How a Bankruptcy Court Refuses to Approve a Mediated Settlement Agreement

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Many interested parties

By: Donald L. Swanson

One of the crucial rules of mediation is this: all pertinent parties need to be included in the mediation session. That’s because excluded parties can blow-up a mediated deal.

Bankruptcy System

In bankruptcy, interested parties are everywhere—and they can’t all be included in every mediation. That’s a problem. So, the Bankruptcy Code and Rules build a solution into the system. The solution is this:

–a debtor can reach a settlement with anyone at any time, but the bankruptcy court must still approve the settlement, after notice to interested parties.

The role of the bankruptcy court, in such process, is to assure that the settlement is fair and reasonable for all interested parties—whether all are included in the mediation or not.

Our bankruptcy system relies upon parties settling most of their disputes. That’s especially true in Chapter 11 business reorganization, which is intended to be a consensual process. An so, mediated settlements are usually approved in bankruptcy without difficulty. But bankruptcy courts can withhold their approval of a settlement. And they sometimes do.

Here’s an example of bankruptcy court refusing to approve a mediated settlement: an opinion in the In re Pullum bankruptcy case [Fn. 1].

Facts of the Case

Creditor obtains pre-bankruptcy judgments against Debtor and files an $825,210.48 proof of claim in Debtor’s bankruptcy case, asserting a valid, perfected judgment lien on Debtor’s ownership interests in various corporations.

Then, Debtor files an adversary proceeding against Creditor in Bankruptcy Court (A.P. No. 16-3008), alleging non-perfection of Creditor’s judgment lien.

Debtor and Creditor mediate their disputes. They reach a Settlement Agreement that would pay $650,000 to Creditor and seek approval of the Settlement Agreement from the Bankruptcy Court, as required by Fed.R.Bankr.P. 9019(a).

Various parties object to approval of the Settlement Agreement, arguing (i) the judgment lien is “permanently void,” (ii) the dispute could be “easily and quickly resolved” in litigation, and (iii) the settlement “is not in the paramount interest of creditors.”

Approval Denied

The Bankruptcy Court denies approval of the Settlement Agreement, despite applying “substantial weight” to the mediated compromise. Here are the Court’s reasons.

–The Legal Standard

A settlement may be approved by a bankruptcy court under Fed.R.Bankr.P. 9019(a) after considering a four-factor test adopted by the U.S. Eleventh Circuit Court of Appeals. The factors are:

  1. probability of success in the litigation;
  2. difficulties, if any, to be encountered in the manner of collection;
  3. complexity of the litigation involved and the expense, inconvenience, and delay necessary in attending it; and
  4. the paramount interests of the creditors and a proper deference to their reasonable views.

When considering whether to approve a settlement under these factors, the bankruptcy judge is to “canvass the issue and see whether the settlement falls below the lowest point in the range of reasonableness.” The “range of reasonableness” criterion “recognizes the uncertainties of law and fact” in a case and “concomitant risks and costs” that are “inherent in taking any litigation to completion.”

–The Legal Standard Applied

After canvassing the issues, the Bankruptcy Court in In re Pullum refuses to approve the Settlement Agreement because “three of the four” factors “weigh against” approval. Here’s how:

  1. Probability of Success. This factor weighs against approval because, although case law on the statute in question is conflicting and unsettled, Debtor has a reasonable chance of success;
  2. Difficulties of collection. This factor is not an issue in this case;
  3. Complexity, Expense, Inconvenience & Delay. This factor weighs against approval because, although the legal issue may be one “of first impression,” its resolution “does not appear to be inordinately complex”; and
  4. Paramount interests of creditors. This factor weighs against approval because claimants holding $25 million of the total $31 million of unsecured debt have objected to the settlement (the settling Creditor’s claim is < $1 million) and because a court is obligated to give deference to “their legitimate views or concerns.”

It appears that the Bankruptcy Court in In re Pullum relies most-heavily on the fourth factor. Such an approach is consistent with the idea that Chapter 11 bankruptcy is intended to be a consensual process.

Conclusion

In any bankruptcy case, there are many interested parties. And it’s impossible to include every one of them in a mediation. So, the bankruptcy process, (i) allows for debtors to settle disputes with individual creditors, but (ii) establishes a notice and hearing process to assure that the interests of other parties are protected.

The upshot, then, is that a mediated settlement will, every now and then, be rejected by the bankruptcy court. That’s an unavoidable part of the system.
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Footnote 1: The opinion is in the case of In re Pullum, Case No. 14-30215, Doc. 433 (Bankruptcy Court for the Northern District of Florida, decided March 14, 2019).

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