MEMORANDUM OF DECISION
These administratively consolidated Chapter 11 cases have come before the court on the debtors’ motion to approve a settlement of certain claims arising from a failed leveraged buyout. The settlement is supported by the debtors’ major secured creditors and the unsecured creditors’ committee. It is opposed by Tamona Enterprises, Inc., and fifty-five other general unsecured creditors, all of whom are parties in an action disputing the ownership of property claimed by the debtors’ estates. After a hearing on the merits of the settlement and a review of the parties’ submissions, the court gave an oral opinion and then took the matter under advisement in order to prepare this memorandum. For the reasons set forth below, the court finds that the settlement is in the best interest of the estates and accordingly grants the pending motion.
Jurisdiction
As discussed below, the pending motion to approve settlement is essentially a motion to dispose of property of the estate. This proceeding is therefore within the jurisdiction of the district court pursuant to 28 U.S.C. § 1334(b) and (d), and may be referred to a bankruptcy judge pursuant to 28 U.S.C. § 157(a). The matter has been so referred pursuant to General Rulé 2.33 of the United States District Court for the Northern District of Illinois. It is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A), (N), and (O), and so a bankruptcy judge may enter final judgment pursuant to 28 U.S.C. § 157(b)(1).
Findings of Fact
General background.
Telesphere Communications, Inc. (“TCI”), and its two subsidiaries, Telesphere Network, Inc. (“TNI”), and Telesphere Limited, Inc. (“TLI”), formerly known as National Telephone Services, Inc. (“NTS”), are related entities that were engaged in the telecommunications industry. On August 19, 1991, an involuntary petition for relief under Chapter 7 of the Bankruptcy Code (Title 11, U.S.C.) was filed against TCI. TM ¶ 1; TS ¶ A.
1
On September 11, 1991,
Shortly after the orders for relief, Tele-sphere ceased doing business as an operating entity, and the bankruptcy cases have focused on the liquidation of Telesphere’s assets. Among these assets are a number of avoidance claims. See TM ¶¶ 22, 23(R)(l)(c) & 23(R)(3); TS IIP, 3 & 10(d)(l & 3). The proposed settlement deals with one group of such claims, arising out of TCI’s 1990-91 leveraged buyout of NTS. See generally TM ¶¶ 1, 5-10,18-20; TS ¶¶ N-P; TS ¶¶ A, E & F.
The NTS transactions. TCI decided to acquire the operator-service business of NTS in 1990, TM ¶ 5; TS ¶ E, and entered into an agreement, dated May 31, 1990, to purchase all of the capital stock of NTS from its shareholders, TM ¶5; Geller Ex. 1; Geller Trans. 28, 43. The largest of these shareholders, owning some 85% of the outstanding stock of NTS, was Ronald Haan, who was also NTS’s president. TM ¶ 5.
TCI did not immediately consummate the stock purchase agreement. Instead, it arranged for an initial payment to be made to Haan separate from the payment that Haan would receive for his stock. This payment was effectuated through a fairly complicated multiparty transaction. First, TCI obtained from Williams Telecommunications Group, Inc. (‘WTG”) a “bridge loan” in the amount of $26.8 million (the “WTG loan”), guaranteed by Francesco Galesi, an insider of TCI. Obj. 11; Geller Trans. 62-63. Second, TCI loaned the proceeds of the WTG loan to NTS (the “NTS loan”). TM ¶ 5; TS ¶ E; Geller Trans. 43, 63. Third, NTS distributed the proceeds of the NTS loan to Haan, in satisfaction of an asserted loan of approximately $23 million owed by NTS to Haan (the “Haan loan”) and a $3 million prepayment penalty incorporated into the Haan loan. TM ¶ 5; TS ¶ E; Geller Trans. 43. Fourth, as collateral for the NTS loan, Haan pledged to TCI all of his stock in NTS and in another corporation. TM ¶ 6; see Geller Trans. 47. Finally, TCI provided as collateral for the WTG loan, among other things, assignments to WTG of the pledges of Haan’s stock and the note evidencing the NTS loan. TM ¶ 6; TS IE; see Geller Trans. 47.
On or about October 11, 1990, in order to complete the purchase of the NTS shares as well as to finance its own business operations, see Geller Trans. 43-44, 69-70, Tele-sphere entered into a financing arrangement with The Chase Manhattan Bank, N.A. (“Chase”), Citibank, N.A. (“Citibank”), and Bell Atlantic (“Bell Atlantic”) (collectively, the “Lenders”). TM ¶ 8; TS ¶ E; Geller Ex. 2; Geller Trans. 28. Under this arrangement, TNI and NTS borrowed $94 million (the “Lenders’ loan”), and TCI guaranteed the repayment. TM ¶ 8; TS ¶ E; Geller Ex. 2. As additional security, TCI, TNI, and NTS all granted the lenders security interests in their accounts, general intangibles, documents, instruments, and equipment, as well as the proceeds of this property (collectively, the “prepetition collateral”). TM ¶ 10; TS ¶ F; Geller Exs. 3-5; Geller Trans. 28-29.
