What is the price of confidentiality? This is the question the District Court for the Southern District of New York recently answered in In re Lyondell Chemical Co. when the court explored whether a debtor’s former employee was entitled to recover an administrative expense under a settlement agreement with a confidentiality provision. In a decision that runs the bankruptcy gamut—from analyzing the specific terms of a settlement agreement to considering the meaning of language found in a reorganization plan, the District Court for the Southern District of New York has issued a decision that teaches some key lessons to debtors and creditors, alike: (i) potentially, any prepetition agreement may be elevated, to some extent, to “administrative expense” status simply by virtue of it containing a confidentiality clause, if a court finds that maintaining the confidentiality of the agreement “conferred a benefit” on the debtor; and (ii) a debtor’s informal objection to a claim may be treated, for all relevant purposes, as a formal objection—highlighting the years’ long battle of form versus substance.
On December 23, 1994, Lyondell Chemical Co, C.A. Baldwin (a former employee of Lyondell) and Ann Baldwin entered into a confidential settlement agreement in connection with C.A. Baldwin’s departure from the company. The agreement provided that Lyondell would make monthly payments to the Baldwins in the amount of $5,208.33, with a final payment on February 1, 2012. Lyondell also agreed to provide Baldwin with a letter verifying his employment and employment terms that Baldwin could use in seeking subsequent employment. Importantly, the settlement agreement contained provisions that required the Baldwins to keep the settlement agreement confidential. Lyondell continued to make payments to the Baldwins until just before Lyondell filed for chapter 11 in January, 2009. Thereafter, Baldwin requested the employment letter, which Lyondell did not provide until several months later.
In the meantime, in October, 2009, the Baldwins filed a complaint in the bankruptcy court alleging that the payments Lyondell owed under the settlement agreement were nondischargeable and that Lyondell breached the settlement agreement by failing to timely provide the employment letter. The Baldwins attached a copy of the confidential settlement agreement to their complaint. Lyondell promptly requested that the Baldwins remove the settlement agreement from the public docket, but the Baldwins did not take any steps to do so. Thereafter, the Baldwins filed an amended complaint alleging that Lyondell had assumed the settlement agreement by seeking to enforce the confidentiality provisions therein and, once again, attached the settlement agreement to the amended complaint. Lyondell moved to dismiss. While Lyondell’s motion to dismiss was pending, the Baldwins filed an “assumption motion” essentially asking the bankruptcy court to recognize that Lyondell had assumed the executory settlement agreement. The “assumption motion” was largely duplicative of the allegations made in the complaint.
Several months later, the bankruptcy court confirmed Lyondell’s chapter 11 plan. The plan established a deadline for seeking payment of administrative expenses. The Baldwins timely filed an application for an administrative expense for “at least” $1.325 million based on the value of the remaining payments under the settlement agreement and Mr. Baldwin’s alleged lost earning potential that resulted from Lyondell’s delay in providing him with the employment letter. The bankruptcy court held that the settlement agreement was an executory contract and that Lyondell had neither assumed nor rejected the contract, thereby dismissing the assumption motion and amended complaint, insofar as the amended complaint sought a declaration that the agreement was an executory contract. The bankruptcy court gave Lyondell 30 days to assume or reject the agreement, and in the event Lyondell rejected the agreement, gave the Baldwins an additional 30 days from the date of the rejection to file a claim for rejection damages. Lyondell rejected the settlement agreement in February, 2011. The following day, Lyondell also filed an objection to the Baldwins’ application for an administrative expense.
That was not quite the end of motion practice for the Baldwins, who thereafter filed a motion to enforce the bankruptcy court’s Confirmation Order. Relying on a clause in Lyondell’s plan of reorganization, which provided that administrative expenses were “deemed allowed” unless objected to by December 27, 2010, subject to extensions by the bankruptcy court, the Baldwins argued that because Lyondell did not object to their request for payment of the administrative expense until February, 2011, the $1.325 million administrative expense was “deemed allowed.”
The Bankruptcy Court
The bankruptcy court rejected the Baldwins’ arguments, characterizing them as “lunacy.” Although Lyondell should have expressly objected to the classification of their administrative expense claim before the objection deadline, the court recognized that Lyondell had already argued in its briefing on the motion to dismiss and assumption motion that Baldwin was not entitled to any administrative expenses. Thus, the court concluded that the Baldwins and the court were clearly aware of Lyondell’s objection to the Baldwins’ claim. Moreover, the bankruptcy court concluded that it had the ultimate authority to determine whether the administrative expenses sought by the Baldwins were properly characterized as such, regardless of whether Lyondell followed the objection procedures provided in its plan.
Finding that Lyondell treated the settlement agreement as if it contained “nuclear launch codes,” despite the court’s skepticism that Lyondell would be harmed by the disclosure of the settlement agreement, the court determined that Lyondell had received a benefit during the time, postpetition, that the Baldwins kept the agreement confidential. The nine-month postpetition period ended, however, once the Baldwins attached the agreement to their complaint in October, 2009. Instead of conducting discovery to ascertain the value of that confidentiality, the parties agreed that it was equal to nine months of monthly payments under the contract. Because Lyondell received such benefits after filing for chapter 11, the court classified the claim for that amount as an administrative expense. The claim for the balance of payments due to Baldwin, however, was classified as a general unsecured claim.
