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Andrews Kurth: " 'Motorola': Absolute Priority Rule, FRBP 9019 Settlements" Press RoomHeadline NewsArticles / PublicationsClient AlertsMedia Contact / Downloads Articles Search Keyword / Topic Author Publication Date (mm/dd/yyyy) between and Practice PracticeAppellateBanking/FinanceBankruptcy/RestructuringCorporate Compliance, Investigations and DefenseCorporate/SecuritiesEnergyEnvironmentalExecutive Compensation/Employee BenefitsHealth CareLitigationProject FinancePublic LawReal EstateSecuritizationTax Industry IndustryArt and Cultural PropertyBanking/FinanceEnergyEnergy RegulationEnergy TransactionsHealth CareReal EstateREITsRestaurantTechnology Articles/Publications Print HTML Print PDF Get Adobe Acrobat " 'Motorola': Absolute Priority Rule, FRBP 9019 Settlements" Peter S. GoodmanNew York Law JournalJune 18, 2007In the recent case of Motorola, Inc. v. Official Committee of Unsecured Creditors,the U.S. Court of Appeals for the Second Circuit addressed and soughtto clarify a bankruptcy court's duties when exercising its discretionpursuant to Rule 9019 of the Federal Rules of Bankruptcy Procedure(FRBP) (Rule 9019) to approve a settlement that binds all creditors,shareholders and other parties in interest.[1] Standard of 'TMT Trailer Ferry'AlthoughRule 9019 does not enumerate any particular standards a court mustfollow in approving the propriety of a settlement, courts routinelyborrow, with minor variation, the standard articulated by the SupremeCourt in TMT Trailer Ferry,[2] wherein the Court held that an"informed and independent judgment as to whether a proposed compromiseis fair and equitable" requires that: the bankruptcyjudge has apprised himself of all facts necessary for an intelligentand objective opinion of the probabilities of ultimate success shouldthe compromised claim be litigated. Further, the judge should form aneducated estimate of the complexity, expense, and likely duration ofsuch litigation, the possible difficulties of collecting on anyjudgment which might be obtained, and all other factors relevant to afull and fair assessment of the wisdom of the proposed compromise.Basic to this process in every instance, of course, is the need tocompare the terms of the compromise with the likely rewards oflitigation.[3]Debtors have used the power and authority ofRule 9019 in numerous ways including the settlement of adversaryproceedings, claim objections and disputes concerning the priority andclassifications of claims.[4] In a number of prominent bankruptcycases, Rule 9019 settlements were used to form the basis of a planprior to the plan confirmation process.[5] For the most part,objections to settlements that bind creditors to a type ofclassification, claim or plan have been largely unsuccessful. Most notably, in Drexel, Adelphia and WorldCom,the bankruptcy court in each case approved settlements over objectingcreditors' concerns that the proposed settlements were in effect a subrosa plan meant to bind parties in interest to a type of plan,classification scheme or claim. [6] For example, in Adelphia,the debtors moved the court for an order approving three relatedagreements which taken together formed a four-way settlement betweenthe debtors and the U.S. Department of Justice, the Securities andExchange Commission and members of John Rigas' (Adelphia's founder)family. The Creditors' Committee, the Ad Hoc Committee of SeniorPreferred Shareholders and others argued, among other things, that thesettlement violated the absolute priority rule. In Adelphia (as in Drexel)the estate's assets were effectively partitioned in the settlementbetween the estate and government's claims asserted on behalf ofinjured investors. In Adelphia, the objecting partiesargued that В§510(b) of the Bankruptcy Code would result in thesubordination of investor-SEC claims to creditors' claims on the theorythat a shareholder who shares in profits and losses should not attain ahigher priority status vis-Г -vis creditors who were seeking return ofprincipal plus interest.