On October 15, 1990, with its financing in place, TCI set aside $1.3 million of the Lenders’ loan for working capital and then com
Payment Recipient Payment’s Purpose Approximate Amount
WTG Retirement of WTG loan $26,800,000
NTS shareholders Purchase of NTS stock 21,000,000
Lenders and others Payment of professional fees 6,000,000
NTS secured creditors Satisfaction of prior working capital facilities 37,300,000
NTS lessor Prepayment of, or cure of ar-rearages on, NTS lease 1,600,000
$92,700,000
In January, 1991, shortly after consummating the NTS acquisition, Telesphere discovered that it had inadequate working capital. Geller Trans. 51-53. To address this problem, Telesphere periodically requested that the Lenders provide additional financing for its working capital needs. Geller Trans. 51-53. The Lenders agreed to do so, eventually providing Telesphere with $10.7 million in addition to the original $94 million loan. Geller Trans. 51-53 & 112; see Fishman Trans, at 175.
The Lenders’ postpetition financing. The involuntary bankruptcy petition that led to the pending bankruptcy cases was filed on August 19, 1991, about ten months after the conclusion of the NTS transaction. Shortly thereafter, on September 13 and October 17, 1991, Telesphere and the Lenders agreed to Telesphere’s use of the proceeds of the pre-petition collateral pursuant to Section 363 of the Bankruptcy Code. TM ¶ 12; TS ¶ H. As adequate protection for this use of collateral, the Lenders received (1) continuing and replacement security interests in the prepetition collateral to the extent the collateral was subject to valid security interests of the Lenders prior to August 19,1991 (the date of the commencement of the involuntary proceedings against TCI); and (2) security interests in (a) all accounts receivables of Tele-sphere generated after August 19, 1991; (b) all property of Telesphere acquired after August 19, 1991; and (c) all property of Tele-sphere not otherwise encumbered as of August 19, 1991 by valid, perfected, and enforceable liens and security interests (collectively, the “postpetition collateral”). TM ¶ 12; TS ¶ H.
The liquidation of Telesphere’s assets. In October, 1991 Telesphere determined to liquidate its assets. TM ¶ 13; TS ¶ I. After a contested hearing, Telesphere was authorized to sell substantially all of the assets used in the operation of its business pursuant to Section 363. TM ¶¶ 13-16; TS HITI-L. As noted above, that sale closed on November 1, 1991. It realized proceeds of $17 million, of which $12 million (the “sales escrow”) has been held in segregated accounts at Chase. TM ¶¶ 13-17; TS ¶¶ I-M.
After consummating the November 1,1991 sale, Telesphere began to liquidate claims of the estates. As of the time of the hearing on the pending motion, that process had led to the collection of unencumbered cash in the amount of approximately $4 million (“Tele-sphere’s general funds”). Compare Nem-mers Trans, at 115 with Counsel Trans, at 5-6. It has also led to the commencement of numerous adversary proceedings which collectively name several hundred defendants in an effort to obtain recoveries of millions of dollars.
The investigation of the NTS transaction.
In early November, 1991 the unsecured creditors’ committee (the “Committee”) began to investigate the existence of potential claims against the Lenders and WTG, among others, as a result of the NTS acquisition. Geller Trans. 21-22 & 29-43;
see
TM ¶ 19; TS ¶ N. Though the Committee did not take
The settlement with WTG. Though presented as a single package, the settlement consists of two largely separate compromises — one with WTG and the other with the Lenders. In each of the compromises, Tele-sphere gives up claims it may have against the other parties, and the other parties provide the estate with either cash consideration; waivers, reductions, or subordination of claims; or both. There has been no objection to the settlement with WTG. The essential features of that compromise are that Telesphere covenants not to sue WTG on any claims arising from the NTS transaction, the Telesphere bankruptcy cases, and certain other commercial transactions Telesphere had with WTG, TS ¶ 6(g), and, in exchange, WTG agrees:
(1)to reduce from $4.1 million to $1.7 million the amount of its administrative claim (with the reduced claim proposed to be allowed), TS ¶ 6(d);
(2) to partially subordinate the reduced administrative claim, TS ¶¶ 6(d) & 10; and
(3) to waive its entire $190 million general unsecured claim, TS ¶ 6(c).
The trial testimony indicates that the reduction and partial subordination of WTG’s administrative claim would benefit the estate in the amount of about $2.8 million. 2 Furthermore, Committee counsel testified that the value of the waiver of WTG’s general unsecured claim was in the range of $500,000 to $4 million, but this value depends on the extent of the estate available for payment to unsecured creditors, an issue discussed below at p. 563 and pp. 564-65. There is no direct evidence concerning the value of the claims against WTG that Telesphere has agreed to give up.
