Court Opinion

ID: 7905
Source: CourtListenerOpinion
Date Created: 2010-04-25 05:32:33+00
Date Added: 2024-06-11T16:46:18.828593
License: Public Domain

United States Court of Appeals,

                         Fifth Circuit.

                          No. 95-10147.

    In the Matter of FOSTER MORTGAGE CORPORATION, a Louisiana
Corporation, Debtor.

 CONNECTICUT GENERAL LIFE INSURANCE COMPANY, et al., Appellants,

                               v.

   UNITED COMPANIES FINANCIAL CORPORATION and Foster Mortgage
Corporation, Appellees.

                          Nov. 9, 1995.

Appeal from the United States District Court for the Northern
District of Texas.

Before REYNALDO G. GARZA, BARKSDALE and EMILIO M. GARZA, Circuit
Judges.

     REYNALDO G. GARZA, Circuit Judge:

     In this opinion, we consider the propriety of a compromise

settlement agreement between a debtor company Foster Mortgage

(Foster) and its parent corporation United Companies (United) in

Chapter 11 bankruptcy. Connecticut General Life Insurance Company,

representing unsecured creditors (the Noteholders) holding 95% of

Foster's indebtedness, opposed the settlement agreement.1   For the

reasons stated below, we vacate the settlement and remand for

further proceedings.

     1
      Foster had already paid its secured creditors by the time
of litigation. The unsecured creditors, now appellants in this
Court, were Connecticut General Life Insurance Co. on behalf of
itself and also on behalf of particular accounts, Cigna Property
and Casualty Insurance Co., Life Insurance Co. of North America,
Insurance Co. of North America, Cigna Mezzanine Partners, the
Franklin Life Insurance Co., Royal Maccabees Life Insurance Co.,
Southern Farm Bureau Life Insurance Co., and the Union Life
Insurance Co.

                                1
                                 Background

      Foster is a Louisiana corporation that engaged in the mortgage

servicing business from headquarters in Fort Worth, Texas from 1990

until 1993 as a wholly owned subsidiary of United.               On December 31,

1992, the audited financial statement of Foster showed assets of

$111.7 million against liabilities of $89 million, for a positive

net   worth   of    $22.7    million.       Among     those     liabilities    was

approximately      $67.4    million   of    unsecured    notes     owed   to   the

Noteholders     who    had     helped       finance     Foster's       formation.

Unfortunately for the Noteholders, Foster's business precipitously

declined such that on May 28, 1993, at the request of United, the

plaintiffs restructured their notes by converting a portion of the

debt to preferred stock to assist Foster in maintaining a positive

net worth. Foster's fortunes did not improve, and in September and

November of 1993 it sold off its mortgage servicing portfolios,

thereby creating approximately $70-80 million of net operating

losses.

      In   December,   1993,    the   Noteholders       filed    an   involuntary

Chapter 11 petition against Foster.           At that time, Foster owed the

Noteholders $47.8 million.            The Bankruptcy Court granted the

petition on February 10, 1994.          The Noteholders moved to terminate

the debtor's exclusive period to propose a plan on May 23, 1994, so

that they could propose their own plan.          This plan included a claim

for tax loss payments owed to the debtor by the parent company

United.    Foster and United had operated under an agreement to file

consolidated tax returns as of January 1, 1990.               As a result of the

                                        2
tax agreement United was required to compensate Foster for a

portion of the net operating losses.        United would use the losses

to offset income from the entire group of companies it owned.

     On June 9, 1994, the Bankruptcy Court granted the Noteholders'

motion to terminate.      That very same day, the debtor filed its plan

of reorganization.        The debtor's plan was constructed around a

proposed     settlement   between   the   parent     company   and   Foster,

releasing all claims against the parent company including but not

limited to the claims of the debtor under the intercompany tax

agreement. The proposed settlement consideration was $1.1 million.

     Foster and United made a joint motion for approval of their

settlement agreement on June 29, 1994, to which the Noteholders

filed objections.      The Noteholders meanwhile offered their Chapter

11 plan a day later on June 30, 1994.               This plan proposed to

preserve the debtor's tax loss claims against the parent company.

The Bankruptcy Court held hearings on the compromise settlement

from August 16-18, 1994. The court denied approval of the original

$1.1 million settlement but subsequently gave its blessing to a

modified settlement for $1.65 million on September 8, 1994.               The

district court affirmed the bankruptcy court approval and this

appeal     followed.      Both   lower    courts'    approbation     of   the

parent-child agreement is the basis for the appeal now before us.

     The question at the center of this dispute is how much Foster

should have been compensated by the parent for its $70-80 million

of losses.    According to United, Foster's transfer of stock during

insolvency worked a deconsolidation for tax purposes such that

                                     3
United was no longer responsible for loss compensation after the

transfer (May 28, 1993).         The Noteholders argue that the parent

owed loss payments to the child for the entire year (in their

estimation, at least $3.5 million and as much as $28 million) and

that the bankruptcy court abused its discretion by approving the

arrangement.     The Noteholders ask us to reverse to allow them to

litigate the     issue    of   tax   loss   reimbursements.       Because    the

bankruptcy court abused its discretion by failing to show adequate

deference   to    the    interests    of    the   overwhelming    majority   of

creditors, we reverse.

