract. That's what the debtor agreed to. The debtor said, no, that's all wrong. What you get if you look at the language of the code, all you're supposed to do is get a stream of payments having a present value as of the effective date of the plan equal to the amount of the cram down loan.

So you get the interest rate equal to the inflation rate because that'll make the stream of payments equal to the value of the loan by definition, or the face amount alone by definition. And if you don't like that, here's another one called the formula approach. The court should look at the risk-free rate, which means the US government interest rate on US government debt, for the same term as the cram down loan.

So if the new truck loan was going to be five years, you look at the five year US government note or bond. And whatever rate that is, you take it as the base rate and then you add a risk factor, but not too high. Because if it's too high, that means the plan was not feasible in the first place and it shouldn't be confirmed. So you add a little bit of a risk factor.

So in the Till decision, by a 5 to 4 margin the Supreme Court said, yes, you use the formula rate. And while it's nowhere written in stone, the amount you add to the risk-free rate should generally be between 0 and 3%. Because if it's higher than that, the plan's probably not feasible. And Justice Stevens has a great line in his decision where he answers the creditor's argument that we're deserving of a loan having an interest rate that will let us sell the loan for its face value. And he's saying, and Justice Stevens writes, "if the interest rate were supposed to make you indifferent between being paid in full in cash and getting a loan that you can immediately sell for that amount of cash, I don't think they'd call it cram down."

So anyway, that decision, if not for the next statement I'm about to tell you, would have settled once and for all what cram down interest rates are in chapter 11 as well. But the Supreme Court dropped a footnote. And in that footnote, the Supreme Court says sort of off-handedly, well, of course if there is an efficient market for loans, as there frequently is in chapter 11 cases and they reference DIP lenders, then maybe the court should just look at what that rate is.

Because part of the rationale for coming up with the formula rate was that we wanted it to be simple. We don't want there to be a long trial over what the rate should be, we want the bankruptcy judge to be able to look at one or two things, say, OK, here's the rate. And the Supreme Court also in Till explains that the rate should not have a profit component in it. It shouldn't have a documentation component in it. You're not making a new loan, you're just assigning an interest rate to money you already loaned.

So ever since Till was decided, in every cram down case there's an argument between the plan proponent and the lender being crammed down as to whether the formula rate in Till or the so-called market rate for DIP loans should be used. And all bankruptcy lawyers immediately say, what was the Supreme Court talking about? Debtor in possession loans are loans during the case. We're talking about exit loans here. That's a totally different story.

But notwithstanding, that's been the tug of war up until this Momentive case. Now, Momentive which you'll find if you look it up, it's MPM Silicone. It's a case pending in the Southern District of New York in the White Plains courthouse. So Judge Drain presided over it and he had a somewhat unusual fact situation come up to him.

First, the case was unusual in that the debtor offered in its plan payment in full in cash to the secured lenders but without their make whole. And the secured lenders said, no, we reject that because you're not paying us the make whole. So the debtor said, well, if you don't take that then I'm cramming down-- I'll leave your loan outstanding, but I'm going to cram it down with this lower interest rate.

And Judge Drain went through the formula approach and came up with interest rates that were-- I think one was like 4% and one was 5%, or 4 and 1/2 and 5 and 1/2, something like that. And they appealed that up to the Second Circuit on the ground that Judge Drain followed the Till rationale as opposed to the Till footnote which says, look at the market.

And when it went to the Second Circuit, the reason I said earlier we still don't have an answer, we just have a little less uncertainty than we had before is the Second Circuit said, well, Judge Drain didn't even look at the market. So we're remanding so he can look at the market. Which means that he has to first decide whether there is an efficient market for loans of that type. And if there is, then what's the interest rate?

Now, I don't know if he's resolved this yet on remand. I know they've started hearings.

ANA ALFONSO: I don't know, I think they were going to try to negotiate.

MARTIN BIENENSTOCK: I'm sure they will.

ANA ALFONSO: Maybe they tried that before they took their chances in front of them in the first place. And the reality was that the lenders thought they might do much better than they-- I mean, the offer to them, as I understand it, was much better than what they got from Judge Drain.