The settlement with the Lenders. The compromise with the Lenders is more complex than the one with WTG. See generally TS ¶¶5-6 & 9-10. As with WTG, Tele-sphere agrees to give up claims against the lenders; specifically, Telesphere would waive all claims against the Lenders arising in connection with the NTS transaction and the bankruptcy cases (including claims under Section 506(e) of the Bankruptcy Code for reimbursement of expenses in connection with liquidating the Lenders’ collateral). TS ¶ 6(k). 3 The question of the value of these waived claims is one of the major issues of dispute between the parties, and is addressed below at pp. 554-64.
In exchange for the waiver, the Lenders agree to provide the following consideration, with the values indicated by the evidence as follows:
Consideration Approximate Monetary Basis for Estimation Value to the Estates of Monetary Value
1.Cash payment (the (“settle- $2,800,000 ment payment”). TS ¶ 5(a). Geller Trans. 101-02 & 125-26; Fishman Trans, at 208-11.
2.Cash proceeds from newly $ 400,000 Geller Trans. 109-10 & 126; made, partially subordinat- Fishman Trans, at 208-11. ed $1.5 million loan (the “bank loan”). TS «5(b) & 10.
3.Waiver of claims to, release $1,100,000 of security interest in, and remission by Chase of funds held to satisfy Telesphere’s taxes (“Chase tax fimds”). TS ¶¶ 5(e)(i) & 6(a)(ii). Geller Trans. 101-02 & 128; Fishman Trans, at 208-11.
4.Waiver of claims to and re- Included in Item 3, above. See Geller Trans. 101-02 & lease of security interest in 128; Fishman Trans, at funds held by Telesphere to 208-11. satisfy its tax obligations. (“Telesphere’s tax funds”). TS ¶6(&)®.
5.Waiver of claims to and re- Included in Item 3, above, lease of security interest in funds held by Telesphere as part of its miscellaneous receipts (“miscellaneous receipts”). TS ¶ 6(a)(ii). Geller Trans. 101-02 & 128; Fishman Trans, at 208-11.
6.Waiver of claims to, release $ 200,000 of security interest in, and remission by Chase of funds relating to that portion of proceeds collected from Telesphere’s accounts receivables in excess of requirements of cash collateral order (“excess postpetition proceeds”). TS ¶¶ 5(c)(ii) & 6(a)(ii). GeUer Trans. 101-02 & 127; Fishman Trans, at 208-11.
7. Waiver of administrative claims for postpetition interest, attorneys fees, and expenses. TS ¶ 6(a)(i). $-0- Compare Geller Trans. 51-52 (Lenders are expected to have a deficiency claim) with Section 506(b) of the Bankruptcy Code (secured creditor entitled to postpetition interest, attorney fees, and expenses only to the extent that collateral exceeds value of secured claim).
8. Assignment of all claims to, $-0- and rights to receive distributions of, amounts owed by Telesphere on account of its subordinated debentures. TS ¶ 5(e). There is no evidence indicating that this assignment is of any ascertainable value. See Geller Trans, at 100-01; TS ¶&.
The status of the objecting parties.
The only parties who have objected to the proposed settlement are Tamona Enterprises, Inc., and fifty-five similarly situated general unsecured creditors (collectively referred to as “Tamona”). All of the Tamona objectors are represented by the same attorneys and all are plaintiffs in an adversary proceeding claiming equitable ownership of certain funds obtained by Telesphere during its operation. The adversary proceeding is further described in this court’s decision awarding summary judgment in favor of Telesphere.
Almar Communications, Ltd. v. Telesphere Communications, Inc. (In re Telesphere Communications, Inc.),
Discussion
A. Settlement approval standards.
The requirement for court approval of settlements has an uncertain basis. There is a substantial body of authority holding that a bankruptcy judge “must apprise himself of all facts necessary to evaluate [a] settlement and make an ‘informed and independent judgment’ about the settlement.”
In re American Reserve Corp.,
The Code itself rejects this view of the role of the bankruptcy court; indeed, one of the express purposes of the Code was to remove the bankruptcy judge from general estate administration, giving that task to the newly created office of United States Trustee. The House Report on the legislation that became the Bankruptcy Code states that the Code provides for a “separation of judicial and administrative functions currently performed by the bankruptcy judges,” with the judges acting as “passive arbiters of disputes that arise in bankruptcy cases” and the United States trustees assuming “the bankruptcy judge’s current supervisory roles.” H.R.Rep. No. 595, 95th Cong., 1st Sess. 107 (1977), U.S.Code Cong. & Admin.News 1978, 5787, 6069.
Consistent with this legislative purpose, the Bankruptcy Code contains no requirement for judicial approval of settlements.
