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Settlement Is in Best Interest of Estate; Not 'Outside the Realm of Reasonableness'

Monday, April 15, 2013
By Diane Davis

A bankruptcy court did not abuse its discretion in approving a settlement agreement between a Chapter 11 debtor and its former member in the limited liability company because it was in the best interest of the estate, the U.S. District Court for the Eastern District of Wisconsin held March 20 (Official Committee of Unsecured Creditors of Renaissant Lafayette LLC v. Interforum Holding LLC, E.D. Wis., No. 2:11-cv-00172-CNC, 3/20/13).

Affirming the decision of the bankruptcy court, Judge C.N. Clevert Jr. concluded that there were sufficient reasons for the bankruptcy court to conclude that the settlement agreement was in the best interest of the estate.

According to the court, the settlement did not fall “outside the realm of reasonableness.” The court considered the relevant factors and the cost and time spent on litigation and the potential expense of litigating avoidance claims, and determined that the costs of litigation would total at least $20,000, equal to the amount that would have been recovered for unsecured creditors. The other option, the court said, would be that there would be no recovery to the unsecured creditors. Further, there was the reality of stalling or dismissing the Chapter 11 case. Thus, there were sufficient reasons for the bankruptcy court to conclude that the agreement was in the best interest of the estate.

Chapter 11 Filing
Debtor Renaissant Lafayette LLC is a Wisconsin limited liability company. Interforum Holdings Inc. is a Class A member of the debtor, holding a 12.5 membership interest, and Interforum Holdings-Lafayette LLC is a Class B member holding a 37.5 membership interest. The remaining 50 percent interest is held by Renaissant Development Group LLC. By letter dated Feb. 13, 2009, Interforum Holdings-Lafayette LLC informed the president of the Renaissant Development Group, Warren Barr, that it elected to cease being a member of the debtor and demanded the full amount being held in an escrow account. On Feb. 17, 2009, the proceeds of a certificate of deposit for $535,632 were transferred into the debtor's checking account and a $500,000 cashier's check was made payable to Interforum Holdings-Lafayette LLC.

Subsequently, Barr signed a resolution as the sole manager and member of the debtor regarding its decision to file for Chapter 11 protection. Several weeks later, the debtor filed for Chapter 11 protection.

Renaissant Development Group then filed a motion to approve the sale of substantially all of the debtor's assets free and clear of liens, claims, or encumbrances. Amalgamated Bank agreed to act as stalking horse bidder in an auction for the debtor's assets with a credit bid of $55 million under the asset purchase agreement.

Interforum then filed an objection and response to the debtor's motion for entry of an order based on a combined 50 percent interest in the debtor. According to Interforum, the debtor failed to list Interforum as Equity Security Holders and the Jan. 25, 2010, State of Financial Affairs erroneously stated that Interforum withdrew as members of the debtor. Interforum argued that it had not received notice of any proceedings during the pendency of the Chapter 11 case and had not consented to the commencement of the case.

Settlement Reached
Subsequently, Interforum moved to dismiss the bankruptcy petition on the grounds that the manager was not authorized to file the Chapter 11 petition on behalf of the debtor. Prior to the evidentiary hearing on the matter, the debtor, Amalgamated Bank, and Interforum reached a settlement allowing Interforum Holdings-Lafayette LLC to retain the $500,000 transfer from a joint instruction certificate of deposit maintained by the debtor under an equity agreement providing that Interforum ceased to be a member of the debtor as of Feb. 13, 2009. As a result, Interforum had no rights or interest in the debtor after that date and withdrew its motion to dismiss and objection to sale.

The debtor contended that the settlement was within the range of reasonableness, citing the cost of continued litigation which would jeopardize the sale process and delay resolution. The debtor also cited a significant reduction in legal expenses and the final resolution of all claims.