MARTIN BIENENSTOCK: Right. So here is where I think we are. And I'm combining things that Judge Drain has said in seminars and logic and common sense that others have corroborated what he said and the facts in MPM Sillicone. In MPM Sillicone, the cram down loan amount is for less than the total value of the collateral security. So it is quite possible that there is an efficient loan market out there that would give you a commercial market rate for a loan of, say, you know, 80% loan amount to collateral value. And if there is, then if parties don't settle it, I think Judge Drain will look at that market and he'll take the rate and that'll be the rate.

But in most of the cram down situations where the amount of the cram down claim is for more than the value of the collateral so you end up reducing the secured claim exactly to the amount of the collateral, in those situations you're dealing with a one to one loan to value ratio. And since--

ANA ALFONSO: Nobody lends without an equity cushion, is that your point?

MARTIN BIENENSTOCK: I think today nobody lends without an equity cushion. I mean, you want at least 10%, usually 20%, 25% cushion. That's not to say that there haven't been times that many of us have lived through where people did give one to one loan to value loans on the theory that values were only going up, so it was only a matter of time before the loan would well-collateralized and they went in the opposite direction.

But I think where the case law is destined to end up is that if it's one to one, you're going to be stuck with the formula approach in Till because there's no efficient market for one to one loans. If it's commercially reasonable or better than one to one, you're going to end up with the market rate.

And philosophically, I frankly don't know where I come out on this question. Because on the one hand I think I understand the Supreme Court's rationale on Till, but I'm not sure as a philosophical matter why we would want to give a debtor an advantage over its competitors with a below market interest rate. And what happens when the loan matures? How is it going to refinance it without paying the market rate at that time, and will it be feasible then, and all that? So I guess the answer is if I'm representing a debtor then I know exactly what I believe in. And if I'm representing a hedge fund, I know a different position I believe in. And I don't have to decide in my own mind which is the better position.

ANA ALFONSO: Well, the good news is that it fosters a lot more negotiation to have that sort of level of constant uncertainty. In that, like I said, nobody ever wants to be negotiating cram down. And they will if they have to, but you may not like what you get. And that goes-- that's true for the debtor, as well.

MARTIN BIENENSTOCK: And I think as a practical matter because we do have this uncertainty-- especially if you are in a one to one situation-- then the first lean holder has a big, big risk that when market rates are eight, it's going to be stuck with a cram down rate of four and it has a hell of an incentive to negotiate a deal. Because that is a real risk. If it's better off than one to one ratio, then the risk recedes as it becomes better off, I think.

OK, where do we go next? Favorite topic. If Michael Richman had not said in his last segment how there are rules against disparaging the judiciary, I would be putting this differently than I'm about to put it. But I will-- [LAUGHTER] he knows what he's talking about so I will be more careful.

There's been an issue in chapter 11 confirmation over the years as to how many impaired accepting classes you need to confirm a chapter 11 plan. So the black letter law if you just take out the bankruptcy code and you read section 11-29 810. It says there needs to be at least one impaired except in class for the plan to be confirmed.

In today's world where in all the large cases you have multiple affiliated debtors, you have the holding company and then a bunch of subsidiaries and subsidiaries of subsidiaries, and that type of thing. The conventional practice has been to have one that people usually label joint plan for all of the different debtors.

Now, even though it's one joint plan, unless all of the creditors have coalesced into an agreement, which is rare when you have these large cases and large numbers to deal with. So even though there's one joint plan, there are classes within the plan for each particular debtor. And virtually every bankruptcy lawyer I know makes sure when they go to confirmation that they identify for the judge how each debtor has at least one impaired accepting class. Now, I'm somewhat guilty for the start of the problem I'm about to tell you about. Because in Enron, we had I think 168 debtors. We had a joint plan as I've explained. And when we got confirmation, there were like two or three of the debtors that had no accepting classes. They didn't have any rejecting votes, they just didn't have anyone accepting votes, largely because they were completely unimportant debtors and they had meager assets among them.

So just so that the judge could confirm the plan as we provided and we wouldn't have to carve out three debtors, we said to the judge, we don't need extra impaired-- we don't need impaired classes for those three. And the judge went along with it. And if you read the-- he didn't write in an opinion, per se. He did findings and conclusions. And there is a conclusion in there that says that those cases didn't need their own accepting classes.

