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In re Washington Mutual, Inc., Case No. 08-12229, 2011 BL 234046 (Bankr. D. Del. Sept. 13, 2011) The United States Bankruptcy Court for the District of Delaware denied confirmation of a savings and loan association’s chapter 11 plan because it included flawed business and tax valuations, provided for the payment of postpetition interest at an improper rate, and wrongly permitted compound interest on claims. Additionally, the Court ruled that the equity committee had stated a colorable claim for disallowance of certain noteholders’ claims based on alleged insider trading activities, but directed the parties to mediation in an attempt to resolve the issues precluding confirmation of the plan.
The Bankruptcy FilingOn September 25, 2008, following a decline in the value of Washington Mutual Bank ("WMB"), the nation’s largest savings and loan association, the Office of Thrift Supervision seized WMB and appointed the Federal Deposit Insurance Corporation ("FDIC") as receiver. That same day, the FDIC sold substantially all of WMB’s assets to JPMorgan Chase Bank ("JPMC") but retained claims that WMB held against other parties. On September 26, 2008 ("Petition Date"), Washington Mutual, Inc. ("WMI"), the holding company that owned WMB, and WMI Investment Corp. (together, "Debtors") filed for chapter 11 bankruptcy relief. Thereafter, disputes arose between Debtors, the FDIC and JPMC regarding ownership of certain assets and claims that the parties had asserted against each other. Following two years of litigation, the parties reached a global settlement agreement ("GSA"), which resolved the issues between Debtors, JPMC, the FDIC, certain large creditors ("Settlement Noteholders"), certain senior noteholders, and the official creditors’ committee ("Creditors’ Committee"). The GSA was then incorporated into Debtors’ proposed reorganization plan ("Plan"). In January 2011, the bankruptcy court issued an opinion ("January Opinion") ruling that the GSA was fair and reasonable. Nonetheless, the bankruptcy court refused to confirm the Plan due to certain deficiencies. In response to the ruling, Debtors modified the Plan ("Modified Plan") to include the cancellation of WMI and the issuance of stock in the newly reorganized WMI (the "Reorganized Debtor") to creditors who elect to receive stock in lieu of cash payments or interests in the Liquidating Trust. In addition to being vested with various assets, the value of the Reorganized Debtor would also include certain tax attributes, namely a significant amount of net operating losses ("NOLs") that could be carried forward to reduce tax liabilities in future years. Use of NOLs to avoid taxes, however, is subject to the limitations of § 382 of the Internal Revenue Code (the "Tax Code"). Upon finalizing the Modified plan, which gained the support of JPMC, the FDIC, the Creditors’ Committee and a group of senior noteholders, among others (collectively, "Supporters"), Debtors sought confirmation from the bankruptcy court. Other parties, including the official equity committee ("Equity Committee"), certain noteholders, and individual creditors and shareholders (collectively, "Objectors") continued to oppose the Modified Plan.
Reasonableness of the GSABeginning its analysis, the bankruptcy court reviewed its finding, in the January Opinion, that the GSA was reasonable based on all of the claims that it resolved and the unlikelihood of Debtors achieving a significantly better result through litigation. Even though the holders of business tort claims included in the GSA had since had their state court lawsuit alleging misconduct by JPMC reinstated, the bankruptcy court indicated that the unlikelihood of success in litigating those claims, the delay and cost of pursuing them, and the likely difficulties they would have in collecting any judgment still favored resolving them pursuant to the GSA. Accordingly, the bankruptcy court declined to reconsider its ruling as to the reasonableness of the GSA.
Value Distributed Under the PlanNext, the bankruptcy court attempted to determine an accurate valuation of the Reorganized Debtor focusing primarily on the proper value assignable to the NOLs, taking into consideration the parties' disagreement over the extent to which the Internal Revenue Service would ultimately invoke § 269 of the Tax Code to disallow many of the NOLs. While noting its obligation to account for the risk that the NOLs would be disallowed, the bankruptcy court observed that, typically, § 269 is only invoked to disallow NOLs when the "principal purpose" of a transaction is tax evasion or avoidance. Scroll, Inc. v. Commissioner, 447 F.2d 612, 618 (5th Cir. 1971). In the instant case, the bankruptcy court determined that, under the Modified Plan, the creditors would not be acquiring the Reorganized Debtor in order to shelter taxable income; rather, they would merely be receiving stock in the Reorganized Debtor in repayment of debt owed to them. Thus, the bankruptcy court reasoned that it was unlikely that the IRS would significantly restrict Debtors’ ability to use the NOLs.
