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In Re: Lower Bucks Hospital v. Leonard Becker

January 2, 2013

IN RE: LOWER BUCKS HOSPITAL, DEBTOR
THE BANK OF NEW YORK, MELLON TRUST COMPANY, NA AS INDENTURE TRUSTEE,
APPELLANT
v.
LEONARD BECKER, APPELLEE



The opinion of the court was delivered by: Savage, J.

MEMORANDUM OPINION

In this appeal from the Bankruptcy Court's refusal to approve, as part of a reorganization plan, a third party release provision that would have precluded the Bondholders from bringing any claims against the indenture trustee, we must decide whether the Bankruptcy Court erred in determining that the notice to the Bondholders was inadequate. As a corollary, we must decide whether the Bondholders' acceptance of the third party release during the settlement motion process constituted a consensual release, and whether the plan should have been confirmed with the third party release provision.

Factual and Procedural Background*fn1

In 1992, Lower Bucks Hospital ("LBH")*fn2 entered into a multi-party municipal bond financing transaction to refinance some of its outstanding debt obligations and to finance capital improvement projects. The Borough of Langhorne Manor Higher Education and Health Authority (the "Authority") issued the bonds and loaned the bond proceeds to LBH. In the Loan and Security Agreement, LBH granted broad indemnification rights to the Authority which, in turn, assigned most of its rights to the original indenture trustee, Continental Bank.*fn3 The Bank of New York, Mellon Trust Company ("BNYM") is the successor to Continental Bank.

Two agreements from the bond financing transaction are relevant. In the Loan and Security Agreement, which governs the relationship between LBH and the Authority, LBH agreed to indemnify the Authority against "any and all claims" arising out of the financing transaction.*fn4 The scope of the indemnity is broad and requires LBH to assume and pay for the defense of any claim against the Authority. It excludes only claims for "malfeasance or nonfeasance in office, bad faith, gross negligence, wilful misconduct, fraud or deceit."*fn5 In another section of the Loan and Security Agreement, LBH agreed to indemnify the Trustee, now BNYM as successor to Continental Bank, against "any liabilities" arising out of its powers and duties.*fn6 Excluded are liabilities caused by the Trustee's "gross negligence, or wilful misconduct."*fn7

The Trust Indenture, which defines the respective rights and obligations of the Authority and the Indenture Trustee, originally Continental Bank and later BNYM, limits the Trust Indenture's liability to the Bondholders to conduct that is willful or negligent.*fn8

On January 13, 2010, LBH filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. *fn9 At that time, LBH owed approximately $26 million to the Bondholders in outstanding principal, plus accrued interest.

On April 30, 2010, LBH commenced an adversary proceeding against BNYM, contending that the security interest created by the Loan and Security Agreement was not perfected at the time of LBH's bankruptcy because BNYM and its predecessors had failed to file valid UCC-1 financing statements after LBH changed its name in 1997 and 2006.*fn10

BNYM filed the financing statements properly identifying the debtor on October 16, 2009, more than three years after the second name change. LBH contended that because BNYM perfected its security interest within ninety days of LBH's filing its Chapter 11 petition, any lien created by BNYM was avoidable under the Bankruptcy Code. Thus, if LBH prevailed in the adversary proceeding, the Bondholders would lose their secured creditor status under 11 U.S.C. § 547(b).

On August 12, 2011, after more than a year of litigation, BNYM and LBH reached a settlement of the adversary proceeding. The settlement stipulation provided that in return for deeming the Bondholders secured creditors, the debt owing them would be reduced from $26 million to $8.15 million. As part of the settlement, LBH and BNYM gave mutual releases and agreed to dismiss the adversary proceeding as of the effective date of the reorganization plan.*fn11 The settlement stipulation also contained a provision that purported to release BNYM from "any and all claims and causes of action arising under or in any manner related to the Bond Documents . . . by any and all parties, including without limitation all Bondholders . . . ."*fn12 This provision is central to the dispute in this appeal.