[7] Both the Bankruptcy Court and the DistrictCourt denied the objections to the settlement, noting that since thegovernment had the right to indict Adelphia, thus putting Adelphiaeffectively out of business, it was in the best interest of the estateand its creditors to approve the settlement despite any technicalviolations of the absolute priority rule.[8] On appeal, theSecond Circuit did not address the absolute priority rule, instead,surprisingly, finding that the case was moot following theimplementation of the settlement by the parties.[9] Accordingly,violations of the priority and classification schemes of the BankruptcyCode did not appear to be a fundamental consideration in the court'sRule 9019 approval standard. The 'Motorola' CaseRecently,however, the Second Circuit seems to have had second thoughts onwhether to include adherence to the absolute priority rule as a prongof the Rule 9019 settlement standard. In the bankruptcy case of Iridium Operating LLC,Motorola Inc. claimed that its potential administrative claim againstthe debtor was effectively subordinated to claims of unsecuredcreditors in contravention of the absolute priority rule of theBankruptcy Code and therefore should not be approved.[10] The Official Committee of Unsecured Creditors ("Committee") in Iridiumchallenged the validity of liens asserted by certain lenders (Lenders)purporting to include all of Iridium's property including its cash andvarious causes of action. The Iridium court had authorized thecommittee to commence an adversary proceeding against the lenders onbehalf of Iridium's estate. The committee was also authorized by thecourt to pursue causes of action including breach of contract, breachof fiduciary duty, as well as avoidance actions against Motorola,Iridium's former corporate parent. However, due toinsufficient resources to fight these two wars simultaneously, thecommittee negotiated a settlement with the lenders whereby the lenders'liens were recognized as valid and the estate's cash was dividedbetween the lenders and the estate, with a portion of the estate's cashbeing directed to a litigation fund (fund) which was created to pursuelitigation against Motorola. The fund was nearly entirely for thebenefit of Iridium's unsecured creditors and any recoveries from thelitigation against Motorola would be distributed, in part to thelenders, with the bulk going to the estate to be distributed pursuantto a future plan.[11] The bankruptcy court approved the settlement overMotorola's objection and the district court affirmed. Onappeal to the Second Circuit, Motorola did not attack the settlement onthe grounds that it did not satisfy the factors set forth in TMT Trailer Ferry andits progeny, but that a settlement cannot be fair and equitable where,as here, there is the potential for the claims of junior creditors tobe satisfied before more senior claimants.[12] Citing precedent from the U.S. Court of Appeals for the Fifth Circuit in United States v. AWECO, Inc.,[13]the Second Circuit held that "whether a settlement's distribution plancomplies with the Bankruptcy Code's priority scheme will often be thedispositive factor [in approving the settlement]."[14] TheSecond Circuit did not, however, hold that a pre-plan settlement mustalways follow the absolute priority rule, noting that such a per serule, as employed by the Fifth Circuit in AWECO, does not "accommodate the dynamic status of some pre-plan bankruptcy settlements."[15] Flexibility Called NecessaryThe Second Circuit pointed to the uncertainties that existed in Iridiumas a prime example as to why flexibility in this rule is necessary:Motorola's administrative claim was not yet established, litigationcosts and remaining balance in the fund were "at best estimates" andclaims against Motorola would not likely be resolved for years.[16] Inthat uncertain environment, requiring a pre-plan settlement to strictlyadhere to the absolute priority rule may be impossible andunnecessarily preclude a settlement that may truly be in the bestinterests of the estate. Instead, "where the remaining [Rule 9019] factors weigh heavily in favor of approving a settlement, the bankruptcy court, in its discretion, could endorse a settlement that does not comply in some minor respects with the priority rule ifthe parties to the settlement justify, and the reviewing court clearlyarticulates the reasons for approving, a settlement that deviates fromthe priority rule."