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Fifth Circuit Affirms Disclosure Statement Adequately Reserved Avoidance Claims

Thursday, August 18, 2011
In re Texas Wyoming Drilling, Inc., No. 09-10717, 2011 BL 190338 (5th Cir. July 21, 2011) The United States Court of Appeals for the Fifth Circuit affirmed a bankruptcy court’s denial of a motion by former shareholders seeking summary judgment with respect to a debtor’s avoidance actions against them. While the defendants argued that the debtor lacked standing because its confirmed plan did not adequately retain the right to bring avoidance actions, the Fifth Circuit held that the plan and disclosure statement’s language specifically detailing the existence of the avoidance actions, the possible amount of recovery, and the basis for the actions was sufficient to reserve the debtor’s right to bring the claims. Notably, the Fifth Circuit’s decision provides guidance regarding the language required in a plan and disclosure statement to ensure retention of causes of action post-confirmation.

Bankruptcy Court Denies Motion for Summary Judgment

Texas Wyoming Drilling, Inc. (“Debtor”) confirmed a plan of reorganization, which, among other things, eliminated all of Debtor’s shareholders’ stock interests. The plan and the related disclosure statement expressly provided that the reorganized debtor retained all rights with respect to any causes of action, which was defined to include avoidance actions. Additionally, the disclosure statement also included a chart outlining the various claims and causes of action Debtor might pursue, including those against various pre-petition shareholders of Debtor for “fraudulent transfer and recovery of dividends paid to shareholders” and valued the claims at approximately $4 million. After confirmation of the plan, Debtor sued thirty-two of its former shareholders, including Laguna Madre Oil & Gas II, L.L.C., et al (“Laguna”), for pre-petition dividend payments that were allegedly fraudulent transfers under §§ 544, 548 and 550, and the Texas Business and Commerce Code (the “Avoidance Actions”). In response, Laguna filed a motion for summary judgment (“Summary Judgment Motion”), arguing that Debtor lacked standing because the Plan did not adequately retain the Avoidance Actions under 11 U.S.C. § 1123 and, alternatively, that Debtor’s claims were barred by res judicata and judicial estoppel. One day prior to the hearing the Summary Judgment Motion, the bankruptcy court sua sponte converted Debtor’s chapter 11 proceeding to a chapter 7 proceeding as a result of Debtor's material default under the Plan. One effect of the conversion was that the chapter 7 trustee (the “Trustee”) had automatically succeeded Debtor as the plaintiff in the Avoidance Actions. Ultimately, the bankruptcy court held that Laguna’s defenses were baseless and that, since the court had converted the case, the Trustee was entitled to pursue the Avoidance Actions. Following the decision, the bankruptcy court granted Laguna’s request for a direct appeal to the Fifth Circuit.

Disclosure Statement May Be Considered in Deciding Standing

Rendering its decision on appeal, the Fifth Circuit began its analysis by explaining that the ability of a debtor to enforce a claim post-confirmation is limited to that which had been expressly retained in the bankruptcy plan. Dynasty Oil & Gas, L.L.C. v. Citizens Bank (In re United Operating, L.L.C.), 540 F.3d 351, 355 (5th Cir. 2008). Laguna argued that when evaluating standing the court was not to consider the disclosure statement alongside the plan. The Fifth Circuit disagreed with Laguna’s assertion, noting that despite the fact that the issue of whether the disclosure statement should be reviewed had not been addressed by a court of appeals, the disclosure statement was routinely consulted in deciding whether res judicata and judicial estoppel apply. See, e.g., Browning Mfg. v. Mims (In re Coastal Plains, Inc.), 179 F.3d 197, 208 (5th Cir. 1999). Moreover, the Fifth Circuit declared that the disclosure statement, as the primary mechanism informing a creditor’s vote for or against a plan, was consistent with In re United Operating’s purpose of placing creditors on notice of the claims the post-confirmation debtor intends to pursue. See United Operating, 540 F.3d at 355; 11 U.S.C. § 1125. Accordingly, the Fifth Circuit held that courts may consult the disclosure statement in addition to the plan to determine whether a post-confirmation debtor has standing.

Debtor Sufficiently Retained the Avoidance Actions

Turning to Laguna’s contention that Debtor failed to retain the Avoidance Action in the plan, the Fifth Circuit distinguished its previous decision in In re United Operating, in which it held that use a generic language in the debtor’s plan reserving “any and all claims” was insufficient to retain a claim for maladministration of the estate. Operating United, 540 F.3d at 356. Unlike the plan in United Operating, which contained only a blanket reservation claims, the Fifth Circuit found that Debtor’s plan and disclosure statement in the present case specifically revealed the existence of the Avoidance Action, the possible amount of recovery to which they would lead, the basis for the actions, and that the reorganized debtor intended to pursue the claims. Similarly rejecting Laguna’s assertion that Debtor lacked standing due to its failure to name the individual defendants in the Plan, the Fifth Circuit noted that the United Operating decision never held that defendants must be named in the plan, as Laguna contended, but rather the decision cited with approval In re Ice Cream, Inc. v. Calip Dairies, Inc. (In re Ice Cream Liquidation), 319 B.R. 324, 337-38 (Bankr. D. Conn. 2005), in which the court held that a plan’s categorical reservation of “preference claims” was sufficiently specific without identification of individual defendants to confer standing the post-confirmation debtor. Notwithstanding this finding, however, the Fifth Circuit found it unnecessary to decide in the present case whether a debtor whose plan fails to identify any prospective defendants has standing to pursue post-confirmation claims against subsequently-named defendants, given that the disclosure statement did identify the prospective defendants as “[v]arious pre-petition shareholders of the Debtor” who might be sued for “fraudulent transfer and recovery of dividends paid to shareholders.” As such, the Fifth Circuit ruled that the plan and disclosure statement’s language was sufficient to reserve Debtor’s right to pursue the Avoidance Actions.

Fifth Circuit Rejects Judicial Estoppel and Res Judicata Defenses

Lastly, the Fifth Circuit disagreed with Laguna’s claim that the Trustee was judicially estopped from pursuing the Avoidance Actions because Debtor failed to disclose the actions on its schedules. Deciding that Laguna had failed to demonstrate the first element of judicial estoppels, that Debtor had taken inconsistent positions, the Fifth Circuit pointed out that the Trustee was simply pursuing the same claims Debtor had explicitly retained in the plan and disclosure statement. See Superior Crewboats, Inc. v. Primary P&I Underwriters (In re Superior Crewboats, Inc.), 374 F.3d 330, 335 (5th Cir. 2004). Employing similar reasoning, the Fifth Circuit further determined that the doctrine of res judicata was also inapplicable because the bankruptcy court’s order confirming the Plan upon which Laguna was not a prior final judgment on the merits of the Avoidance Actions, but rather specifically left open the opportunity for Debtor to bring the claims in a second action. Howe v. Vaughan (In re Howe), 913 F.2d 1138, 1143-44 (5th Cir. 1990). Therefore, the Fifth Circuit held that the Avoidance Actions were not barred by either the doctrine of judicial estoppel or res judicata.

Fifth Circuit Affirms Bankruptcy Court’s Denial of Laguna’s Summary Judgment Motion

Ultimately, the Fifth Circuit affirmed the bankruptcy court’s denial of the Summary Judgment Motion on the grounds that the language in both the plan and disclosure statement was sufficiently particular to retain the right to pursue the Avoidance Actions. Disclaimer This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy. ©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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