On September 14, 2011, the Bankruptcy Court held a hearing to consider approval of the settlement. During the hearing, the Court specifically noted that it did not view the settlement as having any preclusive effect on suits by the Bondholders against BNYM for actions outside the Bankruptcy Court.*fn13 Nonetheless, that day, the Court entered the parties' proposed order, including the provision releasing all claims against BNYM.*fn14

Neither LBH nor BNYM brought to Bankruptcy Judge Eric Frank's attention the third party release provision and its significance at the September 14, 2011 hearing.*fn15

LBH's counsel did not mention the third party release.*fn16 When Judge Frank voiced concerns about making findings concerning BNYM and its relationship to the Bondholders, LBH's counsel deferred to BNYM's attorney, who mentioned the third party release in passing.*fn17 The attorneys did not advise Judge Frank that among the claims to be settled were the Bondholders' claims against BNYM.*fn18 Only when Becker, who held $90,000 of the bonds at issue, moved for reconsideration and objected to confirmation of the plan did Judge Frank become aware of the significance of the third party release.

On September 27, 2011, LBH filed a proposed plan of reorganization and a disclosure statement. The relevant third party release provision was embedded in both of these documents -- page forty-two of the single-spaced forty-seven page proposed plan, and page fifty-five of the single-spaced sixty-two page disclosure statement.*fn19

After Judge Frank approved the disclosure statement the next day, BNYM sent a notice to the Bondholders reporting that the disclosure statement had been approved by the Court. In October 2011, ninety-five Bondholders holding approximately $13.5 million of the bonds at issue, voted on the proposed plan. Of those, ninety Bondholders, holding less than half the value of all outstanding bonds at issue, voted to accept the plan. Five Bondholders, including Becker, who held $90,000 of the bonds at issue, voted to reject it.

On October 14, 2011, Becker filed a class action in the United States District Court for the Eastern District of Pennsylvania against BNYM and its predecessor, JP Morgan Trust Co., asserting claims for negligence, and breaches of fiduciary and contractual duties for failing to perfect a security interest in the collateral backing the bonds.*fn20 On November 10, 2011, in the Bankruptcy Court, Becker filed an objection to LBH's proposed plan on the ground that the third party release was "an impermissible, non-crucial, non-debtor third party release[]."*fn21 He also asserted that the accompanying disclosure statement failed to clearly and conspicuously identify the third party release provision to the Bondholders, depriving them of a fair opportunity to object or vote against it.

On November 16, 2011, the Bankruptcy Court entered an order, sua sponte, severing the issue of whether the proposed plan should contain the third party release provision from the remainder of the proposed plan.*fn22 Characterizing the order as a correction of a clerical error in its prior order dated September 14, 2011, the November 16 order specified that no portion of the September 14 order should be considered as waiving or releasing any claims that the Bondholders may have against BNYM.*fn23

On December 7, 2011, the Bankruptcy Court confirmed the proposed plan without the third party release provision.*fn24 Subsequently, on March 2, 2012, the Bankruptcy Court held a hearing to determine whether the third party release provision should be included in the confirmed plan of reorganization. In a comprehensive opinion issued on May 10, 2012, Judge Frank concluded that the third party release could not be included because it had not been adequately disclosed or explained to the Bondholders. Judge Frank rejected BNYM's contention that the adequacy of the disclosures should not be revisited because that issue was resolved when the order approving the settlement was entered on September 14, 2011.*fn25

In this appeal, BNYM challenges the Bankruptcy Court's finding that the notice to the Bondholders of the third party release was inadequate.*fn26 It contends that notice was adequate because it was provided to the Bondholders numerous times. Specifically, in addition to the disclosures made pursuant to the Bankruptcy Code, BNYM provided the Bondholders with eight notices of the developments in LBH's bankruptcy, including the adversary proceeding. Some of those notices attached the settlement stipulation and the summary of the terms, which included the third party release. BNYM also argues that the Bondholders consented to the third party release when they failed to object to the motion to confirm the settlement stipulation. Finally, BNYM contends that the third party release was an essential component of a global settlement that was both fair and equitable to the Bondholders, and necessary to the success of LBH's reorganization, satisfying the standards for approval of non-consensual third party releases in Chapter 11 reorganization plans.

