US District Court for the District of Delaware Analyzes Sufficiency of Notice for Rule 9019 Settlements

In Burtch v. Avnet, Inc. (In re ManagedStorage International, Inc. et al.),¹ ManagedStorage International, Inc. and its related affiliates (Debtors) filed a bankruptcy petition on February 4, 2009. Simultaneously, the Debtors filed a motion to sell their assets pursuant to a Section 363 sale free and clear of all liens assets to Laurus Master Fund Ltd. (Laurus). Avnet, Inc. (Avnet) objected to the sale and asserted a purchase money security interest in certain of the Debtors’ assets. Eventually, the Debtors, the Official Committee of Unsecured Creditors (Committee), and Avnet entered into a stipulation requiring the segregation and maintenance of Avnet’s collateral (Stipulation).

However, one year later, Avnet filed a motion before the bankruptcy court asserting that its collateral was never segregated into a separate purchase money account as required by the Stipulation. Avnet sought to enforce the Stipulation and Laurus filed an objection to Avnet’s motion. Two days prior to the scheduled hearing, an agenda was distributed to all parties in interest stating that Avnet’s motion was the only contested matter going forward and that Avnet’s counsel had circulated a proposed stipulation that the parties were attempting to finalize. Avnet, Laurus, and the Debtors eventually negotiated a settlement (Stipulation and Release) whereby the Debtors granted Avnet a broad release from any and all causes of action relating to the Debtors and their Chapter 11 cases. In addition, Avnet received a payment from certain parties in satisfaction of all amounts owed by the Debtors under the Stipulation and Laurus was released from claims.

On the day of the hearing, an amended agenda was served on all parties in interest, including the Committee which stated that the parties were submitting under certification of counsel a stipulation resolving the matter and that the hearing had accordingly been canceled. At the same time, under Local Bankruptcy Rule 9019-1, Avnet submitted a certification of counsel (COC) which stated that the Debtors, Avnet, and Laurus have been negotiating a settlement and have agreed upon the Stipulation and Release attached as an exhibit. On the same day and without a hearing, the Bankruptcy Court entered an order approving the Stipulation and Release.

The Debtors’ Chapter 11 cases were converted to Chapter 7 cases approximately six months later. The Chapter 7 trustee thereafter filed a suit against Avnet under Sections 547 and 550 of the Bankruptcy Code to avoid and recover preferential transfers (Preference Claims). The Bankruptcy Court granted Avnet’s motion to dismiss the action, finding that (i) the Chapter 7 trustee was bound by the Stipulation and Release; (ii) the scope of the Stipulation and Release included the Preference Claims; and (iii) the Stipulation and Release was properly approved with notice and hearing as required under Bankruptcy Rule 9019.

The Chapter 7 trustee appealed, arguing, among other things, that the Bankruptcy Court erred by (i) incorrectly finding that the Chapter 7 trustee was bound to the Stipulation and Release because the Bankruptcy Court ignored the parties’ failure to move for approval of the compromise or settlement after notice and a hearing as required under the Federal Rules of Bankruptcy Procedure 9019(a); and (ii) incorrectly finding that adequate notice of the Stipulation and Release was provided to creditors. The District Court agreed.

On appeal, the District Court held that adequate notice of the terms of the Stipulation and Release, particularly the broad language used in the general release, was not provided and that, rather, no notice was provided. The District Court noted that unless the court, for cause, directs that notice not be sent, a 21-day notice is required for a hearing on approval of a compromise or settlement. The District Court further explained that although bankruptcy courts have broad discretion to approve settlements and reduced notice periods, there are limits to that discretion.

Thus, despite the Bankruptcy Court’s finding that it was probable the Committee had notice, and that the notice was appropriate, the District Court held that on a motion to dismiss, the Bankruptcy Court wrongly presumed contrary to the allegations and, based on the record, that notice had been given.

In addition, the District Court found that the Bankruptcy Court was not asked to, and did not, evaluate the propriety of Stipulation and Release under the standards set forth in Myers v. Martin (In re Martin), 91 F.3d 389 (3d. Cir. 1996). However, because the Stipulation and Release dealt with issues beyond the resolution of Avnet’s motion to enforce the Stipulation and Laurus’ objection, such as the waiver of the Preference Claims, the District Court found that parties (not signatories) to the Stipulation and Release would be affected by it. Thus, the District Court remanded the matter to the Bankruptcy Court to assess the Stipulation and Release by the standards of In re Martin.

Takeaways

Bankruptcy Rule 9019 provides a 21-day notice period for the approval of settlements which can be reduced in certain circumstances. However, this case is an important reminder that although consensual resolution of objections are widely encouraged, and a certificate of counsel can be a useful tool in fast-moving bankruptcy cases, parties must always be mindful of the underlying nature of their proposed resolution and its affect on parties in interest and whether a notice is adequate under the circumstances.