Bankruptcy Court Protects Rights of Customers Not Parties to Settlement Negotiation

By: Zach T. Benaharon

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff Member

           Under Federal Rule of Bankruptcy Procedure 9019, a bankruptcy court may approve a settlement involving a debtor so long as the settlement is fair and equitable.[1]  In In re Miami Metals I, Inc., a New York bankruptcy court held that a settlement could not be approved because it adversely affected rights of non-parties thereto.[2] On November 2, 2018 (the “Petition Date”), Miami Metals I, Inc. filed a voluntary petition for relief under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).[3]  The Official Committee of Unsecured Creditors, which consisted of seven customers of Miami Metals I, Inc., (the “Committee”) investigated the Senior Lenders’ prepetition liens, claims, and conduct shortly after its appointment, and identified “potentially colorable claims to challenge the validity, extent, perfection and/or enforceability of certain of the Senior Lenders' liens and claims” (the “Potential Challenges”).[4]  Ultimately, the Committee and Senior Lenders agreed on terms of the Settlement, which required entry into a plan support agreement (“PSA”).[5]

           Thereafter, Debtors, the Committee, and Senior Lenders requested bankruptcy court approval of the Settlement under Bankruptcy Rule 9019.[6]  The Customers, who were creditors not on the Committee and therefore not signatories to the PSA, were not involved in the negotiations with the Debtors in formulating the Settlement or PSA, and subsequently objected to the Motions to confirm the Settlement and PSA.[7]  The Customers claimed any metals delivered to Debtors for refining remained property of the Customers until the refined metals were sold to a third party or paid for by the Debtors, and disputed the Debtors’ contention that the delivered metals became property of the estate .[8]

           A bankruptcy court’s authority to approve a settlement agreement is set forth in Rule 9019 of the Federal Rules of Bankruptcy Procedure.[9] In Protective Committee for Independent Stockholders of TMT Trailer Ferry, Inc. v. Anderson, the United States Supreme Court reasoned that it is the court’s job to apprise itself of “all facts necessary for an intelligent and objective opinion of the probabilities of ultimate success should the claim be litigated,” and to “make an informed and independent judgment as to whether a proposed compromise is “fair and equitable.”[10]  The Second Circuit has also articulated certain factors that must be considered in analyzing the fairness and equitability of a proposed settlement including[11]: (1) the balance between the litigation's possibility of success and the settlement's future benefits; (2) the likelihood of complex and protracted litigation, “with its attendant expense, inconvenience, and delay,” including the difficulty in collecting on the judgment; (3) “the paramount interests of the creditors,” including each affected class's relative benefits “and the degree to which creditors either do not object to or affirmatively support the proposed settlement”; (4) whether the parties in interest support the proposed settlement; (5) the “competency and experience of counsel” supporting, and “[t]he experience and knowledge of the bankruptcy court judge” reviewing the settlement; (6) “the nature and breadth of releases to be obtained by officers and directors”; and (7) “the extent to which the settlement is the product of arm's length bargaining.”[12]  Furthermore, the Second Circuit has instructed that notwithstanding the foregoing factors, “when the rights of non-settling parties are implicated by the terms of a settlement, the court cannot approve it without considering the interests of those non-settling parties.”[13]

           The In re Miami court denied the motion to approve the PSA because of: (i) the potential prejudice to the Customers' rights, and (ii) the timing of the benefits under the Settlement.[14]

           First, the PSA was premised on a plan (“Plan”) that would create a reserve of all proceeds generated by the sale of precious-metal inventory other than undisputed collateral (“Ownership Reserve”) and that would satisfy Customer ownership claims through such Ownership Reserve.[15] However, the ownership disputes were “complex and interrelated . . . and very few of them ha[d] been resolved ….”[16]  Although the Ownership Reserve earmarked monies to distribute to Customers as ownership disputes were resolved, the Plan’s Ownership Reserve “by its very nature” imposed a cap on the recovery of Customers – a cap that could have been inadequate if the Customers prevailed on their ownership claims of the precious metals.[17]

           Second, the court was concerned about the timing of the benefits under the Settlement because certain features automatically triggered, whereas others would have only been triggered if the Plan was confirmed.[18] Effectively, the Settlement ensured that Senior Lenders would reap the full benefit of the Settlement on the Settlement Effective Date, regardless of whether the plan was confirmed, while the Customers’ benefits were contingent on the Plan becoming effective.[19]  Accordingly, the court rejected the Settlement and Plan because neither would be fair and equitable under Rule 9019.

           In re Miami Metals I, Inc. illustrates the standards a bankruptcy court should use when deciding whether a settlement or plan is fair and equitable with regard to third parties.  With guidance from the Supreme Court and Second Circuit, the court made it clear that bankruptcy courts must look beyond the rights of the parties bound by a settlement and consider the rights and complaints of adversely affected third parties.