Article/Intelligence
Court Opinion Review: Fifth Circuit Rejects Serta’s Equitable Mootness, Indemnification Claims; A Humble Houstonologist’s Reading of a Puzzling InfoWars Decision; Stay ‘Extensions’ Draw Criticism in Wellpath
Octus’ Court Opinion Review provides an update on recent noteworthy bankruptcy and creditors’ rights opinions, decisions and issues across courts. We use this space to comment on and discuss emerging trends in the bankruptcy world. Our opinions are not necessarily those of Octus, formerly Reorg, as a whole. Today we consider the implications of the Fifth Circuit’s Serta Simmons decision for equitable mootness and indemnification claims, the bankruptcy court’s decision to reject InfoWars’ proposed sale and magistrate-on-bankruptcy violence in Wellpath.
We have said, and will continue to say, entirely too much about the effect of the Fifth Circuit’s Dec. 31 Serta Simmons decision on uptier exchange transactions (tune in Jan. 14 at 12 p.m. ET for Episode One of our two-part LME webinar series), so here let’s focus on the potentially significant effects of the court’s equitable mootness and indemnification findings for bankruptcy cases. Significant if the complex panel in Houston chooses to heed them, that is.
Brief refresher: In March 2023, former judge David R. Jones issued a very casual, vibes-based summary judgment ruling in favor of the Serta debtors and the lenders that participated in their 2020 uptier exchange. Citing an expert on credit agreements – a certain Professor David R. Jones – Jones found that the “open market purchase” exception to pro rata lender treatment in the underlying credit agreement applied to a privately negotiated non-pro-rata uptier exchange with a select group of lenders, as a matter of law – disagreeing with a SDNY federal district judge’s earlier analysis of the exact same document.
Of course we were not surprised. The debtors presumably filed in Houston because they believed Jones or Judge Marvin Isgur would go their way and effectively reverse the district court – and would do so quickly. The debtors also likely filed in Houston because they suspected the judges there would confirm a plan that assumed the validity of the transaction and allocated virtually all reorganized value to the participating lenders (this was before Judge Marvin Isgur left the complex panel, rejoined the panel, found religion and took the issue seriously in Wesco/Incora).
The debtors also probably knew they had a good shot at pushing through extremely cynical plan indemnification provisions that ensured they would be on the hook for any damages awarded against the participating lenders in litigation after confirmation – cover for the participating lenders just in case Jones’ “I know an open market exchange when I see it” summary judgment decision didn’t hold up. This being the Fifth Circuit, they couldn’t get nonconsensual nondebtor releases – even before Purdue – so they built what was essentially a corporate self-destruct mechanism into the plan in the form of an indemnity that would force another filing.
But there was one catch: This scheme needed an appellate court to find that under the doctrine of equitable mootness, confirmation of the plan prevented either merits review of Jones’ execrable summary judgment decision or merits review of the propriety of the indemnification provisions.
If the former, great: Jones’ “reasoning” stands, and the excluded lenders’ breach of contract suit was done on the merits. If the latter, also great: The summary judgment decision could be reversed, but the reorganized debtors would be on the hook for any damages won by the excluded lenders, and they could simply file another chapter 11 and “restructure” the indemnification claims into oblivion. The debtors of course used the threat of an indemnification-fueled “chapter 22” to gently nudge Jones their way on summary judgment, as if he needed any further convincing.
This was a risky strategy, and not just in hindsight. First, there were pretty obvious issues with Jones’ ruling on the merits: Again, it basically found the exact opposite of a federal district judge in New York applying New York law. As for equitable mootness, there were signs the Fifth Circuit was looking to peg back the doctrine and make real appellate review of bankruptcy decisions a priority.
In August 2022 the Fifth Circuit issued a decision in Highland Capital striking exculpation provisions from the debtors’ confirmed plan, which we discussed in September 2022. Most importantly, the panel held that the “judge-made doctrine” of equitable mootness did not apply because it could simply red-pencil the offending exculpations out of the plan without reversing the reorganization.
Then, in October 2022, the Fifth Circuit issued its second decision in Ultra Petroleum requiring solvent debtors to pay unimpaired creditors make whole premiums and postpetition interest at the contract rate. No equitable mootness analysis here, but the ruling nevertheless emphasized that the Fifth Circuit has few qualms about upsetting debtor and creditor expectations after substantial consummation.
