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Chapter 11 Plan Confirmations and Mediation: The Need For Uniformity Under the Bankruptcy Code

Chapter 11 Plan Confirmations and Mediation: The Need for Uniformity Under the Bankruptcy Code

Matthew Akiba, Barakat + Bossa, PLLC

  1. Introduction

“[B]ankruptcy itself is a form of alternative dispute resolution.”[1] One would think that alternative dispute resolution (“ADR”), more specifically, mediation, would be regularly employed by all Bankruptcy courts given the cost and time constraints imposed on debtors who have resorted to Bankruptcy in the first place. Indeed, the main goal of a Chapter 7 proceeding is “to provide certain debtors who are facing severe hardship with the ability to obtain a ‘fresh start,’ free of creditor harassment, the threat of lawsuits, and overwhelming debt.”[2]

The success of many Chapter 11 proceedings on the other hand, depends on the interested parties’ willingness to reach a negotiated settlement of their claims against the debtor.[3] Why then, do only 51 out of the 94 Bankruptcy courts in the United States authorize the use of mediation,[4] and why is ADR only permitted through the promulgation of local rules[5] as opposed to a uniform rule in the Federal Rules of Bankruptcy Procedure? This article will explore the use of mediation through the lens of Chapter 11 proceedings and seek to explain why a uniform rule would bolster the use of ADR in bankruptcy proceedings in the United States.

  1. Common Chapter 11 Disputes: Contested Matters vs. Adversary Proceedings

 

            From the outset, it is important to note the primary purpose of a Chapter 11 case and the types of disputes that arise once a Chapter 11 is filed. Chapter 11 cases leave much for lawyers to do as opposed to a Chapter 7 case where, “most of the important decisions . . . have been made by Congress and set out in the Bankruptcy Code.”[6] A typical Chapter 11 case calls for a wide-ranging restructuring of the debtor’s finances and that a plan for payment of the creditors will be negotiated between the debtor and creditors to be approved by the bankruptcy court.[7]

Within the ambit of a Chapter 11 case, there are mainly two categories of disputes where ADR mechanisms can regularly be used. First there are “adversary proceedings,” which are separate lawsuits that are initiated by a familiar complaint and answer, mirror a typical civil litigation, and are specifically enumerated in Bankr. R. 7001.[8] Second are “contested matters,” which are more common and “involve more straightforward issues that typically need to be resolved before the bankruptcy case can move forward.”[9] The confirmation of a Chapter 11 plan is an example of a contested matter.[10]

This distinction matters in this context because Bankruptcy courts place restrictions in their local rules on the types of matters that can be resolved through mediation based on what type of dispute it is. For instance, of the 51 courts that authorize mediation five authorize mediation solely for adversary proceedings; fifteen courts authorize mediation solely for contested matters and adversary proceedings; and the rest take a “broader approach, permitting the use of mediation ‘in any dispute’ that arises in the case.”[11] Accordingly, in those bankruptcy courts that permit mediation only for adversary proceedings and contested matters, mediation will not be an option in those instances where plan negotiations in a Chapter 11 case are not classified as either.[12] Luckily, the Bankruptcy Courts for the Southern, Middle, and Northern Districts of Florida all expressly authorize the use of mediation.[13] However, the Northern District limits its mediation procedures to adversary proceedings and contested matters.[14]

Chapter 11 payment plans are negotiated between the parties and are subject to the approval of the bankruptcy court. Mediation may help in this often complicated endeavor given the fact that mediation entails: (1) the contribution of an impartial third party; (2) “the participants need not reach an agreement”; and (3) “the mediator has no power to impose an outcome.”[15] Accordingly, the debtor and the debtor’s creditors are able to efficiently reach an agreement on a Chapter 11 payment plan through the use of mediation without infringing on the court’s sole authority to approve the plan because the mediator has no binding authority. Given the wide latitude for the use of ADR and its success thus far in Chapter 11 cases, it is surprising that parties in nearly half of the bankruptcy courts in the United States who are facing financial ruin do not have access to ADR[16] and thus, are unnecessarily relegated to lengthy and costly litigation which only diminishes the estate and the amount that can be repaid to creditors.

