Contributed by Danielle Donovan
By now (unless you’ve been living under a rock), we’re all familiar with the expression, “Netflix and chill.” It’s everywhere. Flooding your Instagram feed with duplicitous memes. Halloween costumes. Really, really bad pick-up lines. Like the many trite colloquialisms that have come before it, Netflix and chill’s ubiquity has begun to wane with overuse and time. One place totally devoid of the concept is a recent decision from the Bankruptcy Court for the Southern District of New York: In re Relativity Fashion, LLC. What you’re about to witness is a short film we’ll call “When the Court Said Netflix Had Absolutely Zero Chill.”
To understand what’s going on here, we have to rewind to the plan confirmation phase of the (now reorganized) debtors’ chapter 11 cases. The debtors established that their financial viability and the feasibility of their plan depended on the debtors’ ability to release and exploit two highly-anticipated films: “Masterminds” and “The Disappointments Room.” Key to this plot is the license agreement between the debtors and Netflix. The license agreement contemplated the debtors’ executing theatrical releases of the films prior to Netflix’s distribution of the films.
Fast forward a few scenes. Now we’re at the hearing on the reorganized debtors’ motion to compel Netflix to execute amendments to two notices of assignment issued under the license agreement. In short, the notices require Netflix to pay the debtors’ production lenders the payments owed by Netflix under the license agreement. Originally, “Masterminds” and “The Disappointments Room” were set to be released in October and August of 2015, respectively. In connection with the plan process, the debtors negotiated replacement notes for their production lenders, the terms of which included later release dates for both movies.
Netflix objected to the debtors’ motion to compel. First, Netflix argued that it had specifically bargained for the right to stream the films on the dates on which Netflix made payments under the notices of assignment. Netflix also contended that the current notices gave Netflix the right to stream the movies starting in June 2016, regardless of whether the movies were released in theaters before that time. What it boils down to is that Netflix did not like the time gap between when it had to pay the debtors’ production lenders and when it could exercise its rights to stream the films. Basically, Netflix wanted out of the license agreement.
In response, the reorganized debtors argued that Netflix should be barred from taking the positions set forth in the objection on grounds of res judicata and judicial estoppel . . . two very not-so-chill doctrines to have to defend against.
Res Judicata – Take One
Now is a good time to rewind to the debtors’ confirmation hearing. Netflix objected to the debtors’ plan and to the assumption of the license agreement under the plan. In its objection, Netflix took the position that the anticipated benefits of Netflix’s distribution were essential to the debtors’ survival and to the feasibility of the plan. As such, Netflix urged the court to make a determination as to whether the debtors had the ability to release the movies on the projected release dates. This was crucial, Netflix stated, because the debtors’ releasing the movies in theaters (and prior to Netflix’s distribution of the movies) was a material requirement under the license agreement. Let’s pause here for a crash course on res judicata.
In the Second Circuit, the test for whether a party is barred by res judicata is set forth in Corbett v. McDonald Moving Services, Inc. Courts must consider whether (i) the prior decision was a final judgment on the merits, (ii) the litigants were the same parties, (iii) the prior court was of competent jurisdiction, and (iv) the causes of action were the same. Additionally, bankruptcy courts should assess whether an independent judgment in a separate proceeding would “impair, destroy, challenge, or invalidate the enforceability or effectiveness” of the debtor’s plan.
Answering the first inquiry was easy – a confirmation order no doubt constitutes a final judgment on the merits. Confirmation of a chapter 11 plan binds a debtor and its creditors with respect to all of a plan’s provisions, including all related property and non-property-based claims that could have been litigated. Additionally, the court noted that a party who raises an objection to a plan “has interposed a claim for claim preclusion purposes.” A court’s confirmation order rejecting objections and finding that a plan meets the requirements under section 1129 of the Bankruptcy Code is a final adjudication of the issues necessary to reach that decision, and, therefore, a final adjudication that precludes inconsistent claims at a later time.
Answering the second and third inquiries also was easy – Netflix actively participated in (and, therefore, was a party to) the confirmation hearing, and the bankruptcy court certainly had competent jurisdiction to enter the order confirming the debtors’ plan.
