When Not to Approve a Compromise

Compromises are favorites of the law.   A compromise and settlement can avoid expensive litigation and as more than one judge has pointed out, the deal that the parties make will generally be better for them than the ruling the court provides.  However, bankruptcy involves many stakeholders so that when two parties reach a settlement which affects rights of the estate, the parties must go to the court for approval of their compromise under Fed.R.Bankr.P. 9019.   

In submitting motions to compromise, the cases and standards are well-established.  My standard 9019 motion refers to the four factor test set out in  In re Cajun Electric Power Coop, Inc., 119 F.3d 349, 355-56 (5th Cir. 1997) and many other Fifth Circuit decisions.   Most opinions dealing with motions to compromise relate to settlements which were approved which is great help if you are on the compromising side, but not so much on the objecting side.    Bankruptcy Judge Ronald B. King who is notoriously reticent to publish, has provided an opinion demonstrating when a settlement should not be approved.   Case No.  16-51448, In re Jorge R. Alfonso and Naydimar Diaz (Bankr. W.D. Tex. 9/6/09), which can be found here.

What Happened

The Alfonso case involves a variation on a common theme.   A debtor files bankruptcy and failed to list a possible personal injury claim.   Shortly before the discharge was obtained, the debtor hired a law firm to file a lawsuit.   The PI firm ran a search to see if the potential plaintiff was in bankruptcy but did not find the case.   Suit was filed against Ms. Diaz's employer, Nordstroms and the case went to arbitration.  During the arbitration, Nordstroms learned of the bankruptcy and moved to dismiss.  At this point, the plaintiff's lawyer, continuing to do everything right, contacted the trustee, who moved to reopen the bankruptcy case.   

After the case was reopened, the debtors amended their schedules to disclose the claim.  Ms. Diaz claimed her maximum exemption of $23,675 in the lawsuit which was allowed after an objection from the trustee.       

The Trustee discussed employing the PI firm to represent him in pursuing the claim.   However, the Trustee decided instead to accept a settlement offer from Nordstroms.    The Trustee filed a motion to compromise which proposed to settle the claim for $105,000.   The law firm objected, pointing out that the claim was worth between $500,000-$1.5 million.   In fact, Ms. Diaz had medical expenses of over $367,000, most of which were the subject of letters of protection.

There were claims of just over $120,000 in the estate, which meant that creditors would receive a sizable distribution but would not be paid in full.  Most of the filed claims were for student loans which would not be dischargeable.   Therefore, the losers under the trustee's proposed settlement were the law firm, which would miss out on its contingent fee, the medical expense providers who had letters of protection and the debtors and their student loan creditors.   The big winner would be Nordstoms and, to a lesser extent, the trustee.

The Ruling

Judge King succinctly laid out the standards for approving a compromise as follows:
A bankruptcy court has wide discretion to approve or deny a settlement proposed by a trustee. See id.; see also Nellis v. Shugrue, 165 B.R. 115, 122 (S.D.N.Y. 1994) (citing Sec. & Exch. Comm’n v. Drexel Burnham Lambert Grp., Inc. (In re Drexel Burnham Lambert Grp., Inc.), 960 F.2d 285, 293 (2d Cir. 1992)) (“The experience and knowledge of the bankruptcy court judge is of significance in assessing the propriety of the settlement.”). But the Fifth Circuit instructs courts to do so “only when the settlement is fair and equitable and in the best interest of the estate.” Conn. Gen. Life Ins. Co. v. United Cos. Fin. Corp. (In re Foster Mortg. Corp.), 68 F.3d 914, 917 (5th Cir. 1995) (citing Rivercity v. Herpel (In re Jackson Brewing Co.), 624 F.2d 599, 602 (5th Cir. 1980)). To determine whether a settlement is fair and equitable, courts compare the terms of the compromise with the likely rewards of litigation, by evaluating:

• (1) the probability of success in litigating the claim subject to settlement, considering the attendant uncertainties in fact and law;
• (2) the complexity and likely duration of litigation and any attendant expense, inconvenience, and delay, if any, to be encountered in the matter of collection;
• (3) the best interests of the creditors, with proper deference to their reasonable views;
• (4) the extent to which the settlement is truly the product of arms-length bargaining, and not of fraud or collusion; and
• (5) all other factors bearing on the wisdom of the compromise. Cajun Elec. Power Coop., Inc. v. Central La. Elec. Co. (In re Cajun Elec. Power Coop., Inc.), 119 F.3d 349, 356 (5th Cir. 1997) (citing Foster Mortg., 68 F.3d at 917); Jackson Brewing, 624 F.2d at 602.As counsel for Nordstrom argues, a court need not “conduct a mini-trial to determine the probable outcome of any claims waived in the settlement.” Official Comm. of Unsecured Creditors v. Moeller (In re Age Ref., Inc.), 801 F.3d 530, 540 (5th Cir. 2015) (internal citation omitted). Instead, the court is to “canvas the issues” to see if the settlement falls “below the lowest point in the range of reasonableness.” ARS Brook, LLC v. Jalbert (In re ServiSense.com, Inc.), 382 F.3d 68, 72 (1st Cir. 2004).

But while a bankruptcy court should not hold a full-blown trial on the merits, it must “apprise [itself] of the relevant facts and law so that [it] can make an informed and intelligentdecision” on whether the settlement proposed is fair and equitable to parties in interest. Age Ref., 801 F.3d at 541 (alterations in original) (quoting Cajun Elec. Power Coop., 119 F.3d at 356); see also LaSalle Nat’l Bank v. Holland (In re Am. Reserve Corp.), 841 F.2d 159, 163 (7th Cir. 1987). In other words, the court must do more than “rubber stamp” a settlement. See Nellis, 165 B.R. at 122 (“The bankruptcy judge is ultimately responsible for an unbiased and informed assessment of a settlement’s terms.”); Cousins v. Pereira (In re Cousins), No. 09 Civ. 1190(RJS), 2010 WL 5298172, at *4 (S.D.N.Y. Dec. 22, 2010) (holding that “[trustee’s] opinions are not to be automatically accepted as reasonable” and that the “bankruptcy court must make independent determinations in approving a settlement”). Opinion, pp. 6-7.  I set this out at length not because I am too lazy to summarize them, but because Judge King provides a great resource on cases and points to argue when supporting or opposing a compromise.

In making his ruling, Judge King summarized the evidence and arguments of the two parties.  The Plaintiff's firm  established that it had extensively prepared for the arbitration hearing, identified facts that would establish liability, asserted that Ms. Diaz had "excellent facts for proving damages" of at least $367,828.87 representing her medical expenses and provided a "well-supported" estimate of a settlement figure closer to $750,000.   On the other hand, the Trustee and Nordstrom provided more general statements in favor of settlement.

Judge King explained:
Likewise, the trustee presents no evidence as to how or why $105,000 is a reasonable number for settlement. As the Firm pointed out, most of the trustee’s motion to approve the settlement contains generalizations and legal conclusions. See ECF No. 35, pp. 5–7. Thus, when comparing the Firm’s intensive investigation into both legal and factual issues to the figure proposed by the trustee, the second factor (i.e., complexity and likely duration of litigation) and third factor (i.e., best interest of creditors) also weigh against the Proposed Settlement—or at least do not support the trustee’s argument to approve it. Opinion, p. 9.    The Court thus left the parties to either litigate or propose an alternative settlement.

The practice point here is that when supporting or opposing a compromise, the party who provides specific facts will have an advantage over the party offering platitudes.   One danger for a trustee is that if he proposes a settlement based on weaknesses in his case and the settlement is not approved, the trustee will have given the opposing party a roadmap to defeat the claim.