Now, if you speak to that judge today, he's off the bench but he's still-- he's a professor at NYU. He will tell you that he only agreed to that because no one was objecting. And it was sort of a non-event. If he had said, I'm not going to confirm the plan for those three debtors, fine, we'll carve them out. We don't need confirmation for those three debtors. We don't care if they liquidate. But it just wasn't worth the trouble so everyone went along with it.

Well that was then used as authority in charter for when the debtor wanted to cram down a plan against the banks reinstating their old interest rate. And there was no impaired accepting class in many of the intermediate holding companies. The judge said, I don't need one for every debtor. I have one for the joint plan. And that, in my view, was-- with the banks objecting every step of the way, that in my view was reversible error. Easily reversible error. But by the time it got up on appeal, it was equitably moot. And there's a-- we'll get to equitable mootness a little later. It was regrettable in my view that it was equitably moot.

So now we get to the Ninth Circuit's decision in which it's just a few months, it came down January 25, 2018. At 881 of third 724, so it's probably not in my materials. And it's called JPM CC a bunch of words v Trans West Resort Properties. So the debtor was Trans West Resort Properties. And there you have three or four affiliated debtors and only one impaired accepting class.

And so the creditor who'd felt disadvantaged by the confirmation objected on the grounds that you need an impaired accepting class for every debtor. And the bankruptcy judge and the district judge said you didn't. It went up to the Ninth Circuit, and the Ninth Circuit said, well, we start-- this is the famous words of so many bankruptcy decisions and others, we start with the words of the statute.

So they quote 1129(a)(10), which only requires one impaired accepting class. They say, look, only one impaired accepting class. Plain language, plain meaning, that's all you need. Well for crying out loud, the code is written for one debtor. You won't find the word joint plan in the entire code. It doesn't say anything about what you need for a joint plan. It's not even clear you can have a joint plan. But this just says you need one impaired class, affirmed. So now we have a circuit court on the record saying that when you have multiple debtors, you only need one impaired accepting class.

Now, they do say in the decision that the court-- I don't know how the court was doing this, but they said that the court was treating the debtors as substantively consolidated and the creditor did not object. Well, yes it did object when it said you need separate impaired classes for each debtor. What did the court think that meant other than you can't treat them as one?

So now the court didn't get to this, but here's the issue now in the Ninth Circuit from my perspective, if I ever have a case out there. At the beginning of most chapter 11 cases with these multiple debtors, all of whom are affiliates, one of the most standard motions in the world is a motion for joint administration. Now, the purpose of joint administration under the bankruptcy rules is very simply so that for if you have, say, 168 debtors as we did in Enron, or you have five, you can have one docket in the courthouse that'll list all the pleadings filed in all the five cases, or all the 168 cases so that if you're like any of us and you want to look at the docket, instead of looking at 168 different dockets for a pleading you can look at one. Very convenient, very easy.

But that's what gave rise to the joint plan. So if now we're in the Ninth Circuit and someone says, let's have joint administration, the only thing you can do is say, hell no. Because that means you can confirm the plan with only one impaired accepting class. It's ridiculous. But that's the law now in the Ninth Circuit until they change their minds. Something in the drinking water out there.

[LAUGHTER]

ANA ADOLFO: Now, now. I think it's safe to say that a judge in New York or Delaware would love to get their hands on that fact pattern. Stir up a conflict.

MARTIN BIENENSTOCK: Love to take that to the Supreme Court on a conflict of the circuits. OK, so a few words about trading claims. It used to be that on this seminar, the big issue about trading claims is that the bankruptcy court had to approve claim transfers and the courts, especially in New York, didn't always approve them for various reasons. But now the rules have been amended so that it's pretty much a ministerial act and you don't have to worry about-- courts don't have to approve claim transfers anymore.