To answer the fourth inquiry, courts in the Second Circuit examine whether the same transaction, evidence, and factual issues are involved in both proceedings. Whether res judicata applies ultimately turns on whether the party could have or should have asserted the claim in the earlier proceeding. In this case, the debtors’ ability to exploit the films and to reap the benefits under the license agreement “in the way projected, at the times projected, and in the sequence projected” were critical elements of the court’s feasibility finding. Indeed, Judge Wiles stated on the record that he would not have confirmed the plan but for the findings that the debtors had the legal rights and factual ability to release the movies in the manner projected.
Spoiler alert: when it comes to res judicata, there are no take twos!
A Foreshadowed Twist: Judicial Estoppel
In Newhampshire v. Maine, the U.S. Supreme Court outlined the factors that typically guide a court’s decision whether to apply the doctrine of judicial estoppel: whether (i) a party’s later position is clearly inconsistent with its earlier position; (ii) the party has succeeded in persuading a court to accept that party’s earlier position, such that judicial acceptance of the later inconsistent position would create the perception that the court had been misled; and (iii) the party seeking to assert an inconsistent position would derive an unfair advantage or impose an unfair detriment on the opposing party if not estopped. We should note that these factors merely serve as guidance. There is no one formula for determining the applicability of judicial estoppel. The key ingredient is presenting inconsistent positions to a court, which, as you may have guessed, is not very chill.
Let’s quickly rewind to Netflix’s objection to the debtors’ plan. See what Netflix did there? So did the court. Netflix objected to the debtors’ plan on feasibility grounds. Netflix argued that, under the license agreement, the debtors had to theatrically release the films by a certain date, and before Netflix could begin distribution. All of the parties agreed that feasibility of the debtors’ plan depended on the payments Netflix would make in exchange for its rights to distribute the films. Netflix, however, disputed the debtors’ ability to release the movies by the proposed released dates, and, as such, disputed the debtors’ ability to reap the vital benefits under the license agreement. In sum, Netflix argued that because the debtors would not be able to release the films, Netflix would not be able to stream the films, and, as a result, the debtors could not confirm their plan.
We’ve gotta fast forward again. Stay with us! As we noted, before the court was the reorganized debtors’ motion to compel Netflix to execute amendments to the notices of assignment. In its objection, Netflix contended that it had the right to stream the films starting in June 2016, even if the debtors had not theatrically released the films by that time. We don’t even need to rewind for you to see that Netflix took a totally different position in the plan confirmation scene. The court not only accepted Netflix’s original position that the debtors’ prior release of the films was required under the license agreement, but it also based its feasibility finding on the same. Indeed, the court saw the writing on the wall: Netflix just wanted out of the license agreement.
Spoiler alert: when it comes to judicial estoppel, there are no alternate endings!
There are a couple of things we should mention before we get to the closing credits:
In the wee hours of the morning of the hearing on the reorganized debtors’ motion to compel, Netflix filed a supplemental objection, arguing that, under Stern v. Marshall, the court did not have authority to issue a final ruling on the dispute. The court rejected this argument. First, the court reasoned that Stern could not intend to bar the court from enforcing its own prior orders or from making final rulings as to res judicata and judicial estoppel. Second, section 1142(b) of the Bankruptcy Code authorizes the court to direct Netflix to execute the amendments to the notices of assignment. Lastly, the court found that the issues raised in this case did not constitute an incidental counterclaim by the debtors; rather, they were issues raised by the debtors for the purposes of enforcing the confirmation order and the plan. End scene.
Arbitration Gets Cut
Unsuccessfully, Netflix argued that the dispute had to be sent to arbitration. Second Circuit case law instructs that courts must weigh the competing bankruptcy interests and arbitration interests when deciding whether to refer a matter to arbitration. In so doing, a court must make a particularized inquiry into the nature of the claim and the facts of the debtor’s bankruptcy case. Courts also must consider the objectives of the Bankruptcy Code, the goal of centralized resolution of purely bankruptcy issues, the need to protect creditors and the reorganized debtors from piecemeal litigation, and the power to enforce prior orders. This dispute was not merely incidental to the debtors’ post-emergence operations. The court equated Netflix’s position to a “collateral attack on the factual findings and distributions of property that were essential” to the debtors’ plan. Bankruptcy interests prevailed. Oh, one more minor detail is the court’s finding that this dispute was not even subject to an arbitration agreement. And, that’s a wrap!
One day when you’re at home streaming “Masterminds” or “The Disappointments Room,” we hope you’ll find some remaining humor in “Netflix and chill.”
Danielle Donovan is an Associate at Weil Gotshal & Manges, LLP in New York.