The Ultra decision also featured an interesting dissent from Judge Andrew Oldham, a member of the Federalist Society plain-language gang that we’ve been warning you about. Judge Oldham excoriated the majority for applying the old judge-created and “unwritten” solvent debtor exception after the enactment of the Bankruptcy Code, which clearly requires disallowance of unmatured interest without any solvency exception. “Neither the solvent-debtor exception’s historical pedigree nor its policy underpinnings – no matter how compelling – can overcome Congress’s clear, and clearer-than-ever, command on this point,” Judge Oldham wrote.
You can see where we’re going with this.
Which brings us to the unanimous opinion in Serta, penned by, you guessed it, Judge Oldham. There was considerable speculation that the Fifth Circuit would use Serta as an opportunity to kick Jones around for his, ahem, indiscretions, but Judge Oldham largely refrains from doing so – which we think makes the decision more ominous for the new and considerably less personally icky Houston complex panel. Instead of focusing on Jones, the panel more broadly takes the “bankruptcy court” to task for having “bought” the debtors’ blatant indemnity subterfuge.
According to Judge Oldham, the postpetition participating lender indemnity was an obvious attempt to resurrect prepetition indemnification provisions in the uptier exchange documents and an “end-run” around section 502(e)(1)(B) of the Bankruptcy Code, which generally requires disallowance of prepetition indemnification claims. Applying typical Fed Soc logic, Judge Oldham points out that there is no “textual hook” allowing a debtor to circumvent section 502(e)(1)(B) by recharacterizing prepetition contractual indemnification provisions as postpetition “settlement” indemnification provisions in a plan.
Specifically, the judge finds that section 1123(a)(3)(A) of the Bankruptcy Code, which allows a plan to include “the settlement or adjustment of any claim or interest belonging to the debtor or to the estate,” does not “affirmatively provide for the back-end resurrection of claims already disallowed on the front end” by section 502(e)(1)(B). Judge Oldham also rejects the debtors’ and participating lenders’ pretty feeble attempts to distinguish between the prepetition and plan indemnification provisions as “unpersuasive.”
A true Fed Soc Jedi might stop there, having made the minimum required findings to justify reversal – but Judge Oldham goes even further: He concludes that the indemnification provisions also violate section 1123(a)(4) of the Bankruptcy Code, which requires that all claims within a class receive the same treatment. This seems like a small part of the opinion, but its consequences could be massive.
According to Judge Oldham, in determining whether all members of a class receive equal treatment under a plan, the bankruptcy court must take into account the extrinsic value of any indemnification, exculpations or releases provided to the class members. The judge concedes that all members of classes 3 and 4 under the plan are covered by the indemnification provisions, but he says the indemnity only had real value for those class members that were threatened with litigation by the excluded lenders – and that additional value was so substantial as to improperly disadvantage the class members that were not threatened with suit.
Judge Oldham uses the example of Citadel, an appellant and member of classes 3 and 4 “that had no involvement with the uptier” and for whom “the indemnity was worth little or even nothing.” According to the judge, because of the potentially substantial damages covered by the indemnity and thus the additional value of the indemnity for the participating lenders, Citadel got screwed by the plan, even though on paper – in the “plain text” of the plan – Citadel received exactly the same treatment as the participating lenders.
This is pretty amazing stuff, right? Judge Oldham is saying that when determining whether a plan treats all creditors in a class equally, the bankruptcy court must not only consider whether they received the same stuff – reorganized equity, take-back paper, releases, indemnification etc. – but also whether the value of that stuff is equal for all of the class members, as allocated pro rata.
Reading value in this context to cover the economic substance at play rather than formalistic distinctions between creditors could have a lot of knock-on effects. There have been a lot of plans confirmed over much stronger disparate treatment objections than those at issue here.
For example, let’s assume a plan provides for releases in favor of all prepetition lenders, as is typical. The committee raises potential lender liability claims against the ad hoc lender group, but it drops them for a feeble settlement that gets its fees paid (not much of a stretch). A minority lender objects to the plan under section 1123(a)(4), arguing that the releases are only valuable to the prepetition steerco members named in the UCC’s standing motion, and worth nothing for minority lenders who were just riding along.