That said, the current issue that seems to be controversial and producing different results is whether you can basically launder a claim by transferring it. So what do I mean by that? Well, if a claim was subject to equitable subordination when held by its original holder, and that holder sells the claim to someone else, can the debtor equitably subordinate that claim once it's in the hands of a new owner? That issue came up in the Enron case. And the bankruptcy court said yes, of course, you can't launder a claim just by transferring it. Otherwise everyone subject to an equable subordination lawsuit would simply transfer the claim.

The district court rendered a very peculiar decision. The judge said, well first of all, if the claim is assigned, then the S&E takes all of its problems with it. So if you could subordinated in the hands of the original holder and it assigned, you can subordinate it in the hands of the S&E.

Courts said on the other hand, if the claim is sold, then you cannot subordinate it in the hands of the purchaser. The first problem with that is that under the Uniform Commercial Code in New York and everywhere else, a purchase includes a sale and an assignment. It's any transfer. So there is no distinguishing factor between purchase and assignment.

Second problem in New York is that under New York general obligation law section 13-105, it says a debtor can defend against a claim with any defense or counterclaim existing against the transferor before notice of the transfer. So what would be the basis to say that the bankruptcy code preempts New York general obligation law 13-105? It's not contrary to anything in the code.

And finally, you UCC section 9-404(a)(2) says an assignee of a debt takes subject to any defense of the account debtor. So again, you have other New York law which is in the 50 states saying that assignees are subject to the same problems as the original holder. But still, you have this district court decision on the books here which makes a difference between a sale and an assignment.

Another consequence of-- another issue that's impacted by a claim having its problems is section 502(d). 502(d) of the bankruptcy code says that a claim cannot be allowed if the holder of the claim has not disgorged whatever voidable transfers it received. So if it received a preference, its claim can't be allowed and it can't participate before it returns the amount of the preference.

And that's the issue that came up in KB Toys at 736(f) 247. And the Third Circuit had no problem saying that for purposes of section 502(d), a claim can't be allowed whether in the hands of the original holder or the purchaser or assignee if the original holder was the recipient of avoidable transfer.

So as a result, if you're buying claims you normally get an indemnity from the seller that if it's not allowed you get your money back, or the seller will make good on the disgorgement, or whatever. And similarly, if you're selling-- I mean, you should assume that any knowledgeable purchaser is going to require you to provide indemnity. Otherwise it's much too dangerous to buy the claim.

A lot of my friends in the industry used to have cottage industries on transferring claims. I don't know if it's as hot anymore because it's easier to do it and they're are a bunch of generally accepted forms that people use. But it could be a big deal.

JOSEPH SAMET: I find that on some of the claims assignment forms there's a lot of negotiation that goes on with some of these claims traders who want to buy it, but want indemnities, want a range of things. And the forms are not standard and we'd have to negotiate with them. First they'd send out a solicitation that says we want to buy claims and contact us. And it almost sounds fairly unconditional. And then they throw in some paperwork that it becomes a significant problem, or even if you disclose that there's potential preference exposure and the like, they'll say, yeah, but you've got to pay for that and you also have to pay for the defense on an ongoing basis.

MARTIN BIENENSTOCK: OK, we have 10 minutes. I'm not sure if this topic will consume the 10 minutes or not, but it is chronologically comes at the end. Equitable mootness.

JOSEPH SAMET: We have 10 plus 15.

MARTIN BIENENSTOCK: Oh, 10 plus-- OK. That's right we started at-- OK.

JOSEPH SAMET: The CLE providers would dock us and you folks.

MARTIN BIENENSTOCK: Well then I'm going to take this topic out of chronological order and we're going to skip to this anyway, and then we'll fill in. So equitable mootness. You haven't lived until you've represented a creditor objecting to a plan that most other creditors want to be confirmed and consummated. And you have to stand in the way of the plan's going effective. The reason I say you haven't lived is because you don't basically get any sleep from the time the confirmation order is signed by the bankruptcy judge and some court-- whether the bankruptcy judge, the district judge, or the circuit court-- gives you a stay. Because if you can't stop the plan going effective, then more often than not your appeal is going to be thrown out.

Now, why should that happen? Well, on the good side you can tell where I come out on this. And frankly, whether it is true, if I'm representing a debtor I would certainly do my best to promote equitable mootness if it's my plan being confirmed. But I have a certain sympathy for creditors' rights who at least want another court to take a look at it.