Good FaithThe bankruptcy court also rejected the Equity Committee’s assertion that the Modified Plan was not proposed in good faith, as required by 11 U.S.C. § 1129(a)(3). The Equity Committee contended that because the Settlement Noteholders, who participated directly in the GSA negotiations, improperly traded in Debtors’ securities while in possession of material, nonpublic information obtained from those meetings, the Modified Plan was not proposed in good faith. The bankruptcy court explained that, despite allegations of insider trading by the Settlement Noteholders, the Plan was not necessarily proposed in bad faith, because the evidence failed to establish that the Settlement Noteholders’ actions, if true, had a negative impact on the Plan or tainted the GSA.
Best Interests of CreditorsContinuing its analysis, the bankruptcy court addressed the Objectors’ argument that the Plan violated the "best interests of creditors" test to the extent that it: (1) provided for the payment of postpetition interest on unsecured claims at the contract rate, rather than at the federal judgment rate; (2) provided for the compounding of interest; (3) provided for the payment of postpetition interest to unsecured creditors before subordinated claims were paid; and (4) conditioned distributions to creditors on those parties granting a release to JPMC and other non-Debtors. See 11 U.S.C. § 1129(a)(7). With respect to the payment of postpetition interest, the bankruptcy court explained that the "legal rate" of interest due under 11 U.S.C. §§ 726(a)(5) and 1129(a)(7) is defined as the federal judgment rate applicable on the Petition Date, rather than the contract rate. See In re Dow Corning Corp., 237 B.R. 380, 405-06 (Bankr. E.D. Mich. 1999). Moreover, because creditors were only entitled to postpetition interest at the federal judgment rate compounded annually, the Plan’s payment of interest on interest violated § 1129(a)(7). Similarly, the bankruptcy court rejected the argument that Debtors were required to pay certain subordinated noteholder claims before awarding postpetition interest on unsecured claims. In so stating, the bankruptcy court clarified that 11 U.S.C. § 510(b) subordinated the noteholder claims to all "claims," which included unmatured interest on claims. To that end, the bankruptcy court declared that unsecured creditors were entitled to postpetition interest before the subordinated claims were paid. Lastly, the bankruptcy court disagreed that the provision predicating creditor distributions on granting third party releases to JPMC and other non-Debtors violated § 1129(a)(7). Specifically, the bankruptcy court noted that JPMC’s waiver of its claims was funding creditor recoveries and that the voluntary releases applied equally to all creditors.
Equity Committee’s Standing MotionFinally, the bankruptcy court examined whether the Equity Committee had standing to prosecute an action for equitable subordination or equitable disallowance of the Settlement Noteholders’ claims. Highlighting that equitable subordination permits a creditor’s claim to be subordinated to another claim but not to equity, the bankruptcy court averred that, even if the Settlement Noteholders’ claims were subordinated, they would simply be subordinated to other creditors’ claims but still be paid ahead of equity. However, the bankruptcy court acknowledged its authority to disallow a claim on equitable grounds in extreme instances. See In re Adelphia Communications Corp., 365 B.R. 24, 73 (Bankr. S.D.N.Y. 2007). Concluding that that the Equity Committee had stated a "colorable" claim for equitable disallowance based on the Settlement Noteholders’ alleged possession of material nonpublic information, their possible status as temporary insiders of Debtors and their alleged recklessness in their use of material nonpublic information, the bankruptcy court held that the Equity Committee had standing to proceed with its action.
Bankruptcy Court Denies ConfirmationIn sum, the bankruptcy court denied confirmation of the Plan, directing the parties to mediation in an attempt to resolve all remaining obstacles to confirmation.
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