The Baldwins appealed.
The District Court
The district court affirmed the bankruptcy court’s holding. Among other things, the court found that the Baldwins’ claim was properly subjected to judicial review and was not “deemed allowed” as of the objection deadline, the Baldwins were entitled to an administrative expense for the nine months postpetition that they kept the agreement confidential, and the Baldwins were not entitled to interest on the administrative expense. The court began its analysis by citing to section 365 of the Bankruptcy Code, which allows a debtor to assume or reject an unexpired lease or executory contract (which is a contract on which performance remains due on both sides). Citing to the Supreme Court’s N.L.R.B. v. Bildisco and Bildisco, the district court noted that a debtor assumes a contract cum onere, that is, with all of its burdens. The court further stated that a debtor who “elects to receive benefits under the contract while deciding to reject or accept” it, must pay for the “reasonable value of those services,” and the counterparty will be entitled to “administrative expense priority for the benefits it provides under the contract during that period.”
The Claim Was Properly Subjected to Judicial Review
The district court held that Lyondell’s failure to object to the administrative expense application by the plan objection deadline did not result in the allowance of the administrative expense against Lyondell. Despite the absence of a formal objection, the Baldwins had adequate notice that Lyondell opposed such classification through Lyondell’s various pleadings. The district court observed that the Baldwins had sought payment of their alleged administrative expense during a “hotly contested adversarial proceeding,” and Lyondell’s position throughout the litigation clearly reflected its intention that the Baldwins were not entitled to administrative expense priority. Moreover, even if such opposition did not amount to a formal objection, the plan expressly provided that the objection deadline could be extended by the bankruptcy court. The district court found that the bankruptcy court so extended the objection deadline when it provided Lyondell with an additional three months within which to assume or reject the agreement. As the nature and viability of the Baldwins’ claim hinged on whether Lyondell had assumed or rejected the agreement, the court’s extension effectively extended Lyondell’s time to object to the claim as well. An actual objection, the court noted, would have been nothing more than a formality.
Moreover, the court observed that any other reading would have rendered the bankruptcy court’s decision meaningless. If the Baldwins’ claim had already been deemed allowed because Lyondell did not object, the court’s order, which gave the Baldwins 30 days from the rejection date to file a claim arising from or related to the settlement agreement, would have served no purpose. Additionally, the district court noted, case law interpreting section 503(b) of the Bankruptcy Code, which provides that administrative expenses shall be allowed after notice and a hearing, requires that administrative expenses be subject to judicial scrutiny. Thus, the bankruptcy court properly subjected the Baldwins’ claim to judicial scrutiny.
The Baldwins Were Entitled to an Administrative Expense for Maintaining the Confidentiality of the Settlement Agreement Postpetition
The district court noted that the bankruptcy court found the Baldwins provided a benefit to Lyondell by preserving the confidentiality of the settlement agreement. Lyondell did not challenge this finding on appeal. Consequently, the only question was whether that benefit continued after the Baldwins publicly filed the agreement through the date Lyondell rejected the settlement agreement (which was what the Baldwins contended). The district court found that the benefits conferred by the Baldwins on Lyondell ceased when they filed the settlement agreement—with that public filing, the “genie [was] out of the bottle.” Accordingly, the Baldwins were only entitled to an administrative expense for the nine months postpetition in which they maintained the confidentiality of the agreement, which value was equal to nine monthly payments under the agreement, and a sum to which the parties had stipulated.
The Baldwins Were Not Entitled to Interest on Their Administrative Expense
The Baldwins asserted that the “value” of postpetition benefits they conferred upon Lyondell should have included an adjustment for the time value of money. Relying on Second Circuit law, the district court held that whether to award prejudgment interest is within the discretion of the district court. Courts consider several factors in making this decision, such as the need to fully compensate the wronged party for actual damages suffered, fairness and the relative equities of the award. Accordingly, the district court noted that an award of prejudgment interest is not required by applicable bankruptcy law. Yet, even if the court were to apply such factors, the court found that they did not favor an award of prejudgment interest in this case. The amount the Baldwins were to receive was sufficient to compensate them for the nine months they kept the settlement agreement confidential postpetition.
It is unclear whether the district court would have concluded as it did if Lyondell had challenged, on appeal, whether the Baldwins had conferred a benefit on Lyondell by maintaining the confidentiality of the settlement agreement for several months. (Perhaps it was because Lyondell treated the agreement as if it had “nuclear launch codes” that the bankruptcy court was inclined to find that maintaining the agreement’s confidentiality was a benefit to Lyondell.) Certainly, Lyondell might have argued that any benefit conferred on it was eviscerated the moment the settlement agreement became part of the public record. Alternatively, Lyondell could have sought damages resulting from the disclosure. Because, however, Lyondell conceded the benefit issue, the only issue remaining for the district court to decide was the extent to which the Baldwins had conferred the benefit.
Lyondell teaches debtors and creditors two important lessons. First, do not let the “genie out of the bottle.” By preserving the confidentiality of an agreement that contains a confidentiality provision, creditors may not only avoid breaching such provision, but ultimately may be found to have conferred a benefit on the debtor—a benefit for which they may be compensated (maybe even as an administrative expense). Second, creditors should appreciate that timely, but informal, objections to claims may, depending on the circumstances, be sufficient to withstand an objection deadline.