So, the minority lender argues, the plan must allocate additional value of another kind to non-steerco members to equalize treatment within the class. That seems bonkers! But that’s for later. For now, keep in mind that none of this stuff would matter if the excluded lenders’ appeal were equitably moot, as the participating lenders hoped. A few years ago, the participating lenders could probably expect an appellate court to buy their argument that the indemnity, even if legally unsupportable, could not be excised from the plan without blowing up the whole reorganization and sending the parties back to the bankruptcy court to start from scratch – so it had to stay.
Post-Highland, that just doesn’t work anymore, at least in the Fifth Circuit. Judge Oldham reinforces that conclusion in Serta by utterly savaging the doctrine of equitable mootness in the most Fed Soc-appropriate way possible. “At the threshold, we note that equitable mootness is a bit of a misnomer – much like green pastel redness,” the judge says, which, uh, OK. He contrasts “equitable mootness” with “real mootness” (not exactly subtle!) and calls it “judge-created.” He qualifies his equitable mootness analysis with: “to the extent equitable mootness exists at all.”
And he really crushes the participating lenders’ “parade of horribles” argument – that without the indemnity, they would not have supported the plan, and the company would have liquidated, and we would all be sleeping on straw mats instead of overpriced memory foam. “If endorsed, the appellees’ argument would effectively abolish appellate review of even clearly unlawful provisions in bankruptcy plans,” Judge Oldham says, which oh no, God forbid, no way, that’s literally the whole point of equitable mootness, he said it out loud!
“Parties supporting such provisions could always argue they would have done things differently if they had known the provisions would later be excised,” the judge continues, and “if we cannot excise specific provisions but must let the parties go back to square one – which we cannot do without destroying the underlying Plan – then the appellate courts are effectively stripped of their jurisdiction over bankruptcy appeals, despite Congress’s clear intent to the contrary.”
OK, guys, Judge Oldham is now an official Friend of the Show, Fed Soc Division, right there in the pantheon next to Sen. Josh Hawley.
So, what does this mean? This means that for a debtor, getting what you want out of the complex panel in Houston may not be enough. The Fifth Circuit may actually consider the legality of the goodies meted out in the plan on the merits, like the bankruptcy court is almost a Big Boy Court.
Which means more aggrieved creditors and shareholders might actually object to what debtors are doing down there, because they might get actual appellate review of the inevitable pro-debtor rulings, which really just …don’t … stop. And the panel in Houston might in turn have to take those objections a bit more seriously than “I know it when I see it.”
Is that Judge Michael Kaplan’s New Jersey walk-up music we hear? “Atlantic City,” we hope.
Business Judgment Blues
Speaking of Houston, Judge Christopher Lopez’s Dec. 11 decision rejecting a proposed sale of InfoWars to The Onion probably surprised those paying less close attention to the day-to-day action of the complex panel. After all, like we’ve said before, bankruptcy judges don’t tend to take objections to section 363 asset sales very seriously, especially when the debtor/trustee’s preferred buyer is not an insider, the most vocal creditors all support the deal and the objector is a disgruntled bidder standing in for an insider.
Generally, asset sales are rubber-stamped on the basis of the debtors’ reasonable business judgment, and that’s that. We’ve discussed the extremely lenient business judgment standard so many times we thought we might run out of words in this sentence for each of the links. Nice work, editors! Knowing this deference, disgruntled bidders generally object to the sale process rather than the price, but section 363 does not actually provide that any sale process is required, other than a motion and a hearing. There is no auction requirement – see our February 2024 discussion of the proliferation of private, non-auction sales – so what can the bidder really object to?
So why did Judge Lopez have such a problem with the specific auction process in the InfoWars case? Again: There’s no requirement that the trustee even hold an auction at all. So why reject a proposed sale because of the trustee’s decision – in his business judgment – to undertake a sealed bid process and hold a second and final written “highest and best” overbid round in lieu of a live auction? What was the basis for his conclusion that “I don’t think it’s enough money”?
Aren’t bankruptcy judges not supposed to second-guess a debtor’s business decision as to which bid is highest?
That’s the exact kind of judicial second-guessing (dare we say activism?) that you would think a self-professed “textualist” would avoid. How many times have Houston judges called a proposed DIP “expensive” and approved it anyway on business judgment grounds?
The popular press had a field day on this one, with The Onion on the side of justice against Alex Jones as the embattled husk of his former self abandoned by even MAGA true believers. We think that’s the wrong lens. Judge Lopez wasn’t making a political call here (as funny as that would be). Instead, we would whip out the old Occam’s razor and propose a simpler explanation: Judge Lopez decided not to apply the lenient business judgment standard to the proposed InfoWars sale because it was proposed not by the debtors but by a trustee, and was opposed by the debtors.
