Restructuring

Contributed by David G. Litvack
Being one of the first defendants to settle claims has its pros and cons. On the one hand, defendants may avoid protracted litigation. On the other hand, future defendants may ultimately negotiate lower settlement amounts. To avoid “leaving money on the table,” defendants who settle early may seek to include an equal treatment provision, or “most favored nations” (MFN) clause, into the settlement agreement. Although MFN clauses vary, these provisions often enable a defendant to recover some or all of the difference between the amount at which it settled and the negotiated settlement amount reached by a later defendant. Of course, as with all legal agreements, the devil is in the details. A recent ruling in In re Madoff highlights the importance of carefully drafting every MFN clause.
In Madoff, the SIPA trustee asserted that two defendants had withdrawn money from Bernard L. Madoff Investment Securities LLC accounts within the 90-day preference period set forth in section 547 of the Bankruptcy Code. (We have discussed the Madoff Ponzi scheme and ensuing bankruptcy proceeding most recently here and here.) The defendants and the trustee eventually negotiated a settlement agreement in which the defendants agreed to pay 85% of the preference claim amounts sought by the trustee. The settlement agreement also contained an MFN clause, which required the trustee to refund a portion of the settlement amount if the trustee entered into a similar future settlement with any other defendant for a lower settlement percentage. The potential refund under the MFN clause hinged on a requirement that the future settlement involve similar claims and similar circumstances. The MFN clause included the following non-exclusive factors for determining whether the circumstances of the future settlement were similar:

(i) the ability of the defendant (or group of defendants, taken as a whole) to pay, (ii) the nature of the Avoiding Power Claims (such as whether they are for recovery of a preference or for recovery of principal or fictitious profits), (iii) the jurisdictional connections of the defendant . . . , (iv) the knowledge of the defendant (or group of defendants, taken as a whole) or its or their complicity in the fraud that BLMIS perpetrated on its customers, and (v) the stage of any litigation by the Trustee against the defendant (or group of defendants, taken as a whole).

Several years after the original settlement, the trustee settled certain avoidance and common law claims against JPMorgan Chase & Co. and affiliates for approximately 76% of the amount sought by the trustee. Thereafter, the original settling defendants, relying on the MFN clause in their settlement agreement with the trustee, sought a partial refund of their settlement payment. In asserting that the settled claims were similar and the factors in the MFN clauses favored them, the original settling defendants argued that (1) JPMorgan’s ability to pay gave the trustee no incentive to settle for a lower percentage, (2) jurisdictional connections did not favor JPMorgan as the original settling defendants were Bahamian companies with no assets or presence in the U.S., (3) evidence of JPMorgan’s knowledge of Madoff’s scheme was implicitly reflected by a deferred prosecution agreement entered into by JPMorgan with the U.S. Attorney for the Southern District of New York, and (4) the original settling defendants settled with the trustee before a suit was filed, but JPMorgan settled years after the litigation began. The original settling defendants conceded, however, that the “nature of the claims” factor favored the trustee because the claims were not similar.
In response, the trustee primarily argued that the MFN clause only applied to settlements of “simple preference claims.” The court rejected this contention outright, finding that because the criteria for determining similarity between settlements specifically mentioned the nature of the claim, the MFN clause could encompass future non-preference settlements. Nevertheless, the court held that the JPMorgan settlement did not trigger the MFN clause because the “nature of the claims” was too different. According to the court, the claims asserted against the original settling defendants were preference and fictitious profits claims in the nature of strict liability, whereas the claims against JPMorgan were “of a different and more demanding ilk,” mainly involving fraudulent transfer claims, which were more difficult to prove with a less certain outcome than the preference claims. Based on this distinction, the court concluded that the JPMorgan settlement did not trigger application of the MFN clause.
Although the parties heavily negotiated the MFN clause with multiple drafts going back and forth between counsel, it appears that both parties had different subjective meanings with respect to when the clause would be triggered. Unfortunately, any ambiguity in a contractual provision can be a recipe for disaster.