Extracted from Law360.com
What do you do when you find yourself in bankruptcy after generating over $20 million from a sale of assets with no secured creditor only to be faced with the Worker Adjustment and Retraining Notification Act litigation where the plaintiffs are seeking administrative priority treatment for 100 percent of the alleged WARN Act claims (exceeding $16 million)? Putative class action counsel insists that (1) “class” claims can only be resolved via Rule 23 of the Federal Rules of Civil Procedure;[1] (2) settlements can only be reached with his/her blessing; and (3) the debtors are faced with maintaining outsized reserves to address the potential of allowance of WARN Act claims on a priority basis (delaying material distributions to unsecured creditors).
Kusnick v. LMCHH PCP
Traditionally, bankruptcy has been a refuge for debtors seeking to efficiently liquidate their assets and provide timely and meaningful distributions to creditors. Notwithstanding this traditional backdrop, in Kusnick v. LMCHH PCP LLC, et al.,[2] the debtors (and the authors as counsel) were faced with the situation noted above and would have to either capitulate into a settlement that preferred former employees over other creditors or litigate until the end of time exclusively in accordance with Federal Rule of Civil Procedure 23. Because neither option would benefit individual stakeholders and both would displace well-accepted bankruptcy tenets, the debtors and the Unsecured Creditors Committee sought to implement a strategy that utilized traditional bankruptcy structures and concepts to give individual creditors a voice.
Claims Estimation
Initially, counsel to the debtors and the committee considered estimating the WARN Act claims under Bankruptcy Rule 3018 and Section 502(c), and confirming a plan based on the estimated liability. While claim estimation provided a traditional path used by debtors to facilitate quicker distributions, because the WARN Act claimants alleged that 100 percent of their claims were entitled to administration priority, estimation did not resolve the potential requirement that the debtors maintain an outsized reserve that would, again, preclude meaningful distributions in the near term.
Cram Down
Counsel to the debtors and the committee also explored whether they could cram down the WARN Act claimants through a plan to bind dissenters. Again, the contention that the WARN Act claims were entitled to administrative priority provided a roadblock. Under Section 1129(a)(7) (which applies at an individual level to each WARN Act claimant), any single claimant would have the right to challenge confirmation of a plan seeking to cram down dissenting claimants because, if their claim were allowed as a priority or administrative claim, they would be entitled to 100 percent recoveries, before general unsecured creditors, without regard to treatment of the class under a plan.
Settlement in a Plan
Counsel to the debtors and the committee explored whether they could use a plan to settle the WARN Act claims. While this was appealing, interim class counsel contended that the only way to resolve alleged class claims was by complying with the strict procedural requirements of FRCP 23 (where interim class counsel purported to be the sole gatekeeper). Not willing to cede control to interim class counsel, the debtors and the committee sought to utilize traditional bankruptcy concepts to give individual claimants a choice. Bankruptcy policy favors compromises and settlements, and compromises and settlements can be used in a plan. It is a staple of bankruptcy law that litigation can be compromised in the context of a plan over the objection of interested parties.[3] As the U.S. Court of Appeals for the Fifth Circuit explained in discussing the strong policy favoring compromise and settlement of disputes in bankruptcy:
We will not disturb the bankruptcy court’s approval of the settlement of this lawsuit contained in the plan of reorganization absent an abuse of discretion by the court. Matter of Aweco, Inc., 725 F.2d 293 (5th Cir.), cert. denied, 469 U.S. 880, 105 S. Ct. 244, 83 L. Ed. 2d 182 (1984); Matter of Jackson Brewing Co., 624 F.2d 599 (5th Cir. 1980). We find no such abuse of discretion in this case.[4]
But can you settle purported class action claims through a plan? Does the appointment of interim class counsel (of a purported but uncertified class) under FRCP 23(g) change the analysis? Are debtors required to follow the procedures contemplated by FRCP 23 to the exclusion of bankruptcy jurisprudence? The debtors and the committee successfully argued that bankruptcy law, policy and procedures would carry the day legally and practically.
Bankruptcy Versus Class Action
Bankruptcy policy favors plans and the bankruptcy claims allowance process, and is a substantive basis for finding that “class action is [not] superior to other available methods for fairly and efficiently adjudicating the controversy” as contemplated by Rule 23(b)(3). The U.S. Bankruptcy Court for the Northern District of Texas in In re Craft[5] discussed the interference of class certification with both the plan process and the regular claims allowance process. As that court explained:
[Debtor]’s [C]hapter 11 cases are at a critical juncture. It would prejudice [debtor] and its creditors to delay the plan process and claim objection process to conduct a Rule 7023 hearing.[6]
This analysis was adopted by the Fifth Circuit Court of Appeals in Teta v. Chow.[7] There, the court reasoned:
A court’s consideration of bankruptcy-related factors not only generally serves to inform its assessment of the comparative merits of one adjudication method over another, but in a case like this — where a comparable class proof of claim has been filed — assessing these factors also is perfectly in keeping with Rule 23’s requirement that the court consider “the extent and nature of any litigation concerning the controversy already begun by or against class members.” Fed. R. Civ. P. 23(b)(3)(B). As the court here explained, it may well be the case in the bankruptcy context that “the claims process can more expeditiously move [a claimant’s] claims down a parallel track.”
