Restructuring

Contributed by Maurice Horwitz
As noted in a prior blog entry, the recent decision of the United States Bankruptcy Court for the Southern District of New York denying confirmation of the plan of reorganization of Quigley Company contains many noteworthy rulings applicable outside of the asbestos context.  In re Quigley Company, Inc., 2010 WL 3528818 (Bankr. S.D.N.Y. Sept. 8, 2010).  One of these important rulings concerns the effect that third-party releases have on the chapter 7 liquidation analysis (otherwise referred to as the “best interest of creditors” test).

The “best interest” test, as set forth in section 1129(a)(7) of the Bankruptcy Code, requires the bankruptcy court to find that every holder of a claim or interest either has accepted the plan or would receive no less under the plan than what such holder would have received in a chapter 7 liquidation of the debtor.  Typically, satisfaction of the best interest test requires a comparison of the distributions proposed by the chapter 11 plan with the probable distributions that would be available to creditors if the case were converted to a chapter 7 liquidation.
One issue that plan proponents must address in preparing a chapter 7 liquidation analysis is what effect to give to potential claims against third parties on account of the debtor’s obligations.  In Quigley, Judge Bernstein held that, if the liability on account of the third party claims will be released or limited as a result of the plan, the liquidation analysis must take into account the value of the creditors’ claims against such third parties.  As Judge Bernstein notes, “the ‘best interest’ test is not limited to comparing distributions, i.e., the amounts that creditors will receive.  The express language of § 1129(a)(7) also requires [the court] to consider the value of the property that each dissenting creditor will retain under the plan and in the hypothetical chapter 7.”
At the heart of the Quigley plan was the protection of Quigley’s parent, Pfizer, from potential derivative liability for Quigley’s asbestos claims.  The 524(g) injunction to be issued under the plan would have protected Pfizer against claims by two types of Quigley asbestos claimants:  “Settling Claimants,” with whom Pfizer had entered into settlement agreements prior to the commencement of Quigley’s chapter 11 case and who had already received an initial settlement payment and granted Pfizer a release, and “Non-Settling Claimants,” who had neither settled with Pfizer nor granted Pfizer a release.
In a hypothetical chapter 7 case, a 524(g) injunction would not be available, and Pfizer would not receive any protection from the potential claims of the Non-Settling Claimants.  Although the court noted that Settling Claimants had released their claims against Pfizer prior to the petition date, “the confirmation of the [Quigley Plan] and discharge of Pfizer will affect the dissenting Non-Settling Claimants because they would ‘retain’ their right to sue Pfizer if Quigley were liquidated under chapter 7.”
The question for the bankruptcy court, therefore, was whether the value of these derivative claims should be considered when deciding whether the Quigley plan was in the best interest of the dissenting Non-Settling Claimants.  The Quigley court concluded that it must consider them, even though the claims were unliquidated and disputed, reasoning that they constitute “value,” meet the definition of “property,” and “are neither speculative nor incapable of estimation.”  Furthermore, they presently exist and would exist at the time of the date selected for valuation in a hypothetical Quigley chapter 7. ”  Once factored into the equation, the release of these derivative claims caused the Quigley plan to fail the “best interest” test.
Furthermore, almost as a corollary to the foregoing analysis, the court held that in effectively compelling the Non-Settling Claimants to surrender their potential derivative claims against Pfizer, the plan also failed the “equal treatment” requirement under section 1123(a)(4) of the Bankruptcy Code.  Part of this requirement is that each class member must “pay” the same consideration in exchange for its distribution.  The court concluded that eliminating the rights of the Non-Settling Claimants to pursue their derivative claims against Pfizer also resulted in “unequal treatment” for the Non-Settling Claimants, whose price of participation in the plan – surrender of their potential derivative claims against Pfizer – exceeded the price paid by Settling Claimants, who received consideration from Pfizer in exchange for a release.  “This conclusion is simply the flipside of the earlier conclusion that the [plan] violated the ‘best interest’ test.  The latter measured the ‘retention’ value of the derivative claims in a hypothetical Quigley chapter 7.  The ‘equal treatment’ standard measures the value of the same derivative claim in the price of participation….”
Clearly, as courts continue to narrow the circumstances in which they will approve non-consensual third-party releases, Quigley opens a couple of new fronts in this battle.  Not only must debtors in the Second Circuit continue to contend with the Metromedia test, which requires the bankruptcy court to find that “truly unusual circumstances render the release important to the success of the plan” – now, in addition, they may need to think more broadly about how third-party releases affect the other aspects and requirements for the confirmation of a chapter 11 plan.  Moreover, the issues raised by Quigley are not necessarily limited to non-consensual releases.  Plan proponents must bear in mind that, unlike acceptance of a plan (which is a class-based consideration), the best interest test must be satisfied as to any single creditor that has not accepted the plan.  Quigley leaves open, for example, what would happen in a situation in which a class of creditors has the power under an agreement to release third party claims, but such release is conditioned upon confirmation of the plan.  Under that scenario, courts will have to decide whether the hypothetical liquidation analysis should take into account the value of the third party claims that the class of creditors has consensually agreed to release as part of the plan.