Opinion ID: 796969
Heading Depth: 2
Heading Rank: 3

Heading: The Fair and Equitable Standard

Text: 23 Motorola does not contend that the Settlement fails under this multi-factor test. Rather, it argues that the Settlement should not have been approved because it provides for the transfer of money from the Estate to the ILLLC, and from the ILLLC to the unsecured creditors after the Motorola-related litigation. Motorola claims that a settlement can never be fair and equitable if junior creditors' claims are satisfied before those of more senior creditors. 24 The phrase fair and equitable derives from Section 1129(b)(2)(B)(ii) of the Bankruptcy Code, which describes the conditions under which a plan of reorganization may be approved notwithstanding the objections of an impaired class of creditors, 16 a situation known as a cramdown. See Coltex Loop Cent. Three Partners v. BT/SAP Pool C Assocs. (In re Coltex Loop Cent. Three Partners, L.P.), 138 F.3d 39, 42 (2d Cir.1998); see also Kenneth N. Klee, All You Ever Wanted to Know About the Cram Down Rule Under the New Bankruptcy Code, 53 AM. BANKR. L.J. 133 (1979). This provision codifies the judge-made absolute priority rule, which provided that any plan of reorganization in which stockholders [a]re preferred before the creditor, [is] invalid. In re Armstrong World Indus., Inc., 320 B.R. 523, 533 (D.Del.), aff'd 432 F.3d 507 (3d Cir. 2005) (quoting N. Pac. Ry. v. Boyd, 228 U.S. 482, 504, 33 S.Ct. 554, 57 L.Ed. 931 (1913) (second alteration in original)). 17 In its current statutory form, the rule provides that the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property. 11 U.S.C. § 1129(b)(2)(B)(ii). 25 Although the statute by its terms applies only to plans of reorganization, the Supreme Court has held that a settlement presented for approval as part of a plan of reorganization, because it constitutes part of the plan, may only be approved if it, too, is fair and equitable in the sense of conforming to the absolute priority rule. See TMT Trailer Ferry, 390 U.S. at 424, 88 S.Ct. 1157 (The requirements . . . that plans of reorganization be both `fair and equitable,' apply to compromises just as to other aspects of reorganizations.). When a settlement is presented for court approval apart from a reorganization plan, however, the priority rule of 11 U.S.C. § 1129 is not necessarily implicated. Without the requirement that pre-plan settlements conform to the absolute priority rule, only the bankruptcy court's invocation of Rule 9019 factors would protect the interests of any nonsignatory intermediate or impaired creditors. 18 26 In response to this concern, the Fifth Circuit held that the absolute priority rule should also apply to pre-plan settlements, concluding that a bankruptcy court abuses its discretion in approving a [pre-plan] settlement with a junior creditor unless the court concludes that priority of payment will be respected as to objecting senior creditors. United States v. AWECO, Inc. (In re AWECO, Inc.), 725 F.2d 293, 298 (5th Cir.1984). The pre-plan settlement in AWECO sought to resolve litigation involving the debtor and a junior unsecured creditor. Id. The district court approved the settlement without considering proof from the senior secured creditors that the costs of the settlement could seriously deplete the estate and jeopardize the priority position of the senior creditors. The junior creditor argued that priority creditors' claims are often unresolved when settlements with individual creditors occur well in advance of approval of a reorganization plan. Thus it pressed that requiring conformity with the absolute priority rule would effectively preclude all settlements prior to a plan of reorganization. The Fifth Circuit rejected that argument and held that extension of the absolute priority rule to pre-plan settlements was necessary. 27 As soon as a debtor files a petition for relief, fair and equitable settlement of creditors' claims becomes a goal of the proceedings. The goal does not suddenly appear during the process of approving a plan of compromise. Moreover, if the standard had no application before confirmation of a reorganization plan, then bankruptcy courts would have the discretion to favor junior classes of creditors so long as the approval of the settlement came before the plan. Regardless of when the compromise is approved, looking only to the fairness of the settlement as between the debtor and the settling claimant contravenes a basic notion of fairness. An estate might be wholly depleted in settlement of junior claims—depriving senior creditors of full payment—and still be fair as between the debtor and the settling creditor. 28 Id. at 298. The Fifth Circuit accurately captures the potential problem a pre-plan settlement can present for the rule of priority, but, in our view, employs too rigid a test. 29 The Settlement here differs significantly from the facts in play in AWECO, and points out the shortcomings of the AWECO rule. The Settlement resolves claims of one group of senior creditors while at the same time compromising their preferred position by providing that they be paid only a portion of any monies received from the Motorola litigation. The Settlement also funds pursuit of the Estate's most significant asset—the Motorola claims. Lastly, many important facts are still in dispute. Motorola's claim as an administrative creditor is yet to be established, the costs of the litigation (and any balance remaining in the litigation fund at the close of the proceedings) are at best estimates, and the claims against Motorola are perhaps years from a sum certain judgment. It is difficult to employ the rule of priorities in the approval of a settlement in a case such as this when the nature and extent of the Estate and the claims against it are not yet fully resolved. In our view, a rigid per se rule cannot accommodate the dynamic status of some pre-plan bankruptcy settlements. 30 Rejection of a per se rule has an unfortunate side effect, however: a heightened risk that the parties to a settlement may engage in improper collusion. Thus, whether a particular settlement's distribution scheme complies with the Code's priority scheme must be the most important factor for the bankruptcy court to consider when determining whether a settlement is fair and equitable under Rule 9019. The court must be certain that parties to a settlement have not employed a settlement as a means to avoid the priority strictures of the Bankruptcy Code. 31 In the Chapter 11 context, whether a settlement's distribution plan complies with the Bankruptcy Code's priority scheme will often be the dispositive factor. However, where the remaining 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 if the parties to the settlement justify, and the reviewing court clearly articulates the reasons for approving, a settlement that deviates from the priority rule. 32