See In re Lee Way Holding Co.,
1990 U.S.Dist. LEXIS 20228 at *12 (“[Tjhere is no specific Bankruptcy Code provision authorizing a trustee to settle controver-sies_”). One of the rules of bankruptcy
The settlement presented by the pending motion is subject to court review, since the trustee is seeking to liquidate assets of the estate — certain avoidance claims — and notice and a hearing is required, under Section 363(b) of the Code, for any use or sale of estate assets out of the ordinary course.
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However, two aspects of procedure under Section 363(b) again reflect the overall policy of the Code regarding judicial involvement. First, the “notice and a hearing” requirement of Section 363(b) mandates court review of a proposed disposition of estate assets only where there is an objection. Where there is no objection after notice, a proposed disposition of assets may be effective without judicial review.
In re Winston Inn & Restaurant Corp.,
Where an objection is made, the standard to be applied by the court in approving a disposition of assets is variously stated, but the general thrust is that the proposed sale should be in the best interest of the estate.
See In re Schipper,
Together, the decisions set forth a two-step methodology for determining whether a proposed settlement of claims held by the estate is in the estate’s best interest. The first step is “a comparison of the settlement’s terms with the litigation’s probable costs and probable benefits,”
American Reserve,
B. The likely litigation outcome.
It is not a simple task to determine what would happen if the Telesphere estates litigated the claims against WTG and the lenders that they now propose to settle. At issue are avoidance claims (for preferences and fraudulent transfers) arising from the NTS transaction. 10 The nature of these claims makes the impact of litigating them difficult to assess for three reasons.
The first complication is that the prospective defendants in the litigation — WTG and the Lenders — are unsecured creditors of the estate. To the extent that these claims against the estates are not disallowed or subordinated, the defendants would receive, as unsecured creditors, some portion of any judgment they were required to pay into the estates.
Second, preference judgments may serve to increase the defendants’ claims against the estates. Avoidance of a preference results in a return of transferred property to the estate, but may also result in the defendant asserting a claim that otherwise would have been satisfied by the transferred property.
See
11 U.S.C. § 502(h) (providing for allowance of claims arising from recovery of property in avoidance actions);
In re Allied Com
Finally, the extent to which Telesphere can recover on its avoidance claims is limited by Section 550(c) of the Code, which allows only a single satisfaction for any avoided transfer. See
In re Bennett,
Therefore, in assessing the likely outcome of litigating the claims involved in the pending settlement, it is necessary not only to consider (1) the likelihood of Telesphere obtaining a particular recovery, and (2) the litigation costs it would incur, but also (3) the portion of any recovery that would be returned to the defendants as payment of their unsecured claims and (4) the impact of the recovery on the estates’ right to pursue other defendants. 12
1. The likely recovery by Telesphere. The possible recoveries for avoidance actions are set forth in Section 550 of the Bankruptcy Code. Although, as noted below, the causes of action overlap, it is useful to consider separately the recoveries that Telesphere would likely obtain if it litigated its claims against WTG and the Lenders.
Claims against WTG.
From the scant evidence presented at the hearing with respect to WTG, it appears likely that Tele-sphere would prevail against WTG on a preference claim under Section 547(b) of the Bankruptcy Code. In such a claim, Tele-sphere would assert that the $26.8 million payment that Telesphere made to WTG from the NTS loan proceeds (1) was for the benefit of an insider/creditor who had guaranteed the loan, (2) was on account of an antecedent debt (the WTG loan), (3) was made while Telesphere was insolvent, (4) was made within one year of the filing of the petition; and (5) enabled the creditor/insider to receive more (by way of release from his guaranty) than if the payment had not been made and he had received a distribution in a Chapter 7 case. The legal validity of this analysis was established in this Circuit by
Levit v. Ingersoll Rand Financial Corp. (In re V.N. Deprizio Construction Co.),
Telesphere also has a potential avoidance action against WTG based on a fraudulent conveyance theory. Section 544(b) of the Code provides that a trustee (and hence a debtor in possession under Section 1107(a)) “may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim.” Thus, Section 544(b) allows a debtor in possession to pursue a fraudulent conveyance action under applicable state law.
In re Xonics Photochemical, Inc.,
Claims against the Lenders. Telesphere’s avoidance action against the Lenders would be grounded solely on a fraudulent conveyance theory, as defined by Section 548 of the Bankruptcy Code. 15 As noted above, (n. 11) Section 548(a) grants a right to avoid both fraudulent transfers and fraudulent obligations. 16
The initial claim.
Transfers are fraudulent under section 548(a) if: (1) they were made by the debtor with an actual intent to defraud creditors (“actual fraud claims”); or (2) they are presumed to be fraudulent as a matter of law (“constructive fraud claims”). 11 U.S.C. § 548(a)(1) and (2);
see Wieboldt Stores, Inc. v. Schottenstein,
Constructive fraud claims can also arise in the context of leveraged buyouts.