So what's this all about? Well, as Judge Ambro in the Third Circuit has commented in the decisions, he's written about equitable mootness. This is a doctrine that appears to only exist in bankruptcy. And in bankruptcy, it only exists when it comes to confirmation of a plan. And I'll get back to that because the Second Circuit had a few words about that in the GM situation.

And there are two types of mootness. There's constitutional mootness and equitable mootness. Constitutional mootness starts with the case and controversy requirement that an Article III court can only rule on something that's a case-- you can only exercise judicial power on a case or controversy. And to exercise judicial power, there has to be an injury that your order can remediate at least in part.

So the concept of constitutional mootness is that even though there's an injury, you know, the plan has been confirmed and deprived you of your statutory and constitutional rights, that's your injury. But if the court is powerless to issue any order to help you, then it's constitutionally moot and it's thrown out. That is rarely the case because Article III courts can revoke confirmation and tell people to go back to their original positions if they want to. So confirmation is almost never constitutionally moot.

But this other doctrine of equitable mootness has formed over the years. And its essential elements are that although the court could issue an order reversing confirmation and telling parties to go back to their original positions, that it's too much like unscrambling an egg. Too many innocent people will have relied on confirmation and be hurt in the process. Too much of it will not be truly reversible. The money will be out the door. And given all of the company's going concern may be impaired. And it would just be too impracticable and too unfair under the circumstances to reverse. And therefore the court says I could issue an order reversing, but it would be inequitable so I'm not going to deal with it. So that's equitable mootness.

Now, the dynamics are such in chapter 11 practice that everyone proposing a plan starts off by saying to the judge that even though the bankruptcy rules and federal rules of civil procedure provide an automatic stay of 14 days on confirmation, the first thing you do is ask the court to waive the stay. Then the next thing you do is to try to structure the confirmation or the consummation of the plan such that immediately after the judge signs the order, you can go effective and attain at least what they call under the code substantial consummation.

Now, what does that mean? It means that if you're supposed to distribute stock, you distribute at least some of it. If you're supposed to distribute money, you distribute that. If you're supposed to issue contracts, enter into some sort of investment with a new entity, you do that. And the more steps you take then the more inequitable and difficult it becomes to undo them. So that helps your case on equitable mootness.

And I would think looking at it not from the viewpoint of a debtor or creditor, but just an observer, an academic, that rationally, unless there's some exigent circumstance requiring immediate effectiveness, in fairness things should be done in a way that the district court and if possible the circuit court can take a look at it.

But I'm not using any names. When I've gone to certain bankruptcy judges-- some of them new on the bench-- and I've explained this, and I've said, how do you feel about that? A surprising number has said to me, why would I want it to be reviewable? Now, I guess that's an understandable reaction but I was sort of sorry to hear it. Because trust me, if you're the creditor it's not fun when even the judge wants to help make the confirmation order unreviewable.

So lately the Third Circuit has issued a number of decisions cutting back on equitable mootness. They've been holding situations not equitably moot when other courts would have said they are. But in almost all of these cases, it was relatively simple such as in Sem Crude in the Third Circuit. It was relatively simple to say to the reorganize debtor, hey, the subjecting creditor, if it's right, then say you'll pay it a few more bucks. So no big deal. The egg doesn't have to be unscrambled. I guess logically there hasn't been a situation where a court has said I'm so outraged by this going effective without my opportunity to review. I'm going to reverse it anyway. And I don't think that's likely ever to happen. It could conceivably happen but I doubt it will because it is by definition, it's unfair, and it's hard, and it's impracticable. But what I find surprising is there's not more pressure from the appellate courts to tell bankruptcy courts not to waive the 14 day stay so that there can be review in the normal course before it's too late. Now--

JOSEPH SAMET: Martin, yesterday I spoke about 363 sales and courts waiving the 14 day period. You better appeal and try to get a stay, otherwise it's going to be moot in most instances. Taking into account your observations, are the courts as a practical matter really being asked to waive the 14 day stay as much in confirmation of a chapter 11 plan as contrasted to the 363 sales which tend to be-- there be a waiver of the 14 days the purchases as I'm walking, otherwise if you don't get the state waiver? You have any sense-- I know there were fewer confirmations of plans than 363 sales. But is your sense that regularly in confirmation that there's the waiver?