  • Authority to Employ ADR and the Lack of Uniformity Amongst the Local Rules

 

            The lack of Bankruptcy courts that have an official ADR program may be the result of the absence of a uniform rule governing when to refer parties to ADR and confusion as to where that authority is to be derived from.[17] The ADR Act of 1998 states that: “each district court shall authorize, by local rule . . . the use of alternative dispute resolution processes in all civil actions, including adversary proceedings in bankruptcy, in accordance with [the ADR Act].” To add to the confusion, the Judicial Conference “has neither considered the question of whether the ADR Act’s requirements apply to bankruptcy courts nor suggested how the requirements should be interpreted.”[18] Thus, while it is unclear whether bankruptcy courts can look to the ADR Act for authority to use ADR, it is clear that the ADR Act does not bar bankruptcy courts from authorizing ADR programs.[19]

In fact, bankruptcy courts regularly use their district’s ADR programs or refer the parties to ADR on an ad-hoc basis absent a defined ADR program.[20] More importantly, of the courts that use ADR, only forty explicitly permit—by local rule or standing order—judges to order the parties to commence ADR, which is less than half of the bankruptcy courts in the United States.[21] More perplexing still is that in a 2009 survey, 81% of bankruptcy judges “reported having used or permitted [mediation] in a chapter 11 proceeding” and 69% of judges were favorably inclined to use mediation in Chapter 11 cases.[22] Given that the use of ADR in bankruptcy is overwhelmingly governed by local rules, mediation is often used in a variety of different ways depending on the district the bankruptcy court is located in and when it is employed, “its use may vary from judge to judge, even within a single court.”[23] Accordingly, in as early as 1995, Ralph R. Mabey et al. called for “a consistent standard for the use of mediation and a unifying procedural framework”[24] which will be discussed in more depth in section V below.

  1. Effective use of ADR in “Mega” Chapter 11 Bankruptcies

            On February 18, 2020, the Boy Scouts of America filed for Chapter 11 bankruptcy in the Delaware Bankruptcy Court, following nearly 1,700 sexual abuse claims and the number is expected to grow.[25] The organization listed its liabilities as ranging from $100 million to $500 million and estimated its assets between $1 billion to $10 billion.[26] Importantly, the Boy Scouts have asked a federal bankruptcy judge to serve as an independent mediator to negotiate a payment plan between the parties.[27] This request was granted given that the Delaware bankruptcy court authorized mediation, other ADR, and Court-ordered mediation pursuant to Local Rule 9019(2)-(3), (5) respectively.[28] Indeed, “Judge Silverstein agreed to appoint three mediators to assist the Boy Scouts of America and its stakeholders, including abuse survivors, insurers, and other important parties in the case, as they work to resolve complex issues in connection with the Chapter 11 plan of reorganization.”[29] As of August 2021, it appears that the mediation efforts have proven somewhat successful in that, Judge Silverstein approved an $850,000,000 Restructuring Support Agreement entered into between the Boy Scouts of America and nearly 250 local councils and law firms representing approximately 70,000 former scouts who allege they were molested.[30]  Whether the outcome of this mediation will be successful is still in the air, but other “mega” Chapter 11 mediations have received praise for their swift and cost-effective outcomes.[i]

In mega-Chapter 11 cases such as the Boy Scouts case, bankruptcy courts are often driven to use ADR out of necessity to resolve large mass tort claims.[31] In such cases, the debtor business has amassed hundreds if not thousands of personal injury claims against it and “[r]esolving these claims for distribution, or to establish feasibility of a Chapter 11 plan for confirmation purposes, rests with the court, the debtor, and the claimants.”[32] In these situations, bankruptcy courts use mediation programs to get to a negotiated confirmation plan—usually in the form of a trust—which operates post-confirmation.[ii] Mediation can be especially useful in cases such as the Boy Scouts bankruptcy, where future, unknown, or unidentified creditors are to be expected by appointing independent representatives to represent these claimants.[33] While unknown claimants would obviously not be parties to the present mediation, these independent legal representatives will be parties to the mediation and can advocate on the unknown creditors’ behalves.[34]

  1. Effective use of Mediation for Small Businesses in Chapter 11

Small businesses can particularly benefit from mediation, especially under the new Chapter 11 Subdivision V bankruptcy rules, also known as the Small Business Reorganization Act (“SBRA”). The SBRA makes Chapter 11 bankruptcy more enticing to small businesses through the streamlining of the bankruptcy reorganization process, lowering the costs associated with filing for Chapter 11 bankruptcy.[iii] Reduced costs can be a saving grace for small businesses experiencing financial stress.