See, e.g., Wieboldt Stores,
Section 548(c) does not define “good faith,” and there is no clear source of interpretative guidance.
20
Courts applying Section 548(c) have therefore avoided definitions of good faith.
See, e.g., In re Agricultural Research and Technology Group, Inc.,
Thus, in assessing the likelihood that the Lenders could successfully assert good faith under Section 548(e), it is important to consider the factual context of this case. As noted above, Telesphere itself is not likely to be found to have acted in bad faith in borrowing funds from the Lenders, but rather to have had a good faith intention of making a successful acquisition of NTS. If Telesphere was acting in good faith in seeking funding for the acquisition, could the Lenders have been acting in bad faith in supplying it? Tamona points only to the precarious financial condition of both Telesphere and NTS in arguing for a bad faith finding. However,
The governing rule was announced by the court within a few years after the 1898 Bankruptcy Act went into effect.
In re Soudan Mfg. Co.,
There is nothing in the bankrupt law which interdicts the lending of money to [an insolvent], if the purpose be honest, and the object not fraudulent. And it makes no difference that the lender had good reason to believe the borrower to be insolvent, if the loan was made in good faith, and without any intention to defeat the provisions of the bankrupt act. It is not difficult to see that in a season of pressure the power to raise money may be of immense value to a man in embarrassed circumstances. With it he might be saved from bankruptcy, and without it financial ruin would be inevitable. If the struggle to continue his business be an honest one, and not for the fraudulent purpose of diminishing his assets, it is not only not forbidden, but is commendable.
More than forty years after
Soudan,
the Seventh Circuit returned to the issue of good faith in
In re Peoria Braumeister Co.,
Finally in
Covey v. Commercial National Bank of Peoria,
Under this standard, the Lenders are quite likely to be found to have acted in good faith in making their loans to Telesphere. There is no evidence whatever that the Lenders were engaged in any effort to defraud creditors, and, in contrast to Soudan, there is no evidence that the borrower was engaged in any such effort. Moreover, the Lenders made their loans in the ordinary course of their business, after performing an extensive due diligence investigation into numerous aspects of the NTS transaction, including the financial condition of Telesphere and the value to be received by Telesphere as a result of the NTS transaction. That investigation generated several opinion letters from legal counsel and at least three reports from independent consulting firms. Though those letters and reports identified legal and economic risks with the NTS transaction, they also disclosed a reasonable prospect of success of the NTS transaction and the eventual repayment of the Lenders’ loan. The Lenders apparently relied on these opinion letters and reports in extending the Lenders’ loan. Their reliance on such documents may have been negligent,' but it hardly negates the substantial likelihood that the Lenders made their loans in a good faith expectation of being repaid from a successful transaction.
Resulting recovery. Given a likely finding of good faith under Section 548(c), it is necessary to estimate the value received by Tele-sphere in the NTS transaction. To the extent such value was given, the Lenders will be able to retain their liens and rights to enforce Telesphere’s obligations. The parties are in some dispute regarding the extent of this value, but even after collapsing the transaction, the NTS loan proceeds plainly benefitted Telesphere at least to the extent that Telesphere’s pre-existing secured working capital facilities were retired (approximately $37.8 million) and a commercial lease was paid ($1.6 million). There may be additional value. Although, as noted earlier, the extent of payments for the loan processing may be questioned, some fees would likely be approved as fair value. Most significantly, it is likely that some value would be attributed to the NTS stock acquired. Thus, of the $92.7 million obligation incurred by Tele-sphere to the Lenders, a minimum of $38.9 million would remain an enforceable obligation, to which the Lenders would retain their liens, and Telesphere’s likely judgment against the Lenders under Section 548 would not exceed $53.8 million.
Section 550(c) limitation.
The preceding analysis suggests that Telesphere has a prob
2. Litigation costs. The anticipated judgment against WTG and the Lenders would be obtained only after substantial litigation. The analysis set forth above gives some indication of the difficult factual and legal issues that the cases would involve. Prolonged factual hearings and extensive briefing would be required to bring the recovery about. No one has contested the fact that Telesphere will incur significant costs and delay in adjudicating fraudulent transfer claims against WTG and the Lenders. See Geller Trans. 107-08. The parties, however, have not provided an estimate of the costs of pursuing such litigation. Such an estimation is difficult to make, in large part because Telesphere has not yet retained counsel to pursue the litigation. If the litigation were pursued under a contingency fee agreement, Telesphere’s costs could reasonably be expected to exceed $10 million [($54 million recovery) x (20% contingency fee rate)]. And even if the litigation were pursued by counsel retained under an hourly fee agreement, Telesphere’s litigation costs would probably exceed $1 million in light of the complex issues arising from the NTS transaction; the amount of the claims; and the tenacity, sophistication, and financial resources of WTG and the Lenders. See Geller Trans. 107-08. In order to value the settlement conservatively, the court will use $800,000 as an estimate of Telesphere’s litigation costs, reducing the likely monetary recovery to no more than $26 million.