MARTIN BIENENSTOCK: Definitely

ANA ALFONSO: It was waived three weeks ago in Fieldwood. Now, I don't know their reason for that-- it was a comprehensive restructuring that also added a tack-on acquisition. And so the desire to complete the acquisition was driving the desire for a waiver, but it was granted without protest. Now, that was largely a consensual prepackaged plan.

JOSEPH SAMET: In a Bankruptcy Act case, you mentioned sacrificial lambs. I was a sacrificial lamb as a fourth year associate or something like that where my opposition was the giant Harvey Miller. And the debtor wanted to confirm the plan. And we said, no, no, you can confirm the plan but we want to stay pending appeal in order to block the distributions, et cetera. And obviously Harvey was very much opposed to that. And I said, judge, but there really is a case. And somebody said, what is it? And based on-- I hadn't thought about this in 30 years. But there's a case out of Second Circuit, I believe, called Roberts Farms.

MARTIN BIENENSTOCK: Yes-- oh no, that's Ninth Circuit.

JOSEPH SAMET: Is it Ninth Circuit? OK. And so there's a case out there on the subject of mootness, and I think we were trying to rely on Roberts Farms to say that-- and in fact, give us a stay or it's really not going to be moot. And in any event, the confirmation order got signed about two minutes later. But that was--

ANA ALFONSO: Nice try.

MARTIN BIENENSTOCK: OK, so-- yes?

AUDIENCE: --release a motion on relatively small matters, small collateral. And I asked that the 14 day stay on the stay relief function of 4001 be waived, and routinely the judges denied it. Very small collateral, very small issue, nobody's opposing. One judge even told me, your hair has to be on fire before I'll grant that.

MARTIN BIENENSTOCK: Well, good. You've given me some hope. Two issues I guess we have in 13 minutes, and I'm glad we have the extra time. In the two latest examples of equitable mootness, one is the city of Detroit where after highly public and difficult chapter 9 case, deals were cut with most of the creditor groups. They didn't like the deals, but they cut them. And some of the retirees appealed conformation on the ground-- they had a lot of grounds. But basically there they were getting only a 4 and 1/2 percent discount on their retiree claims, but they didn't think it was fair and they appealed. And the Sixth Circuit had no problem saying, do you really think with all of this money dispersed and these deals cut that we're going to reverse confirmation for this? They said, sorry, it'd just be too inequitable.

On the other side, in the GM case we remember GM started with a sale free and clear of claims. And that has now become embroiled in massive litigation that I'm sure you've read about to one extent or another. Because once it became clear that GM concealed the ignition switch defect, all of the injured parties are saying, well, it couldn't have been free and clear of that. You hid it from us. We couldn't file claims. And the bankruptcy judge initially said, well, I see nothing wrong with my order approving the sale free and clear including of your claims. And besides it would be equitably moot. Well, the Second Circuit put its foot down. And aside from reversing on due process grounds, it said, wait a minute, equitable mootness has never applied to a sale before. It's only been applied to confirmation and we're not expanding the doctrine here. That's one for the good guys.

So now in the last 10 minutes, here is the topic. Given what we've just said about equitable mootness, so if you're the plan proponent's lawyer, or if you're the objector's lawyer, what can you do to prevent it other than asking the bankruptcy judge not to waive the stay and being prepared to prosecute the appeal quickly? And as a practice tip, if you're going to appeal confirmation and you're running against the clock, you don't file the notice of appeal and then ask the appellate-- the district judge for an extension to file your brief. You show up with your brief like you mean business and you want an expedited appeal. Because otherwise you're not taken seriously.

So what might you do to avoid this equitable mootness theory? So here's an idea based on-- well, it's based on a lot of stuff, but it ties into a decision in the last year in the District of Delaware. In most chapter 11 cases, as you know, at the end of the plan after treatment of all the classes of claims and stuff like that there are like three paragraphs normally. The debtor releases claims against creditors, the debtors, and officers, and members of the statutory committees are exonerated from claims of third parties, and then there's a third paragraph which is the most avant garde but still sort of irregular where the actors in the case-- the creditors, the professionals, everyone else-- gets released by all creditors and shareholders. We call these third party releases.