[17] Because the record below did not contain anarticulation of the reasons to violate the absolute priority rule, theSecond Circuit remanded the matter for further findings. ConclusionItis not clear that the Second Circuit's directive that settlementproponents must justify, and courts must articulate a reason for,deviating from the priority scheme is a new standard or that it willultimately have had any impact on the Iridium case, or would have had an impact on prior decisions for that matter. In Adelphia,for example, the bankruptcy court's reasoning that, despite itstechnical violation of the absolute priority scheme, failure to approvethe settlement would sink the company and its creditors may be thatcarefully articulated reason that the Second Circuit was looking for inMotorola. Peter S. Goodman is a partner at Andrews Kurth, where he specializes in complex reorganization proceedings and out-of-court restructurings. Christopher Lynch, an associate at the firm, assisted in the preparation of this article.Endnotes:1. See Motorola, Inc. v. Official Cmte. of Unsecured Creditors (In re Iridium Operating LLC), 478 F3d 452 (2d Cir. 2007). 2. Protective Comm. for Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390 US 414 (1968). 3. Id. at 424-25. 4. See, e.g., Prin Corp. v. Altman (In re Altman), 265 B.R. 652 (Bankr. D. Conn. 2001); In re Bennett Funding Group, Inc., 1999 Bankr. LEXIS 1860 (Bankr. N.D.N.Y. April 9, 1999). 5. See, e.g., In re Adelphia Communications Corp., 327 B.R. 175 (Bankr. S.D.N.Y. 2005), affirmed by Ad Hoc Adelphia Trade Claims Committee v. Adelphia Communications Corp., 337 B.R. 475 (S.D.N.Y. 2006); In re WorldCom Inc., Case No. 02-13533 Docket #8125 (Bankr. S.D.N.Y. Aug. 6, 2003); see also In re Drexel Burnham Lambert Group, Inc., 995 F.2d 1138 (2d Cir. 1993); Lambert Brussels Assocs. Ltd. Partnership v. The Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 140 B.R. 347 (S.D.N.Y. 1992); In re Drexel Burnham Lambert Group, Inc., 138 B.R. 723 (Bankr. S.D.N.Y. 1992). 6. See, e.g., Pension Benefit Guaranty Corp. v. Braniff Airways, Inc. (In re Braniff Airways, Inc.), 700 F.2d 935 (5th Cir. 1983). 7. See 11 USCA В§510(b) (West 2007); Adelphia, 327 B.R. at 168; see also In re Enron Corp., 341B.R. 141 (Bankr. S.D.N.Y. 2006); John J. Slain and Homer Kripke, "TheInterface Between Securities Regulation and Bankruptcy - Allocating theRisk of Illegal Securities Issuance Between Securityholders and theIssuer's Creditors," 48 N.Y.U.L. Rev. 261 (1973); see also H.R. Rep.No. 95-595, at 194-96 (1977) (noting Congress' adoption of the Slain/Kripke position and the rejection of that espoused by the SEC). 8. Adelphia,327 B.R. at 168-70 (discussing these objections and noting as part ofthe court's reasoning that the equity holders and defrauded noteholderswould be sharing in a fund created and owned by the government, and notassets of the estate under a plan). 9. Ad Hoc Adelphia Trade Claims Cmte v. Adelphia Comm. Corp., 2006 WL3826700 (2d Cir. Dec. 26, 2006). 10. Motorola, Inc. v. Official Committee of Unsecured Creditors (In re Iridium Operating LLC), 478 F3d 452 (2d Cir. 2007). 11. Motorola, 478 F3d at 459 12. Id. at 462. 13. United States v. AWECO, Inc. (In re AWECO, Inc.), 725 F2d 293 (5th Cir. 1984); see also Motorola, 478 F3d at 464 (interpreting AWECO asrequiring strict compliance with absolute priority rule in 9019settlements in the U.S. Court of Appeals for the Fifth Circuit). 14. Motorola, 478 F3d at 464. 15. Id. 16. Id. 17. Id. at 464-65 (emphasis added). Associated Lawyers Peter S. Goodman © 2008 Andrews Kurth | Search | Disclaimer | Quick Contact | Site Map | Site Powered by Firmseek Our Offices: Austin - Beijing - Dallas - Houston - London - Los Angeles - New York - The Woodlands - Washington, DC Unless otherwise indicated, attorneys listed on this Web site are not certified by the Texas Board of Legal Specialization. Prior results do not guarantee a similar outcome and depend on the facts of each matter. Attorney Advertising.Andrews Kurth is responsible for the content of this web site. 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