Similar reasoning was employed by the district court in In re Ephedra Products Liability Litigation:[8]
Here, the potential interference with timely distribution in itself presents sufficient grounds to expunge the class claims. The liquidating plan was already submitted for a vote of creditors before the Court was finally asked to decide whether or not to exercise its discretion under Rule 9014. Applying Rule 23 to the class claims now would initiate protracted litigation that might delay distribution of the estate for years. Pre-certification discovery would be needed for three putative class claims with three putative class attorneys, two of whom are competing to represent the same consumers. If the classes were then certified, notice to class members followed by discovery on the merits and the bankruptcy equivalent of a trial would further delay distribution. It is simply too late in the administration of this Chapter 11 case to ask the Court to apply Rule 23 to the class proofs of claim.
The important step is to be positioned to conclude the case and commence distributions without having to reserve 100 percent for disputed claims. The key is to find a way to make direct proposals to each individual claimholder. The support for this approach is stated clearly in In re Shell Oil Refinery,[9] which held that: “Class members are free to accept or reject individual settlement offers. Plaintiffs’ argument that individual settlements are impermissible because they might destroy the class action is without merit.” This is especially true in a bankruptcy context.
The strategy to bring these disparate legal principles together is to develop a plan that contains a compromise and settlement that has been negotiated, even if not agreed to. A unilateral proposal from the plan proponents to the holders of potential allowed WARN Act claims can be made through a plan with court-approved solicitation materials, and the use of sophisticated claims agents enables the plan proponents to prepare customized ballots for each claimant telling her the exact amount (before taxes) the claimant will receive if she agrees to the settlement. The ballot will not be a ballot in the classic sense because the claimant is not voting on the plan. The claimant is deciding whether or not to accept her individualized settlement. This structure is an integral part of the plan and cannot proceed if the plan is not confirmed, and it can be a condition of the effective date that a certain percentage or number of WARN Act claimants take the settlement (though, strategically, it may not be wise to limit the effectiveness of a plan).
The Benefits of the Disclosure Statement Process; Third-Party Releases
Though proceeding through the plan process provided the debtors with the ability to go directly to the WARN Act claimants, did this affect their procedural or substantive rights? No. Unlike the resolution of class claims, the bankruptcy plan and disclosure-statement process provide full notice to claimants, a summary of their proposed treatment and a formalized mechanism to ensure that the results are appropriately presented to a court for its evaluation. The disclosure statement process also provides an opportunity for those opposed to the settlement to provide information to the individual claimants. Similarly, the WARN Act claimants maintained their right to object to confirmation and their ability to opt out and reject their individual proposed settlement. If they chose to opt out, the plan’s releases simply would not apply, and litigation would proceed with those that did not agree to the compromise and settlement. But those who wanted an efficient and timely distribution (without years of litigation) could elect to settle, accept payment and effectuate releases.
Through the plan and direct solicitation process, the debtors had the ability to seek settlement with those who did not want lengthy litigation, leaving a smaller universe with a much smaller reserve for those that want to litigate instead of accept a reasonable offer. If 50 percent of the WARN Act claimants take the deal, then the number of claimants is reduced, the amount of the reserve is reduced and any issues that might have arisen with the Section 1126(c) requirements are avoided. If 67 percent take the deal, better, and if 90 percent take it, the result is even better, and the likelihood of the class not being certified goes up; or if it is certified, there will be a much smaller number of members with smaller claims. Similarly, because class settlements provide authority to bind nonrespondents, you have the ability to bind all those who do not elect to opt out.[10] In Kusnick v. LMCHH PCP, the court’s confirmation order reflected that 86.7 percent of all the debtors’ former employees (671 of 774) did not opt out of the settlement, and 74.3 percent (298 of 401) who actually returned ballots voted for the settlement.
An additional benefit of the structures described above is evidenced by the U.S. Court of Appeals for the Second Circuit’s decision in Lucas v. Dynegy Inc.,[11] which focused on the lack of standing to object by one who opts out of a release and is thus not bound by it. As the court explained, “[F]urthermore, since he opted out of the release in his individual capacity, Lucas lacks standing to appeal the order confirming the Plan.” This is consistent with the long-standing aggrieved party requirement for appellate standing.
In summary, combining the various mechanisms available by thinking like a bankruptcy lawyer, in bankruptcy terms, and not as a class action lawyer can lead to a more reasonable and efficient resolution in a shorter period of time.
Footnotes:
[1] Applicable in bankruptcy cases pursuant to Rule 7023 of the Federal Rules of Bankruptcy Procedure.
[2] Kusnick v. LMCHH PCP, LLC (In re LMCHH PCP, LLC) , Nos. 17-10353, 17-1021, 17-1024, 2017 Bankr. LEXIS 1940 (Bankr. E.D. La. July 13, 2017).
[3] In re Texas Extrusion Corp. , 844 F.2d 1142 (5th Cir. 1988).
[4] Id. at 1158-1159.
[5] In re Craft , 321 B.R. 189 (Bankr. N.D. Tex. 2005).
[6] Id. at 199.
[7] Teta v. Chow (In re TWL Corp.) , 712 F.3d 886, 896-897 (5th Cir. 2013).
[8] In re Ephedra Prods. Liab. Litig., 329 B.R. 1, 5 (S.D.N.Y. 2005).
[9] In re Shell Oil Refinery, 152 F.R.D. 526, 535 (E.D. La. 1989)
[10] Additionally, though there has been recent debate concerning opt-out ballots, the validity of an opt-out provision in connection with a plan settlement can be further supported through a settling claimant’s acceptance of the proposed settlement proceeds.
[11] Lucas v. Dynegy Inc. (In re Dynegy Inc.) , 770 F.3d 1064 (2d Cir. 2014)