And the circuits differ as to how difficult it is to get these third party releases. If pressed I would argue they're unconstitutional on the simple ground that the Supreme Court has said that if you want to give a debtor a discharge there has to be a commensurate distribution of that debtor's assets to its creditors in a fair manner. And these third party releases are almost never accompanied by distributions of the third party's assets. In fairness, they're usually releases against nuisance claims. It's very rare that a real claim is being released. But it's the specter of someone will be sued for breach of duty, or negligence, or something like that, and you just want to wipe the slate clean and eliminate that type of litigation.

So everyone would agree that a tort claim of one non-debtor third party against another, so a tort claim of a shareholder or creditor against a debtor's director or officer requires adjudication by an Article III judge. No one disputes that. But nevertheless, the release of one non-debtor's claims against other non-debtors is routinely ordered by the non-Article III bankruptcy judge. And it always seemed to me was-- let me get this straight. If you're going to have this tort claim litigated with due process and fairness, you need an Article III judge. But if you eliminate due process and fairness, then you can have a non-Article III judge just wave a wand and say your claim is zero. You can never prosecute it. And never made sense to me why that could be the law.

So in the Millennium case in the District of Delaware, a district judge made exactly that argument. Said, how can it be that you don't need an Article III judge to release claims between two non-debtor third parties? And he remanded the case to the bankruptcy judge who wrote a 50 or 60 page decision saying, sorry district judge, you're wrong. I'm non-Article III, I can do it. And oh and by the way, even if you disagree these parties conduct waived that objection so you shouldn't hear it in the first place when it goes back up on appeal.

So I'm raising this really for two reasons. First, in confirmation there is an argument that for these third party releases there's a need for an Article III judge. You will not be popular with the judge or the other parties when you raise that. Bankruptcy judges, you can tell from the way they write their decisions on Article III they don't like to be told they don't have the power to do this. But I think the better analysis is they don't. At least, if parties are objecting they don't. If parties don't object, maybe that's implicit consent.

But second, if a plan includes that type of release you can say to the district court, I don't really need a stay because this order by a non-Article III judge confirming the plan really can't be issued by a non-Article III judge. So it's not a real order. It's not a constitutional order till you approve it, and I have the reasons here why you shouldn't. Apparently the argument must have been made in this Millennium case and they got somewhere with it. And I think it would work outside of that on Article III issues.

Now, in that context there's a lot of old-- by old I mean, you know, 1940, 1950 Supreme Court decisions-- to the effect that constitutional issues need to be determined by Article III judges. So another argument that can be made-- I've never seen it made, and I confess I haven't made it yet-- is that if there's a cram down fight and the creditor is fighting about the value of its collateral, which is a Fifth Amendment claim, you can say that requires an Article III judge.

Now, I think some judges would scoff at the notion and laugh at it because they've been doing it for so long. It's a conventional duty of bankruptcy judges to value collateral. But when it comes to applying that to constitutional rights in an adversarial or contested cram down, there's an argument on the books that you could say you need an Article III judge for that. I don't think it's frivolous by any means. It might even be meritorious.

JOSEPH SAMET: Martin, I want to say a couple of things about releases. I know there are some controversies over that. But we also have to look to section 524(e) having to do with discharge of claims, and under 1141, I believe. But if, for instance, if the state is giving a release to professionals in the case, it seems to me that everybody's had the opportunity to look at what the professionals have done-- fee applications, objection time, and the like. And if they're getting releases in the case, then that seems OK to me.

With regard to indenture trustees, same thing. If they've been involved in the, case if the claims under the indenture have been dealt with under the plan, et cetera, and anybody wants to assert a claim against the indentured trustee, let them do it during the course of a very significantly protracted chapter 11 case. The plan funder who puts money in is putting something in there of significance, is looking for release. And people should understand what's gone on up to that point, have had an opportunity to object conformation, et cetera, to the nature of the funding. If creditor's committee members want a release then people know about what they've done.