The purpose behind filing for bankruptcy under the SBRA is to allow small businesses to remain in business,[iv] but this may be a fruitless endeavor in the wake of a bankruptcy dispute. Filing for bankruptcy alone may incur costs that are significant to the small business, but litigation for adversary proceedings may lead to total financial ruin through high attorney’s fees. In this sort of case, any cost-saving measures may be the difference that allows the small business to continue operating. Avoiding a buildup of attorney’s fees in bankruptcy disputes leaves the small business with extra funds to use to help settle some of its debts through a Chapter 11 reorganization plan.

Creditors to these small businesses may also benefit from mediation in bankruptcy proceedings. Creditors run the risk of receiving drastically lower amounts than what is owed to them, or even nothing at all. If there is an increase in the likelihood of success for the small business under Chapter 11, Creditors, in turn, have a higher likelihood of receiving some portion of their claim against their debtors.[v]

  1. Finding Uniformity for ADR Programs in Bankruptcy

            It is important to note that if the Boy Scouts of America filed their Chapter 11 case in New Hampshire, for example, mediation would likely be unavailable because the court has no local rule authorizing mediation, other ADR, nor court-ordered mediation.[35] Despite that there exists sufficient case, statutory, and inherent legal bases to enact a uniform rule to govern an ADR program, there has been no change to Bankruptcy Rule 9019, which governs “Compromise and Arbitration.” Rule 9019(c) is limited to arbitration and provides: “On stipulation of the parties to any controversy affecting the estate the court may authorize the matter to be submitted to final and binding arbitration.” However, as Mabey et al. pointed out nearly 25 years ago, “[t]here does not appear to be any reason to limit the reach of Bankruptcy Rule 9019(c) to binding arbitration in light of the expanded uses of ADR.[36]

This realization is only bolstered by the fact that as of 1995, only 12 Bankruptcy courts had local rules governing court-annexed ADR programs, and that number has since exploded.[vi] A simple amendment to Rule 9019(c), as proposed by Mabey et al. could read as follows: “The court may authorize the matter to be submitted to final and binding arbitration or to any other form of alternative dispute resolution.[37] Such a rule would help unify the divergence amongst bankruptcy courts, indeed, even amongst different judges within the same bankruptcy court in employing ADR in bankruptcy matters. Further, as Mabey et al. correctly pointed out: “a body of case law interpreting the [amended] ADR rule will be encouraged, thereby increasing litigants’ knowledge and familiarity with the extent and limitations of ADR.”[38]

 

[i] See Ralph Peeples, ADR Meets Bankruptcy: Cross-Purposes or Cross-Pollination?: The Uses of Mediation in Chapter 11 Cases, 17 Am. Bankr. Inst. L. Rev. 401, 405 (2009) (referring to the R.H. Macy reorganization, the Greyhound Lines ADR program, and the Second Best Products Chapter 11 filing).

 

[ii] Thomas H. Oemke et al., Arbitration and Mediation of Bankruptcy Disputes, 105 Am. Jur. Trials 125 § 70 (2007) (citing to the Dalcon Shield Claimant’s Trust, the Manville Property Damage Settlement Trust, and the Manville Personal Injury Settlement Trust as examples).

[iii] Paul W. Bonapfel, A Guide to the Small Business Reorganization Act of 2019, 93 AM.

BANKR. L.J. 571, 574 (2019).

 

[iv] Id.

 

[v] Kerr Russell, Preparing for Mediation in Bankruptcy, JDSupra (Mar. 11, 2021) https://www.jdsupra.com/legalnews/preparing-for-mediation-in-bankruptcy-5141552/

[vi] 51 courts as of 2010. See Ralph Peeples, ADR Meets Bankruptcy: Cross-Purposes or Cross-Pollination?: The Uses of Mediation in Chapter 11 Cases, 17 Am. Bankr. Inst. L. Rev. 401, 407 (2009).

[1] Robert J. Niemic et al., Guide to Judicial Management of Cases in ADR, Federal Judicial Center at 36 (2001).

[2] Justia, Chapter 7 Bankruptcy, ¶1 (Apr. 2018) https://www.justia.com/bankruptcy/chapter-7/.