Objection to Settlement
The Official Unsecured Creditor's Committee filed an objection to the motion to approve the settlement agreement, arguing that there was a “lack of legal and factual justification for the compromise, specifically for the release of a potential avoidance claim of $500,000.” According to the Committee, the debtor had not “made a clear showing that releasing the claim is in the best interest of the estate.”

Amalgamated Bank, the largest unsecured creditor, filed a response to the objections of the Committee stating that the “probability of avoiding a $500,000 transfer for the Interforum Entities as a preferential transfer is low” and that the monies had been held in escrow on behalf of Interforum since 2007. According to Amalgamated Bank, the benefit to the estate achieved through settlement far outweighed the benefits of any potential avoidance action and its costs.

Settlement Approved
The bankruptcy court granted the motion to approve the settlement, concluding that the court had jurisdiction under 28 U.S.C. § 1334, and that it was a core proceeding under 28 U.S.C. § 157(b). The court also found that the settlement was fair, reasonable, and in the best interest of the estate and creditors.

Under Federal Rules of Bankruptcy Procedure 9019(a), the bankruptcy court may approve a compromise or settlement “[o]n motion by the trustee and after notice and a hearing,” the court explained. The bankruptcy court, the court noted, must determine whether the proposed compromise is in the best interests of the bankruptcy estate. Among the factors the bankruptcy judge should consider in his analysis are the “litigation's probability of success, the litigation's complexity, and the litigation's attendant expense, inconvenience, and delay (including the possibility that disapproving the settlement will cause wasting of assets),” the court said, citing In re Doctors Hospital of Hyde Park Inc.,, 474 F.3d 421 (7th Cir. 2007).

In its arguments on appeal, the Committee focused on the potential avoidance claim and the carve-out distribution. Underlying both arguments was the assumption that the court was acting within its jurisdiction, the court said. At no time did the Committee challenge the authority of the debtor to initiate the case, the court said.

No Standing to Challenge Jurisdiction
A federal bankruptcy court has no power to entertain a voluntary petition for bankruptcy filed on behalf of a corporation by those without authority under local law, the court noted, citing Price v. Gurney, 324 U.S. 100 (1945). Nevertheless, an unauthorized filing of a voluntary petition on behalf of a corporation may be ratified in appropriate circumstances, the court explained, by ensuring conduct of persons with power to have authorized it originally. In this case, the court pointed out, Interforum waited five months after learning about the Chapter 11 filing before seeking dismissal. Then, after filing its motion to dismiss, agreed to withdraw it. Thus, if Interforum was a member of the debtor when the Chapter 11 petition was filed, this constitutes an express ratification of the filing of the petition, the court said. On the face of the petition as to which all members of the debtor supported, the bankruptcy court found that it had subject matter jurisdiction, the court noted.

According to the court , the settlement agreement executed by the debtor and Interforum on Dec. 7, 2010, states that Interforum had no interest in the LLC after Feb. 13, 2009. Thus, it follows that the Chapter 11 was filed properly and Interforum did not have standing to challenge it, the court said.

Settlement in Best Interest of Estate
The court was also satisfied that all appropriate factors were considered. The court rejected any assertion that the compromise was a way of “tossing away the potential to recover a $500,000 preference, and found that the settlement did not fall “outside the realm of reasonableness.” The court also considered the cost and time spent on litigation and the potential expense of litigating Interforum's claims. The court weighed the costs of litigating the claim and the reality of the distribution scheme outlined by the attorneys. Amalgamated Bank would receive 96 percent of any proceeds, the court pointed out, whereas the remaining unsecured creditors would only recover 4 percent. If $500,000 were recovered, that would translate into $20,000 for unsecured creditors other than Amalgamated Bank, the court noted, but it is reasonable to assume that if the settlement was not permitted and the motion to dismiss was litigated and denied, the costs of litigation would total at least $20,000.

Alternatively, if Interforum prevailed on its motion to dismiss, there would be no recovery available to the unsecured creditors, the court noted. Thus, there were sufficient reasons for the bankruptcy court to conclude that the agreement was in the best interest of the estate.

By Diane Davis

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