And even the officers and directors there's a disclosure statement. And often there's the opportunity of claims to be asserted against officers and directors, and what the assets are of the estate including such claims. And if that hasn't been done by confirmation, absent transfer of the claims to the claims administrator, claims trustee, then it seems to me those claims are gone. And if somebody wants to object and say there are real claims against former officers and directors, let them say it prior to confirmation of the plan. I know there may be other parties that fall outside of the grouping that I've just mentioned, but at least I think that's an argument why some releases are appropriate, that there is sometimes adequate consideration or opportunities for investigation.

MARTIN BIENENSTOCK: Yeah, and what bankruptcy judges can do which has almost the same effect as the release is they can channel all claims into their court which has a sobering effect on people who want to bring those claims.

AUDIENCE: Can I ask a couple questions? It ties into what Joe was saying about the disclosure statement in the plan. I mean, I would think that before that release language appears the confirmation order it would appear in the closure statement so as Joe said, parties are on notice of that. Then I just wonder if this release language really has its origination to a certain extent from those tort cases like AH Robins, and Johns Mansville, and then the Drexel case where you had a plan funder maybe not through a sale, but through a contribution in order to get rid of tort clains and a channeling injuction through bankruptcy court so that it could get that third party released, but at least there was consideration for it.

JOSEPH SAMET: For those on the web and for those who will see in the future, we're talking about AH Robins going back to the '80s, as well as Mansville and other cases that have dealt with some claims.

ANA ALFONSO: You know, in the real world in most of these cases, if somebody thinks they have a cause of action or there ought to be an investigation about causes of action against directors, officers, and so on, it gets screamed high and widely, and something is done to commence an investigation and so on. And so a lot of these things wind up sorting themselves out as part of what is on the table when you're negotiating at the end of the case.

So I think what we're really focused on here are those things that are essentially unknown or unknowable that somebody could theoretically assert against a party whose cooperation is considered vital to getting the plan confirmed. And for that reason whatever constitutional argument you want to make, I think it's essential that a bankruptcy judge who can see and has lived through the reality of the different players in the game and what their motivations might be, they need to be able to bring closure to it. Otherwise the system just doesn't work.

JOSEPH SAMET: We're going to take one more question. Yes?

AUDIENCE: Are you talking about claims against directors for matters that they did in the bankruptcy or outside of the bankruptcy? Because if you're talking about outside the bankruptcy, very often those claims are asserted by people who don't participate in the bankruptcy. So you're requiring people who otherwise wouldn't hire lawyers, don't have any expectation of recovering anything from the bankruptcy, to release claims that they may be pursuing outside of the bankruptcy, because otherwise they're subordinated in the bankruptcy, or they have no reason to believe they're going to collect from the company.

JOSEPH SAMET: The question relates to potential claims against officers and directors that might sounds to be direct claims against the officers and directors of those individual creditors or party shareholders might have against those third parties. And are those going to be released? One thought is number one, are some of the claims out there-- and I'm not suggesting yours are-- are they really estate claims? Because sometimes and often, the claims are out there against officers and directors are claims of the debtor and debtor in possession that under applicable law pass to the debtor. They may have been pre-bankruptcy claims by shareholders, but they pass to the debtor as derivative claims. And those are corporate claims. And those will be dealt with generally in connection with the chapter 11 cases.

If there is a direct claim by creditors that can be separated out as direct claims, then those may be third party claims against the officers and directors that potentially could survive, I would think. And then you have the question of the scope of whatever remaining insurance may be there to cover those kinds of claims.

ANA ALFONSO: Most courts are going to make you put some limiting factors around the scope of the release. It's not going to encapsulate things that truly are not within the province of the court and the case in general.

JOSEPH SAMET: We thank you very much for being here for the last two days, asking lots of questions and finding some answers for this or at least given you some more fuel for thought. I'd like to thank the audience for being so attentive and involved in this. And for those of you on the web, if you have any final questions, you're welcome to send it in to PLI and somebody will get back to you as long as those hypothetical questions don't involve us in any personal capacity, or as counsel or advisor to any of the parties and interests. So thanks very much and enjoy the rest of the day and the week. Thank you.

ANA ALFONSO: Thank you.

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