Connecticut General Life Insurance v. United Companies Financial Corp. , 68 F.3d 914 ( 1995 )

United States Court of Appeals,
Fifth Circuit.
No. 95-10147.
In the Matter of FOSTER MORTGAGE CORPORATION, a Louisiana
Corporation, Debtor.
CONNECTICUT GENERAL LIFE INSURANCE COMPANY, et al., Appellants,
v.
UNITED COMPANIES FINANCIAL CORPORATION and Foster Mortgage
Corporation, Appellees.
Nov. 9, 1995.
Appeal from the United States District Court for the Northern
District of Texas.
Before REYNALDO G. GARZA, BARKSDALE and EMILIO M. GARZA, Circuit
Judges.
REYNALDO G. GARZA, Circuit Judge:
In this opinion, we consider the propriety of a compromise
settlement agreement between a debtor company Foster Mortgage
(Foster) and its parent corporation United Companies (United) in
Chapter 11 bankruptcy. Connecticut General Life Insurance Company,
representing unsecured creditors (the Noteholders) holding 95% of
Foster's indebtedness, opposed the settlement agreement.1 For the
reasons stated below, we vacate the settlement and remand for
further proceedings.
1
Foster had already paid its secured creditors by the time
of litigation. The unsecured creditors, now appellants in this
Court, were Connecticut General Life Insurance Co. on behalf of
itself and also on behalf of particular accounts, Cigna Property
and Casualty Insurance Co., Life Insurance Co. of North America,
Insurance Co. of North America, Cigna Mezzanine Partners, the
Franklin Life Insurance Co., Royal Maccabees Life Insurance Co.,
Southern Farm Bureau Life Insurance Co., and the Union Life
Insurance Co.
1
Background
Foster is a Louisiana corporation that engaged in the mortgage
servicing business from headquarters in Fort Worth, Texas from 1990
until 1993 as a wholly owned subsidiary of United. On December 31,
1992, the audited financial statement of Foster showed assets of
$111.7 million against liabilities of $89 million, for a positive
net worth of $22.7 million. Among those liabilities was
approximately $67.4 million of unsecured notes owed to the
Noteholders who had helped finance Foster's formation.
Unfortunately for the Noteholders, Foster's business precipitously
declined such that on May 28, 1993, at the request of United, the
plaintiffs restructured their notes by converting a portion of the
debt to preferred stock to assist Foster in maintaining a positive
net worth. Foster's fortunes did not improve, and in September and
November of 1993 it sold off its mortgage servicing portfolios,
thereby creating approximately $70-80 million of net operating
losses.
In December, 1993, the Noteholders filed an involuntary
Chapter 11 petition against Foster. At that time, Foster owed the
Noteholders $47.8 million. The Bankruptcy Court granted the
petition on February 10, 1994. The Noteholders moved to terminate
the debtor's exclusive period to propose a plan on May 23, 1994, so
that they could propose their own plan. This plan included a claim
for tax loss payments owed to the debtor by the parent company
United. Foster and United had operated under an agreement to file
consolidated tax returns as of January 1, 1990. As a result of the
2
tax agreement United was required to compensate Foster for a
portion of the net operating losses. United would use the losses
to offset income from the entire group of companies it owned.
On June 9, 1994, the Bankruptcy Court granted the Noteholders'
motion to terminate. That very same day, the debtor filed its plan
of reorganization. The debtor's plan was constructed around a
proposed settlement between the parent company and Foster,
releasing all claims against the parent company including but not
limited to the claims of the debtor under the intercompany tax
agreement. The proposed settlement consideration was $1.1 million.
Foster and United made a joint motion for approval of their
settlement agreement on June 29, 1994, to which the Noteholders
filed objections. The Noteholders meanwhile offered their Chapter
11 plan a day later on June 30, 1994. This plan proposed to
preserve the debtor's tax loss claims against the parent company.
The Bankruptcy Court held hearings on the compromise settlement
from August 16-18, 1994. The court denied approval of the original
$1.1 million settlement but subsequently gave its blessing to a
modified settlement for $1.65 million on September 8, 1994. The
district court affirmed the bankruptcy court approval and this
appeal followed. Both lower courts' approbation of the
parent-child agreement is the basis for the appeal now before us.
The question at the center of this dispute is how much Foster
should have been compensated by the parent for its $70-80 million
of losses. According to United, Foster's transfer of stock during
insolvency worked a deconsolidation for tax purposes such that
3
United was no longer responsible for loss compensation after the
transfer (May 28, 1993). The Noteholders argue that the parent
owed loss payments to the child for the entire year (in their
estimation, at least $3.5 million and as much as $28 million) and
that the bankruptcy court abused its discretion by approving the
arrangement. The Noteholders ask us to reverse to allow them to
litigate the issue of tax loss reimbursements. Because the
bankruptcy court abused its discretion by failing to show adequate
deference to the interests of the overwhelming majority of
creditors, we reverse.