After so many mega-cases, a fellow can get a bit confused and forget that section 363 says “the trustee,” not the “debtor-in-possession,” may sell assets of the estate. Sure, section 1107 of the Bankruptcy Code says that the debtor-in-possession has all the rights, powers and duties of a trustee, but that doesn’t mean the business judgment of a debtor-in-possession is entitled to more deference than the business judgment of a trustee.
As newly minted “textualists” – thanks to Judge Oldham, the scales have fallen from our eyes – we would defer to the plain language of the statute: The trustee and debtor-in-possession are essentially the same for asset sale purposes and entitled to the same level of deference.
But we know that only the debtor’s business judgment and fiduciary duties carry much weight with mega-case judges – see our discussion of Yellow from June 2024. The business judgment and fiduciary duties of committees and trustees never get the same kind of laissez faire treatment as the debtors’ fiduciary duties and business judgment in big chapter 11 cases, unless, of course, the committee has taken the debtors’ deal to get its fees paid and supports whatever the debtor wants – in which case the fiduciaries have spoken and your argument, dear individual creditor, is invalid.
So in a rare case like InfoWars, where a trustee is in control of the estate and proposing a sale opposed by the debtor, it might be tough for a mega-case judge in Houston to shift their deference over from the debtors to the trustee. After years of applying the presumption that the debtor is always right, the reflex kicks in, and the trustee’s sale process gets scrutinized carefully by noted asset auction expert Christopher Lopez.
To be clear, we have no issue with bankruptcy judges applying a more stringent test than “business judgment” to bankruptcy sales and other debtor actions that require approval without specifying any kind of standard of review. For example, we have no beef with Judge Karen Owens recently badgering the Silvergate debtors into conducting a postpetition marketing process to check the debtors’ plan valuation rather than deferring to the prepetition process.
Nothing in the Bankruptcy Code specifies a business judgment standard, and anyway, isn’t the whole point of bankruptcy oversight that a higher level of scrutiny is appropriate than outside bankruptcy?
At the very least, we ask that bankruptcy courts apply the same standard, whatever it is, to debtors and other fiduciaries, including trustees and committees. Where the debtors’ business judgment comes up against a committee’s business judgment, then there should be no deference, and the court must apply a higher standard. Not too much to ask, right? You know better.
Here’s a new one for us: On Dec. 4, U.S. Magistrate Judge Kimberly G. Altman of the Eastern District of Michigan refused to recognize Judge Alfredo R. Pérez’s Nov. 12 amended interim order extending the Wellpath Holdings debtors’ automatic stay to protect nondebtor defendants from litigation. One non-Article III sub-district judge smacking down another non-Article III sub-district judge? Fantastic.
You will not be surprised to learn that Judge Altman’s ruling takes issue with some shenanigans in Houston. As we’ve discussed before, the first step in the mass tort bankruptcy playbook – heck, the playbook for any bankruptcy involving prepetition litigation, including (up until Dec. 31, 2024, maybe) uptier cases like Serta – involves securing a stay of litigation against nondebtor co-defendants, usually by citing the nondebtors’ right to indemnification from the debtor.
There are two sources of authority for these nondebtor litigation stays (to the extent there is any authority at all, post-Purdue): the automatic stay under section 362(a) of the Bankruptcy Code and the bankruptcy court’s equitable powers under section 105(a) of the Bankruptcy Code. Section 362(a) seems a poor fit; after all, a “textualist” reading of the statute clearly leads to the conclusion that the automatic stay only benefits debtors, not nondebtors.
However, the section 105(a) argument creates a procedural problem for debtors: To get an injunction under that section you have to, well, ask for an injunction. And to get injunctive relief, an adversary proceeding must be filed, in accordance with Federal Rule of Bankruptcy Procedure 7001(g). That means the debtor must file a complaint, file a motion, secure service of process, get a hearing, ugh, how very tiresome it all is. The debtor also has to satisfy the standard for a preliminary injunction – irreparable harm, balance of harms, public interest, what a drag.