                                 Discussion

A. Standard Of Review

      This Court should review the Bankruptcy Court's approval of

the compromise settlement for abuse of discretion.               In re Emerald

Oil Co., 807 F.2d 1234, 1239 (5th Cir.1987);           In re Jackson Brewing

Co., 624 F.2d 599, 602-603 (5th Cir.1980).           The Bankruptcy Court's

conclusions of law are subject to de novo review but its findings

of fact may not be set aside by the reviewing court unless "clearly

erroneous."      Sequa Corp. v. Christopher (In re Christopher), 28
F.3d 512, 514 (5th Cir.1994).          An appellate court may reverse a

fact finding of the lower court only if left with "a firm and

definite conviction that a mistake has been committed."              Sequa, 28
F.3d at 514.

B. Did The Court Abuse Its Discretion In Accepting This Settlement?

      A bankruptcy court may approve a compromise settlement of a

                                       4
debtor's claim pursuant to Bankruptcy Rule 9019(a).2             However, the

court should approve the settlement only when the settlement is

fair and equitable and in the best interest of the estate.            Jackson

Brewing Co., 624 F.2d at 602;           U.S. v. AWECO (In re AWECO), 725
F.2d 293, 298 (5th Cir.), cert. denied, 469 U.S. 880, 105 S. Ct.
244, 83 L. Ed. 2d 182 (1984).           The judge must compare the "terms of

the compromise with the likely rewards of litigation."                Jackson

Brewing, 624 F.2d   at   607    (citing   Protective    Committee   for

Independent Stockholders of TMT Trailer Ferry v. Anderson, 390 U.S.
414, 425, 88 S. Ct. 1157, 1164, 20 L. Ed. 2d 1 (1968)).

          When considering a compromise settlement, courts have applied

various factors to ensure that the settlement is fair, equitable,

and in the interest of the estate and creditors.              This circuit has

applied a three-part test.        In specific, the bankruptcy court must

consider:

(1)   the probability of success in the litigation, with                   due
      consideration for the uncertainty in fact and law,

(2) the complexity and likely duration of the litigation and any
     attendant expense, inconvenience and delay, and

(3) all other factors bearing on the wisdom of the compromise.

Jackson Brewing, 624 F.2d at 609.

          While this Circuit has not elaborated on the "other factors

bearing on the wisdom of the compromise", we do so now.              One such

      2
      Bankr.R. 9019(a), 11 U.S.C. (Supp.1995), provides: "On
motion by the trustee and after notice and a hearing, the court
may approve a compromise or settlement. Notice shall be given to
creditors, the United States trustee, the debtor, and indenture
trustees as provided in Rule 2002 and to any other entity as the
court may direct."

                                         5
factor relevant to the case sub judice is the fourth prong to the

famous test offered by the Eighth Circuit in Drexel v. Loomis:         the

paramount interest of creditors with proper deference to their

reasonable    views.3    This   Circuit   stated   in   Matter   of   Texas

Extrusion Corp., 844 F.2d 1142, 1159 (5th Cir.), cert. denied, 488
U.S. 926, 109 S. Ct. 311, 102 L. Ed. 2d 330 (1988), that "in the

bankruptcy context, the interests of the creditors not the debtors

are paramount."

         While the desires of the creditors are not binding, a court

"should carefully consider the wishes of the majority of the

creditors."     In re Transcontinental Energy Corp., 764 F.2d 1296

(9th Cir.1985).    Several courts have incorporated creditor support

for a compromise as one of the factors in deciding whether to

approve a settlement.     See, e.g., Reiss v. Hagmann, 881 F.2d 890,

892-893 (10th Cir.1989);        Nellis v. Shugrue, 165 B.R. 115, 122

(S.D.N.Y.1994);     In re MCorp Financial, Inc., 160 B.R. 941, 953

(S.D.Tex.1993).

         In Reiss v. Hagmann, the Tenth Circuit vacated a settlement

     3
      This circuit's three-part test was derived from the
four-part test first announced in Drexel v. Loomis, 35 F.2d 800,
806 (8th Cir.1929) (articulating the factors as "(a) the
probability of success in the litigation; (b) the difficulties,
if any, to be encountered in the matter of collection; (c) the
complexity of litigation involved, and the expense, inconvenience
and delay necessarily attending it; (d) the paramount interest
of creditors and a proper deference to their reasonable views in
the premises."). For discussion of the Loomis test, see Jackson
Brewing Co., 624 F.2d at 609. For application of the four-part
test, see In re Justice Oaks II, Ltd., 898 F.2d 1544, 1549 (11th
Cir.), cert. denied 498 U.S. 959, 111 S. Ct. 387, 112 L. Ed. 2d 398
(1990); In re A & C Properties, 784 F.2d 1377, 1381 (9th Cir.),
cert. denied 479 U.S. 854, 107 S. Ct. 189, 93 L. Ed. 2d 122 (1986).