Discussion
A. Standard Of Review
This Court should review the Bankruptcy Court's approval of
the compromise settlement for abuse of discretion. In re Emerald
Oil Co., 807 F.2d 1234, 1239 (5th Cir.1987); In re Jackson Brewing
Co., 624 F.2d 599, 602-603 (5th Cir.1980). The Bankruptcy Court's
conclusions of law are subject to de novo review but its findings
of fact may not be set aside by the reviewing court unless "clearly
erroneous." Sequa Corp. v. Christopher (In re Christopher), 28
F.3d 512, 514 (5th Cir.1994). An appellate court may reverse a
fact finding of the lower court only if left with "a firm and
definite conviction that a mistake has been committed." Sequa, 28
F.3d at 514.
B. Did The Court Abuse Its Discretion In Accepting This Settlement?
A bankruptcy court may approve a compromise settlement of a
4
debtor's claim pursuant to Bankruptcy Rule 9019(a).2 However, the
court should approve the settlement only when the settlement is
fair and equitable and in the best interest of the estate. Jackson
Brewing Co., 624 F.2d at 602; U.S. v. AWECO (In re AWECO), 725
F.2d 293, 298 (5th Cir.), cert. denied, 469 U.S. 880, 105 S. Ct.
244, 83 L. Ed. 2d 182 (1984). The judge must compare the "terms of
the compromise with the likely rewards of litigation." Jackson
Brewing, 624 F.2d at 607 (citing Protective Committee for
Independent Stockholders of TMT Trailer Ferry v. Anderson, 390 U.S.
414, 425, 88 S. Ct. 1157, 1164, 20 L. Ed. 2d 1 (1968)).
When considering a compromise settlement, courts have applied
various factors to ensure that the settlement is fair, equitable,
and in the interest of the estate and creditors. This circuit has
applied a three-part test. In specific, the bankruptcy court must
consider:
(1) the probability of success in the litigation, with due
consideration for the uncertainty in fact and law,
(2) the complexity and likely duration of the litigation and any
attendant expense, inconvenience and delay, and
(3) all other factors bearing on the wisdom of the compromise.
Jackson Brewing, 624 F.2d at 609.
While this Circuit has not elaborated on the "other factors
bearing on the wisdom of the compromise", we do so now. One such
2
Bankr.R. 9019(a), 11 U.S.C. (Supp.1995), provides: "On
motion by the trustee and after notice and a hearing, the court
may approve a compromise or settlement. Notice shall be given to
creditors, the United States trustee, the debtor, and indenture
trustees as provided in Rule 2002 and to any other entity as the
court may direct."
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factor relevant to the case sub judice is the fourth prong to the
famous test offered by the Eighth Circuit in Drexel v. Loomis: the
paramount interest of creditors with proper deference to their
reasonable views.3 This Circuit stated in Matter of Texas
Extrusion Corp., 844 F.2d 1142, 1159 (5th Cir.), cert. denied, 488
U.S. 926, 109 S. Ct. 311, 102 L. Ed. 2d 330 (1988), that "in the
bankruptcy context, the interests of the creditors not the debtors
are paramount."
While the desires of the creditors are not binding, a court
"should carefully consider the wishes of the majority of the
creditors." In re Transcontinental Energy Corp., 764 F.2d 1296
(9th Cir.1985). Several courts have incorporated creditor support
for a compromise as one of the factors in deciding whether to
approve a settlement. See, e.g., Reiss v. Hagmann, 881 F.2d 890,
892-893 (10th Cir.1989); Nellis v. Shugrue, 165 B.R. 115, 122
(S.D.N.Y.1994); In re MCorp Financial, Inc., 160 B.R. 941, 953
(S.D.Tex.1993).
In Reiss v. Hagmann, the Tenth Circuit vacated a settlement
3
This circuit's three-part test was derived from the
four-part test first announced in Drexel v. Loomis, 35 F.2d 800,
806 (8th Cir.1929) (articulating the factors as "(a) the
probability of success in the litigation; (b) the difficulties,
if any, to be encountered in the matter of collection; (c) the
complexity of litigation involved, and the expense, inconvenience
and delay necessarily attending it; (d) the paramount interest
of creditors and a proper deference to their reasonable views in
the premises."). For discussion of the Loomis test, see Jackson
Brewing Co., 624 F.2d at 609. For application of the four-part
test, see In re Justice Oaks II, Ltd., 898 F.2d 1544, 1549 (11th
Cir.), cert. denied 498 U.S. 959, 111 S. Ct. 387, 112 L. Ed. 2d 398
(1990); In re A & C Properties, 784 F.2d 1377, 1381 (9th Cir.),
cert. denied 479 U.S. 854, 107 S. Ct. 189, 93 L. Ed. 2d 122 (1986).