In response, Becker urges affirmation of the Bankruptcy Court's findings. He contends that the third party release "cannot be valid unless it comports with the requirements of Federal Rule of Bankruptcy Procedure 3016(c)," which it does not.*fn27

Alternatively, he argues that the Bankruptcy Court lacks subject matter jurisdiction to enter an order approving the third party release because it affects the legal relationship between two non-debtors.

Standard of Review

The district court reviews the bankruptcy court's "legal determinations de novo, its factual findings for clear error[,] and its exercise of discretion for abuse thereof." In re Reilly, 534 F.3d 173, 175 (3d Cir. 2008) (quoting In re Trans World Airlines, Inc., 145 F.3d 124, 130-31 (3d Cir. 1998)), rev'd on other grounds, Schwab v. Reilly, __ U.S. __, 130 S. Ct. 2652 (2010). Where the bankruptcy court's decision involves a mixed question of law and fact, the district court must segregate the legal and factual determinations, and apply the appropriate standard of review to each. In re Montgomery Ward Holding Corp., 326 F.3d 383, 387 (3d Cir. 2003).

The bankruptcy court's factual findings will not be disturbed unless they are clearly erroneous. In re IT Grp., Inc., 448 F.3d 661, 667 (3d Cir. 2006); Fed. R. Bankr. P. 8013. A factual finding is clearly erroneous if the district court is firmly convinced, based on all the evidence, that the bankruptcy court made a mistake. Gordon v. Lewistown Hosp., 423 F.3d 184 (3d Cir. 2005); Fed. R. Bankr. P. 8013 advisory committee's note (according the same weight to a bankruptcy judge's findings as that given the findings of a district judge under Fed. R. Civ. P. 52(a)). The district court may notengage in independent fact finding. In re Indian Palms Assocs., Ltd., 61 F.3d 197, 210 n.19 (3d Cir. 1995) (citing 28 U.S.C. § 158(a)). In reviewing factual findings, the district court must give due regard to the bankruptcy judge's opportunity to observe the demeanor and credibility of witnesses. See Bose Corp. v. Consumers Union of U.S., Inc., 466 U.S. 485, 500 (1984); In re Myers, 491 F.3d 120, 126 (3d Cir. 2007) ("The Bankruptcy Court is best positioned to assess the facts, particularly those related to credibility and purpose."); Fed. R. Bankr. P. 8013 ("[D]ue regard shall be given to the opportunity of the bankruptcy court to judge the credibility of the witnesses.").

The bankruptcy court's conclusions of law are reviewed under the less deferential de novo standard. In re Goody's Family Clothing, Inc., 610 F.3d 812, 816 (3d Cir. 2010) (internal citation omitted). Under the de novo standard, the district court makes a judgment independent of the bankruptcy court, without deference to that court's analysis and conclusions of law. Scimeca v. Umanoff, 169 B.R. 536, 541-42 (D.N.J. 1993), aff'd, 30 F.3d 1488 (3d Cir. 1994).

Discussion

The Bankruptcy Court had subject matter jurisdiction to approve the third party release as part of the plan of reorganization.

Before considering BNYM's challenge to the Bankruptcy Court's finding that the notice of the third party release was inadequate, we must determine that the Bankruptcy Court had subject matter jurisdiction to approve the third party release as part of the plan of reorganization.*fn28 This inquiry requires us to determine whether, by virtue of the indemnification agreement between LBH and BNYM, the purported third party ...


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