Restructuring

Five years after Quigley Company, Inc., a subsidiary of Pfizer, Inc., filed for chapter 11 protection seeking to confirm a “prenegotiated” plan of reorganization, Bankruptcy Judge Bernstein of the Southern District of New York denied confirmation of Quigley’s latest plan.  In re Quigley Company, Inc.,  2010 WL 3528818 (Bankr. S.D.N.Y. Sept. 8, 2010). 
Other important aspects of the memorandum decision have already been covered in related posts.  This post focuses on Judge Bernstein’s conclusion that the plan was not proposed in good faith under section 1129(a)(3) of the Bankruptcy Code, to which Judge Bernstein devotes a good part of his decision.  In a warning shot to parties that attempt to assure the outcome of a vote on a chapter 11 plan by making side deals with a subset of affected creditors, Judge Bernstein ruled that Quigley’s plan was proposed in bad faith, ignored the underlying principles of the Bankruptcy Code, and achieved acceptance through an engineered vote.  Understanding the rationale behind this decision requires some factual context.

In 1968, Pfizer, a well-known research-based global pharmaceutical company that develops and manufactures prescription medicines, acquired Quigley, a manufacturer of certain asbestos-related products.  At the time, Pfizer also manufactured a limited range of asbestos-related products, and both Pfizer and Quigley subsequently discontinued their asbestos-related businesses, with Quigley ceasing to operate as a going concern altogether.  
Judge Bernstein concluded that in the time leading up to Quigley’s chapter 11 filing, Pfizer changed its strategy for dealing with asbestos personal injury claims arising from Quigley’s operations.  As Judge Bernstein describes in his decision, Pfizer first sought to resurrect Quigley, its now non-operating wholly-owned subsidiary, as an independent operating entity, with the goal of filing a chapter 11 case that would involve a channeling injunction in Pfizer’s favor under section 524(g) of the Bankruptcy Code.  Second, Pfizer changed the way in which it entered into settlement agreements with asbestos personal injury claimants to settle derivative claims against Pfizer on account of Quigley’s asbestos-related liabilities.
Although Pfizer previously had settled Quigley-related asbestos claims against it, the new settlement agreements only sought to release Pfizer from liability to claimants (regardless of whether claimants had asserted a claim against Pfizer) and avoided settling Quigley’s liability at the same time.  This approach was a departure from Pfizer’s historical practice of settling liability for both itself and Quigley at the time it resolved a Quigley-related asbestos claim.  Judge Bernstein viewed the potential release of Quigley under these prepetition settlement agreements as an additional step that Pfizer and Quigley would have been able to achieve at little additional, if any, incremental cost.  Crucially, the settlement agreements also conditioned part of the settlement payments to claimants on the successful confirmation of a Quigley plan of reorganization that included a 524(g) channeling injunction in Pfizer’s favor. 
The court concluded that the prepetition settlement agreements were clearly engineered to ensure that settling claimants had no incentive to do anything other than vote to accept any Quigley plan of reorganization:  if settling claimants voted in favor of a plan of reorganization that was successfully confirmed, they would receive a second payout (albeit one that, as a result of subordination provisions in the plan, would in effect reduce any payout they would be entitled to receive under Quigley’s plan of reorganization to 10% of the original claim against Quigley);  if they voted against a plan of reorganization, and the plan was not confirmed, they would receive nothing.  Given that settling claimants already had received a payout on the settlement agreements, and with the additional payments structured to look like a bonus payment, the outcome was virtually guaranteed in Quigley’s favor, regardless of the plan of reorganization proposed. 
In fairly stark terms, Judge Bernstein determined that Quigley’s chapter 11 filing was a bankruptcy filing in Quigley’s name only, noting that Pfizer was “the architect of the global strategy, the only source of chapter 11 and plan financing and the principal beneficiary of the channeling injunction, [and the] real proponent of the plan.”  As a result of having put into place settlement agreements that, in Judge Bernstein’s view, effectively bought enough votes to assure that any plan of reorganization would be accepted, Pfizer was also found to have manipulated the voting process on Quigley’s plan of reorganization to assure its confirmation, with the obvious intention of gaining the benefit of a channeling injunction for itself.  This strategy did not succeed, and Judge Bernstein ruled that the proposed plan of reorganization was not proposed in good faith, as required by section 1129(a)(3) of the Bankruptcy Code, and therefore would not be confirmed.  
So what now? Judge Bernstein helpfully notes in his memorandum decision that Quigley had the legal means of confirming its plan of reorganization, and Pfizer had the legal means to obtain the benefit of channeling injunction it sought, without the need to engineer the vote on Quigley’s plan of reorganization, by doing one or more of the following:

• bypassing the settlement agreements entirely and increasing its contribution to an asbestos trust put in place to settle asbestos related liability, in a like amount, to be shared equally between all present and future claimants;
• entering into settlement agreements that included a release for both Quigley and Pfizer; or
• separately classifying settling claimants and non-settlement claimants and requiring that each class accept the plan of reorganization, thus removing any suggestion that the settlements influenced the outcome of voting.

This decision ultimately affirms that distressed companies and their advisors, when determining their preferred workout strategy, must not lose sight of the underlying principles of the Bankruptcy Code in the pursuit of their strategic objectives.  Proposing a plan of reorganization that has been designed not to fail may be an attractive option for a debtor and its affiliates, but as Judge Bernstein makes clear, the plan must still serve the primary purposes of the Bankruptcy Code, such as rehabilitating a debtor, preserving going concern value, and maximizing property available to satisfy creditors, and acceptance of the plan should not simply be achieved through clever structuring and applied game theory.