So friendly mega-case judges tend to indulge debtors and issue nondebtor litigation stays very quickly on section 362(a) grounds, with only a motion on file. Typically, they cite the indemnification claims – which, as Judge Oldham reminded us in Serta, could be completely and totally worthless – as grounds for “extending” the stay to a nondebtor. The automatic stay applies, these judges “reason,” because if judgment is entered against the nondebtor, then the nondebtor would have an allowed claim against the debtor. Again, arguably bollocks, for a dozen reasons beyond section 502(e)(1)(B) – but that’s what they tell us.
That way the bankruptcy judge can avoid hearing evidence and making findings on those pesky injunction requirements at the first day hearing – come on, they got stuff to do. They can just enter an “interim” order that halts litigation against the nondebtors on the basis of the automatic stay and continue extending it indefinitely when the “interim” period runs out. For a good example, see Judge Lopez’s “temporary,” totally “interim” stay in the Tehum Care two-step case; for a contrary view, see Judge Jeffrey Graham’s decision (in the Southern District of Indiana) rejecting a nondebtor stay extension in the Aearo case.
You probably won’t be surprised to read that Judge Pérez went with the Judge Lopez approach – you can’t sit on a complex panel if no complex cases get filed in your district, after all – and we haven’t seen any big Indiana cases after Aearo, if you catch our drift. In his Nov. 12 order, Judge Pérez directs that all claims against the Wellpath nondebtors’ exhaustive list of co-defendants – including the doctors targeted in the Michigan case before Judge Altman – “are stayed in their entirety” on “an interim basis pursuant to section 362 of the Bankruptcy Code.”
Judge Pérez also set a “final” hearing on the stay for Dec. 24. See? It’s just “interim” – no big deal, no harm done! If you think that Dec. 24 hearing actually went forward, we’ve got some Hawk Tuah coin you might be interested in. On Dec. 20, the judge continued the hearing to Jan. 14. But for Judge Altman’s order, we suspect it would have been continued “temporarily,” every few months, until the confirmation of a plan or the heat death of the universe, whichever comes first.
(On Nov. 27, 15 days after Judge Pérez halted litigation against nondebtors for as long as he sees fit, the debtors filed an adversary complaint seeking injunctive relief protecting nondebtor management from ongoing litigation. But that only includes litigation against the CEO, not the other employees, which tells you what these injunctions are probably all about. The debtors intended to keep the “luxury” stay of claims against doctors in place with as little time and effort as possible, using endless extensions; the stay protecting the CEO seems to be much more serious business.)
But Judge Altman decided to throw a spanner in the works by flat-out refusing to enforce Judge Pérez’s Nov. 12 order, using a little bit of his own logic against him. As Judge Altman points out, bankruptcy judges only have concurrent jurisdiction to interpret the scope of the automatic stay; any judge can decide for themselves whether the stay applies to the case in front of them.
Because Judge Pérez cited only the automatic stay as support for his stay order, Judge Altman concludes that she has concurrent jurisdiction to disagree with him and interpret the stay more narrowly, as excluding claims against nondebtors, in the particular case before her. And she does disagree, citing the fact that, well, section 362(a) by its terms does not protect nondebtors.
According to Judge Altman, bankruptcy judges in the Sixth Circuit – which includes Michigan – lack authority to “extend” the stay to protect nondebtors, even on an interim basis. Thus, the judge concludes, she could not stay the litigation before her on the basis of a stay “extension” from the Houston bankruptcy court.
Judge Pérez’s interim order does not cite section 105(a), “set forth the preliminary-injunction factors” (including a substantial likelihood of success, danger of irreparable injury and balancing of the harms to the debtors and the claimants) or “contain any analysis on the subject,” Judge Altman points out. Absent a showing that a preliminary injunction is warranted, the magistrate concludes, “neither this Court nor the bankruptcy court can otherwise ‘extend’ the automatic stay to non-debtor defendants.”
Pretty clever, but we don’t expect much to come of it. We expect Judge Perez to make injunctive relief findings if the Jan. 14 hearing on the stay extension protecting employees goes forward, pulling the rug out from under Judge Altman’s bold gambit. At the very least, however, Judge Altman will have forced the bankruptcy judge to actually proceed with a real evidentiary hearing on the nondebtor stay, rather than entering another perfunctory extension while continuing the hearing until doomsday.
Like we suggested above in our Serta discussion, getting the Houston judges to adhere to real rules and real limitations would be a decided improvement from what often seems like ends-based jurisprudence.