3. Payout to defendants. The next element involved in measuring the benefit to Telesphere of litigation against WTG and the Lenders is the extent to which the likely recovery would be diluted by payments to WTG and the Lenders in their capacity as unsecured creditors. To see the problem here, assume that, after satisfaction of any judgment obtained by Telesphere, WTG and the Lenders together held 90% of the allowed unsecured claims, and that all of the funds recovered by Telesphere were available to pay unsecured creditors. The result would be that WTG and the Lenders would take back, as unsecured creditors, $23.4 million of the $26 million monetary recovery, with the other creditors taking only $2.6 million. Since the proposed settlement proposes to subordinate claims of WTG and the lenders to those of the other creditors, it is important to determine what portion of the anticipated litigation recovery would be paid to these other creditors. In other words, the benefit of litigation to the “Telesphere” estates, under the facts of this case, is the net increase in assets available to creditors of the estates other than WTG and the Lenders (the “non-settling creditors”).
Priority of claims.
Tamona, in objecting to the proposed settlements, has argued that the full amount of any litigation recovery would redound to the benefit of the non-settling creditors, because the claims of WTG and the Lenders should be equitably subordinated under Section 510(c) of the
Telesphere is very unlikely to prevail on a claim of equitable subordination against either WTG or the Lenders on either of the two grounds for equitable subordination. First, there has been no indication that either WTG or the Lenders engaged in inequitable conduct.
Kham & Nate’s Shoes,
Similarly, there is nothing in the nature of the financing of a leveraged buyout that ere-
Amount of claims. Because the unsecured claims of WTG and the Lenders are thus unlikely to be subordinated, it is necessary to determine what portion of the claims they constitute, in order to determine how large a proportion of the estimated litigation recovery would be paid with respect to these claims. Telesphere and Tamona did not develop a complete evidentiary record concerning the allowed amount of unsecured claims against Telesphere. However, as noted in the following table, it is possible from the available evidence to estimate the probable amount and priority of the allowed claims against Telesphere:
Creditor Estimated Amount of Allowed Estimated Amount of Administrative and Priority Claims General Unsecured Claims
1. Lenders $-0- $ 38,000,000 27
2. WTG $ 4,100,000 28 $190,000,000 29
3. Non-settling creditors $ 6.500,000 30 $ 65.000.000 31
Total $10,600,00 $293,000,000
Benefit to non-settling creditors. Under the facts and estimates set forth above, it is possible to compute the likely benefit to the non-settling creditors of the pursuit of litigation against WTG and the Lenders. First, Telesphere would likely recover, from WTG, $26 million in cash, net of costs, and the Lenders’ unsecured claim would be reduced from $38 million to about $11 million. The $26 million in cash would then be distributed pro rata to satisfy unsecured claims totalling about $266 million ($11 million for the Lenders, $190 million for WTG, and $65 million for the non-settling creditors). WTG and the Lenders would be entitled to receive about 76% (201/266) of this estate, or about $19.6 million. The non-settling creditors would receive the remaining 24% of the estate (65/266) or about $6.4 million, somewhat less than a 10% distribution. This is the likely net benefit to the non-settling creditors of pursuing litigation only against WTG and the Lenders.
f. Impact of Telesphere’s right to pursue other defendants.
In addition to its claims against WTG and the Lenders in connection with the NTS transaction, Telesphere also has claims against the ultimate recipients of the funds, Francesco Galesi (for the WTG loan repayment) and Ronald Haan (for the purchase of NTS stock). To the extent that Telesphere obtained a recovery from WTG and the Lenders, it would forego its right to recover against Galesi and Haan, since Section 550(c) allows only a single recovery with respect to any avoided transfer.
32
It would therefore be in the best interest of Tele-sphere to pursue Haan (and the other NTS shareholders) rather than the Lenders for the recovery of the purchase price for the NTS stock ($21 million). Fraudulent conveyance claims against these individual defendants would result in an inflow of cash into the estate, rather than a mere reduction of the Lenders’ unsecured claims. If the stock purchase with the NTS shareholders were
C. The value of the settlement.
The valuation of the settlement is again complex, because the settlements involve numerous items of value, including claim subordination and extension of new credit. In order to gauge the value of the settlement, it is necessary to observe how its terms affect the likely distribution to non-settling creditors, using the same methodology as applied to the issue of the benefit of pursuing litigation.
Priority of claims. Under the proposed settlements WTG and the Lenders have agreed to subordinate their claims so as to allow an earmarked fund of $6.7 million to be distributed to other creditors. The effect of the subordination is considered below.