                                    6
where there was only a single creditor, that creditor was able to

cover the costs of litigation and would receive nothing without

success in the lawsuit. 881 F.2d at 892-893.       Citing the First

Circuit, the court observed that, "we have found no precedent for

a compromise ... actively opposed by the major creditors and

affirmatively approved by none."          Id. (citing In re Lloyd, Carr &

Co., 617 F.2d 882, 889 (1st Cir.1980)).             This suggests that a

bankruptcy court may not ignore creditors' overwhelming opposition

to a settlement. We believe a bankruptcy court should consider the

amount of creditor support for a compromise settlement as a "factor

bearing on the wisdom of the compromise," as a way to show

deference to the reasonable views of the creditors.

       Another factor bearing on the wisdom of the compromise at

hand is the extent to which the settlement is truly the product of

arms-length bargaining, and not of fraud or collusion. Nellis, 165
B.R. at 122;    MCorp Financial, 160 B.R. at 953;        In re Present Co.,

141 B.R. 18, 21 (Bkrtcy.W.D.N.Y.1992).          When a debtor subsidiary

settles a claim it has against a parent corporation without the

participation of the creditors, a bankruptcy court should carefully

scrutinize the agreement.        In re Drexel Burnham Lambert Group,

Inc., 134 B.R. 493, 498 (S.D.N.Y.1991).

       When we look to the record and decision of the bankruptcy

court below, we are not convinced that the lower courts considered

all   factors   bearing   on   the   wisdom   of   the   compromise.   The

bankruptcy court made findings showing its consideration of the

first two factors found in Jackson Brewing.          The court found that

                                      7
"Foster or a trustee would have a limited chance of success on the

tax claims raised."       The court concluded from the evidence put on

by the parties that a full-fledged trial on the tax issues would

take approximately seven trial days, would cost between $500,000

and $700,000 and would take two to three years to reach resolution.

Finally, the bankruptcy court found that the settlement offer was

"reasonably equivalent to the value of the claims released" and was

therefore "in the best interest of the creditors of the estate."

      We do not pass on the bankruptcy court's finding on the tax

question.         Our   concern    is   that     the    courts     below    gave    no

consideration to issues we find dispositive:                      that nearly all

creditors    in    interest     opposed       this    settlement    and    that    the

settlement was reached between insiders without the participation

of   the   creditors.      In     our   estimation,      the     court    abused   its

discretion by not showing proper deference to the views of the

creditors.

      As in Reiss v. Hagmann, the Noteholders, acting as one, have

opposed    Foster's     settlement      and     are    willing    to     cover   their

litigation costs.       The Noteholders were and are prepared to bring

this tax claim that the debtor had against its parent company and

which it settled in haste as the creditors closed in.4                      They are

willing to forego the $1.65 million received by Foster in favor of

uncertain litigation to establish Foster's right to greater loss

payments.    The bankruptcy court below made no findings on creditor

      4
      The Noteholders stated on oral argument that they had
established a fund with which to finance the tax litigation.

                                          8
opposition.    We find this itself an abuse of discretion;          the judge

failed to consider what in this case was nearly unanimous creditor

opposition to the settlement between parent and child.

      The relationship between United and Foster troubles us as

well.    United acted to settle its dispute with its child company

before even determining what tax savings it had actually received

from Foster's losses.         The court below should have examined more

carefully this deal between parent and child.              The relationship

between parent and child militates in this case against allowing a

settlement for considerably less than the creditors believe they

are owed and are willing to litigate for.                 This Court is not

surprised that the creditors oppose the settlement between parent

and child, the negotiation of which they were not a part.

        The opinion of this Court does not preclude the consideration

of   future   possible   compromise     agreements   of    this   claim.      In

examining such a compromise, the bankruptcy court must consider the

"paramount    interest   of    the   creditors"   and   the   nature   of    the

negotiations as factors bearing on the wisdom of the compromise.

The court's scrutiny must be great when the settlement is between

insiders and an overwhelming majority of creditors in interest

oppose such settlement of claims.          While no magic words need be

spoken, there must be evidence that such factors were considered.

We are careful to add that we are creating no per se rule allowing

a majority of creditors in interest to veto a settlement.                   This

Court merely states that for failing to consider the overwhelming

opposition to the settlement and the familial relationship between

                                       9
Foster and United, the bankruptcy court abused its discretion by

accepting this settlement.

                             Conclusion

     Finding approval of the settlement agreement to be an abuse of

discretion, we REVERSE the district court and VACATE the settlement

between Foster and United and REMAND for further proceedings in

accord with this opinion.

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