[3] Ralph Peeples, ADR Meets Bankruptcy: Cross-Purposes or Cross-Pollination?: The Uses of Mediation in Chapter 11 Cases, 17 Am. Bankr. Inst. L. Rev. 401, 405 (2009).

[4] Id. at 407

[5] P Moore’s Federal Practice,  Civil § A , ¶ 2 (2019).

[6]  David G. Epstein et al., Bankruptcy: Dealing with Financial Failure for Individuals and Businesses 25 (4th ed. 2015).

[7] Id.

[8] Id. at 32.

[9] Carron Nicks, What are the Differences Between an Adversary Procedure and a Contested Matter?, Nolo, https://www.nolo.com/legal-encyclopedia/what-are-the-differences-between-an-adversary-procedure-and-a-contested-matter.html.

[10] Epstein, supra note 6 at 33.

[11] Peeples, supra note 3 at 410.

[12] Id.

[13] Bankr. S.D. Fla. Local Rule 9019-2(B)(1) (“The court may order the assignment of a matter or proceeding to mediation at a pretrial conference or other hearing, upon the request of any party in interest or the U.S. Trustee, or upon the court’s own motion.”); Bankr M.D. Fla. Local Rule 9019-2(i) (“Any pending case, proceeding, or contested matter may be referred to mediation by the Court at such time as the Court may determine to be in the interests of justice. The parties may request the Court to submit any pending case, proceeding, or contested matter to mediation at any time.”); Bankr. N.D. Fla. Local Rule 7016-1(A) (District Local Rule 16.3, concerning Mediation, ”shall be applicable in all adversary proceedings and contested matters as directed by the Bankruptcy Court.”).

[14] Bankr. N.D. Fla. Local Rule 7016-1(A)

 

[15] Jay Foldberg, Resolving Disputes: Theory, Practice, and Law (3d ed. 2016).

[16] Peeples, supra note 3 at 408-09.

[17] P Moore’s, supra note 5 at ¶ 2.

[18] Id.

[19] Id.

[20] Id.

[21] Peeples, supra note 3 at

[22] Id. at 420.

[23] Id. at 405.

[24] Ralph R. Mabey et al., Expanding the Reach of Alternative Dispute Resolution in Bankruptcy: The Legal and Practical Bases for the Use of Mediation and Other Forms of ADR, 46 S.C. L. Re. 1259, 1308 (1995).

[25] Paul Mones, Boy Scouts of America Bankruptcy, https://www.paulmones.com/practice-areas/boy-scout-sexual-abuse/boy-scouts-of-america-bankruptcy/?keyword=%2Bboy%20%2Bscouts%20%2Bbankruptcy&gclid=EAIaIQobChMI2f6Etcro5wIVAZSzCh3DxwHoEAAYASAAEgJWhvD_BwE.

[26] Eric Levenson, Boy Scouts’ Bankruptcy Plan Follows Similar Path as USA Gymnastics and Catholic Diocese, CNN (Feb. 20, 2020).

[27] Nathan Bomey, Boy Scouts Bankruptcy: What we know about victims, assets and the future of scouting, USA Today (Feb. 18, 2020).

[28] Peeples, supra note 3 at 411, Table 1.

[29] Boy Scouts of America. Bankruptcy Court Grants Extension of Nationwide Preliminary Inunction, Pausing Abuse Lawsuits unitl Nov. 16; Appoints Mediators to Assist in Parties’ Negotiation of BSA Plan of Reorganization, available at https://www.bsarestructuring.org/event/bankruptcy-court-grants-extension-of-nationwide-preliminary-injunction-pausing-abuse-lawsuits-until-nov-16-appoints-mediators-to-assist-in-parties-negotiation-of-bsa-plan-of-reorganization/.

[30] Andrew G. Simpson, Judge Clears Boy Scouts’ $850M Sex Abuse Settlement Plan with Conditions, Claims Journal, (August 23, 2021), available at https://www.claimsjournal.com/news/national/2021/08/23/305544.htm.

[31] Thomas H. Oemke et al., Arbitration and Mediation of Bankruptcy Disputes, 105 Am. Jur. Trials 125 § 70 (2007).

[32] Id.

[33] Id.

[34] Id.

[35] Peeples, supra note 3 at 411, Table 1.

[36] Mabey, supra note 21 at 1310.

[37] Id. at 1309 (emphasis added).

[38] Id. at 1310.

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