Amount of Claims. Under the terms of the proposed settlement, the claims allowed to WTG and the Lenders are substantially reduced, as follows:
Estimated Amount of General Unsecured Claims Creditor Estimated Amount of Allowed Administrative and Priority Claims
$ 38,000,000 35 1. Lenders $1,500,000 34
$-0- 37 2. WTG $1,700,000 36
$ 65,000,000 3. Non-settling creditors $6.500.000
$103,000,000 Total $9,700,000
Funds in estate. The settlement also makes a substantial change in the funds available in the estate. As noted above, at the time of the settlement hearing, Tele-sphere had unencumbered cash in an amount slightly less than $4 million, augmented by a $1.5 million escrow account. To this $5.5 million base, the court added $5 million in expected recoveries not related to the NTS transaction, leaving $10.5 million in the estate. The settlement adds to this:
$2,800,000 Cash payment from Lenders. TS ¶ 5(a).
1,500,000 New loan from Lenders. TS ¶ 5(b).
1,600,000 Tax and miscellaneous receipt escrows. TS ¶ 5(c), 6(a)(ii); Geller Trans at 101-_ 02.
$5,900,000 Total
This results in an estimated estate, under the settlement, of about $16.4 million.
Benefit to non-settling creditors.
The proposed settlement specifies payments to credi
Payment of priority claims: $ 9,700,000
Priority payment to nonsettling creditors 6,700,000
Balance to be distributed pro rata _-0-
Total $16,400,000
The $6.7 million distribution to non-settling creditors under the proposed settlement exceeds the likely return to them if litigation regarding the NTS transaction is pursued only against WTG and the Lenders.
Impact of Telesphere’s right to pursue other defendants. The proposed settlement is structured to allow Telesphere to continue to pursue claims arising from the NTS transaction against defendants (such as Haan and Galesi) other than WTG and the Lenders, and even provides a litigation fund for that purpose. The settlement does not result in a full avoidance of the transaction, and hence further recoveries would appear possible under Section 550(c). Because of the waiver of the WTG unsecured claim, any recovery against other defendants would provide the non-settling creditors with a larger distribution than they would otherwise have received. Thus, if the estate were increased by a $10 million additional net recovery (resulting in an estate of $26.4 million), the distribution would be as follows:
Payment of priority claims: $ 9,700,000
Priority payment to nonsettling creditors 6,700,000
Balance to be distributed pro rata 10,000,000
Total $26,400,000
The nonsettling creditors would receive about 63% (65/103) of the funds available for pro rata distribution, in this example, about $6.3 million, for a total distribution of $13 million, a 20% distribution. This is substantially more than the non-settling creditors would have received if litigation were pursued against the same defendants in the absence of a settlement.
D. The settlement and the reasonable range of litigation possibilities.
From the preceding discussion it is apparent that the proposed settlement is within the reasonable range of litigation possibilities, and may even exceed this range. If the estates are relatively small, the settlement provides a minimum distribution, funded by the Lenders, and effectuated by partial subordination of the claims of both the Lenders and WTG. If the estates are larger, the settlement results in a larger proportion being paid to the nonsettling creditors, primarily as a result of the waiver of WTG’s unsecured claim.
Tamona has suggested that the settlement with WTG be approved, but that the settlement with the Lenders be rejected. This is not possible. Although the terms of the settlement can certainly be seen as involving separate transactions, and although WTG indicated its willingness to enter into a separate transaction, in fact the proposed settlement is an integrated package, with the agreements of WTG and the Lenders mutually dependent. The settlement has been presented to the court as a whole, and must be approved or rejected on that basis. Ta-mona may be correct that the Lenders are not contributing an amount equivalent to a judgment avoiding the NTS transaction, but this is not the standard for approval and, as noted earlier, the lack of a full satisfaction is actually a prerequisite to further action against other defendants.
From the evidence presented at the hearing it is evident that the proposed settlement is in the best interest of the Telesphere estates.
Conclusion
For the reasons set forth above, the court grants the motion to approve the proposed settlement. A separate order will be entered in conformity with this opinion.
Notes
. The relevant facts are principally drawn from the following sources:
(a) Motion Of Telesphere Communications, Inc., Telesphere Network, Inc. And Tele-sphere Limited, Inc. For Entry Of An Order Pursuant To Federal Rule Of Bankruptcy Procedure 9019(a) Authorizing And Approving Agreement Compromising And Settling Claims And Causes Of Action And For Other Relief (hereinafter, "TM”);
(b) Agreement Compromising And Settling Claims And Causes Of Action (hereinafter, “TS”);
(c) The Objection of Tamona Enterprises, Inc. to the settlement motion (hereinafter, “Obj.”)
(d) Testimony of Jay S. Geller appearing in Transcript of November 4, 1993 (hereinafter, "Geller Trans.”);
(e) Testimony of Joseph Nemmers appearing in Transcript of November 4, 1993 (hereinafter, "Nemmers Trans.”);
(f) Testimony of Robert M. Fishman appearing in Transcripts of November 4, 1993 and 5, 1993 (hereinafter, "Fishman Trans.”);
(g) Colloquy with counsel appearing in Transcript of November 22, 1993 (hereinafter, "Counsel Trans.");
(h) Trial exhibits introduced during the examination of Jay S. Geller on November 4, 1993 (“Geller Ex.”).