6
where there was only a single creditor, that creditor was able to
cover the costs of litigation and would receive nothing without
success in the lawsuit. 881 F.2d at 892-893. Citing the First
Circuit, the court observed that, "we have found no precedent for
a compromise ... actively opposed by the major creditors and
affirmatively approved by none." Id. (citing In re Lloyd, Carr &
Co., 617 F.2d 882, 889 (1st Cir.1980)). This suggests that a
bankruptcy court may not ignore creditors' overwhelming opposition
to a settlement. We believe a bankruptcy court should consider the
amount of creditor support for a compromise settlement as a "factor
bearing on the wisdom of the compromise," as a way to show
deference to the reasonable views of the creditors.
Another factor bearing on the wisdom of the compromise at
hand is the extent to which the settlement is truly the product of
arms-length bargaining, and not of fraud or collusion. Nellis, 165
B.R. at 122; MCorp Financial, 160 B.R. at 953; In re Present Co.,
141 B.R. 18, 21 (Bkrtcy.W.D.N.Y.1992). When a debtor subsidiary
settles a claim it has against a parent corporation without the
participation of the creditors, a bankruptcy court should carefully
scrutinize the agreement. In re Drexel Burnham Lambert Group,
Inc., 134 B.R. 493, 498 (S.D.N.Y.1991).
When we look to the record and decision of the bankruptcy
court below, we are not convinced that the lower courts considered
all factors bearing on the wisdom of the compromise. The
bankruptcy court made findings showing its consideration of the
first two factors found in Jackson Brewing. The court found that
7
"Foster or a trustee would have a limited chance of success on the
tax claims raised." The court concluded from the evidence put on
by the parties that a full-fledged trial on the tax issues would
take approximately seven trial days, would cost between $500,000
and $700,000 and would take two to three years to reach resolution.
Finally, the bankruptcy court found that the settlement offer was
"reasonably equivalent to the value of the claims released" and was
therefore "in the best interest of the creditors of the estate."
We do not pass on the bankruptcy court's finding on the tax
question. Our concern is that the courts below gave no
consideration to issues we find dispositive: that nearly all
creditors in interest opposed this settlement and that the
settlement was reached between insiders without the participation
of the creditors. In our estimation, the court abused its
discretion by not showing proper deference to the views of the
creditors.
As in Reiss v. Hagmann, the Noteholders, acting as one, have
opposed Foster's settlement and are willing to cover their
litigation costs. The Noteholders were and are prepared to bring
this tax claim that the debtor had against its parent company and
which it settled in haste as the creditors closed in.4 They are
willing to forego the $1.65 million received by Foster in favor of
uncertain litigation to establish Foster's right to greater loss
payments. The bankruptcy court below made no findings on creditor
4
The Noteholders stated on oral argument that they had
established a fund with which to finance the tax litigation.
8
opposition. We find this itself an abuse of discretion; the judge
failed to consider what in this case was nearly unanimous creditor
opposition to the settlement between parent and child.
The relationship between United and Foster troubles us as
well. United acted to settle its dispute with its child company
before even determining what tax savings it had actually received
from Foster's losses. The court below should have examined more
carefully this deal between parent and child. The relationship
between parent and child militates in this case against allowing a
settlement for considerably less than the creditors believe they
are owed and are willing to litigate for. This Court is not
surprised that the creditors oppose the settlement between parent
and child, the negotiation of which they were not a part.
The opinion of this Court does not preclude the consideration
of future possible compromise agreements of this claim. In
examining such a compromise, the bankruptcy court must consider the
"paramount interest of the creditors" and the nature of the
negotiations as factors bearing on the wisdom of the compromise.
The court's scrutiny must be great when the settlement is between
insiders and an overwhelming majority of creditors in interest
oppose such settlement of claims. While no magic words need be
spoken, there must be evidence that such factors were considered.
We are careful to add that we are creating no per se rule allowing
a majority of creditors in interest to veto a settlement. This
Court merely states that for failing to consider the overwhelming
opposition to the settlement and the familial relationship between
9
Foster and United, the bankruptcy court abused its discretion by
accepting this settlement.
Conclusion
Finding approval of the settlement agreement to be an abuse of
discretion, we REVERSE the district court and VACATE the settlement
between Foster and United and REMAND for further proceedings in
accord with this opinion.
10