Judge Wiles Rules Mercon Coffee Plan Releases Are Prohibited Transfers Benefiting ‘Insiders’

Relevant Document:
Memorandum Decision

Judge Michael E. Wiles issued a decision today denying releases granted under the Mercon Coffee debtors’ fourth amended plan of liquidation to a subset of officers and directors. The judge concluded that to the extent such individuals are insiders, the releases are postpetition “transfers” of estate claims subject to section 503(c) of the Bankruptcy Code, which prohibits retention bonuses or payments.

The U.S. Trustee originally objected to the releases on the basis that they lacked adequate consideration. At confirmation, Judge Wiles himself questioned whether the releases were, in fact, impermissible retention payments under section 503(c).

The debtors argued that section 503(c) of the Bankruptcy Code is “inapplicable or, if it does apply it does not preclude” releases under a plan, contending instead that the releases were governed by section 1123(b)(3) of the Bankruptcy Code and Bankruptcy Rule 9019, which apply the more relaxed “business judgment” standard as opposed to the more restrictive requirements of section 503(c).

The confirmed plan identifies 19 individuals as the beneficiaries of releases for “all claims of any kind.” However, if any released party is also an insured person under a D&O policy, the release is limited to “the liability of any such party or person that exceeds the proceeds of the D&O Policies.” The release does not extend to fraud, gross negligence or willful misconduct.

According to the debtors, the released parties are individuals who “made significant contributions to … attempted sale and financing activities or went above and beyond in their efforts to maximize the value of assets as [the debtors] liquidated them,” did not have managerial control “outside of their local country,” and did not have direct responsibility or control of the global company or its finances. The debtors have also stated that they believe “there would be no tangible economic benefit” in pursuing the released parties because they are located outside the United States, and the expense of obtaining and enforcing a judgment “would not make sense.”

Judge Wiles says that, after reviewing the record, the debtors’ explanations for the proposed releases where “somewhat difficult to pin down,” noting that it was initially unclear whether the releases were being proposed as “bonus” for prior work or whether the debtors were seeking the approval of releases in “fulfillment” of a prior deal. The “primary justification” for the releases offered by the debtors for the releases, Judge Wiles writes, was that “some of the recipients had threatened to terminate their employment if the parties did not commit to seek the releases,” and the debtors agreed to provide the releases in order to “keep the company from going into a Chapter 7 liquidation.”

Parsing the statute, Judge Wiles identifies 503(c)’s clear prohibition that any “transfer” or “obligation” for the benefit of an insider “for the purpose of inducing such person to remain with the debtor’s business” cannot be “paid.” He emphasizes that the statute applies to all “post-petition ‘transfers’ and ‘obligations’ generally, not just to cash payments.”

“Surely nobody would contend,” Judge Wiles writes, “that section 503(c) could be evaded just by agreeing to provide an insider with some form of property other than cash, such as a new home or a new car” (emphasis added).

Judge Wiles further observes that “there is no contention” that the proposed releases are in consideration of any post-confirmation work that the released parties “might provide” because the parties “admittedly” agreed to provide the releases “in order to induce continued employment.” Additionally, the debtors have “conceded,” Judge Wiles writes, that “the more exacting standards of section 503(c) have not been met.”

Judge Wiles adds that although It was “clear” at confirmation that “only some of the purported releasees” were insiders, the relevant portion of the hearing transcript where debtors’ counsel identified the persons who were insiders is “garbled” with respect to which releases allegedly had no management responsibilities. The court directs the debtors and the UST to confer and identify which proposed releasees are insiders, adding that the court would make determinations to the extent that no agreement is reached.