. Counsel for the Committee testified that the reduction of the allowed amount of WTG’s administrative claims has a value of approximately $2.4 million. See Geller Trans. 101-02; Fish-man Trans, at 208-11. That testimony also indirectly indicates that the partial subordination of WTG’s reduced administrative claim has a worth of nearly $400,000. Compare TS ¶¶ 6(d) & 10 (amount, time, manner, and source of payment of WTG's reduced administrative claim) with TS ¶¶ 5(b) & 10 (amount, time, manner, and source of payment of bank loan) and Geller Trans. 109-10 & 126 (valuation of bank loan).
. In addition to the claim waiver, Telesphere agreed to provide the Lenders with two other items of consideration, neither of which appears to have substantial cost to the estates. First, the estates give up any claim to the remaining proceeds of the Section 363 sale, held in the sales escrow. These funds, however, are clearly encumbered by the liens imposed as part of the adequate protection for the debtors’ use of pre-petition collateral, and thus the estates had no substantial claim to these proceeds. Second, the Lenders are given the option of requiring the Telesphere to pursue collection of a $1.44 million promissory note. If the note has value, it would be in the estates' interest to pursue collection of the note in any event, since collection of the note would reduce the Lenders’ claims against other estate assets.
. The subordination is effected by allowing creditors other than WTG and the Lenders a security interest in a $6.7 million fund. TS ¶ 5(f).
. Title 28 U.S.C. § 2075, which accords the power to adopt bankruptcy rules, specifies that they shall not "abridge, enlarge, or modify any substantive right.”
See In re Phillips,
. For example, court approval is ordinarily not required in the process of allowing a claim against the estate. Claims filed pursuant to Section 501 of the Code are automatically allowed, pursuant to Section 502(a) unless an objection is filed under Section 502(b).
In re Abijoe Realty Corp.,
. The settlement of a cause of action held by the estate is plainly the equivalent of a sale of that claim. There is no difference in the effect on the estate between the sale of a claim (by way of assignment) to a third party and a settlement of the claim with the adverse party.
. Section 102(l)(B)(i) of the Code makes it clear that the phrase "after notice and a hearing,” as used in Section 363(b), "authorizes an act without an actual hearing if such notice is given properly and if such a hearing is not requested timely by a party in interest.” Thus, as the House Report points out, "[i]f an objection to the proposed action is not made, then the trustee may proceed with the same authority as if he had obtained a court order authorizing the action.” H.R.Rep. No. 595, 95th Cong., 1st Sess. 108 (1977). However, even though court review is not required, neither is it prohibited: a bankruptcy judge may choose to review the propriety of any disposition of assets under Section 363(b), even in the absence of objection.
In re VIII South Michigan Associates,
. The major issue in dispute in the cases applying Section 363(b) is whether, in the context of a reorganization, a sale of substantial assets of the estate may short-circuit the plan confirmation
. Apparently in order to provide for a global settlement, the agreement between Telesphere and the settling parties includes a fairly broad covenant from Telesphere not to sue WTG and a fairly broad release of the Lenders. TS ¶¶ 6(g) & 6(k). However, the objecting party, Tamona, has not identified, presented any evidence, or made any argument about claims unrelated to the NTS transaction. Similarly, with one exception, Ta-mona has not presented any significant evidence or argument regarding causes of action that do arise from the NTS transaction other than avoidance claims. The one exception — a claim for equitable subordination under Section 510(c) of the Bankruptcy Code — is discussed at pp. 560-62, below. Otherwise, the discussion of potential litigation outcomes is limited to avoidance claims arising from the NTS transaction.
See Lionel,
.The Lenders have argued that fraudulent conveyance recoveries would have a similar effect: that to the extent a lender is required to give up fraudulently conveyed collateral, its secured claim would be reduced, but its unsecured claim would increase. This argument is not persuasive. The relevant fraudulent conveyance provisions — Section 548(a) of the Bankruptcy Code; Sections 5(a)(1) and 8(a)(1) of the Uniform Fraudulent Transfer Act, 740 ILCS 160/5(a) and 8(a)(1) (1992), and Sections 4, 9-10 of the Uniform Fraudulent Conveyance Act, N.Y. Debtor & Creditor Law §§ 273, 278-79 (McKinney 1994)— provide not only for the avoidance of fraudulent transfers of property, but also for the avoidance of "obligations" that are deemed fraudulently incurred. Thus, for example, if insolvent debtors incur an obligation without fair consideration, the obligation itself, as well as the transfer of any collateral, would be avoided.
See Covey v. Commercial National Bank of Peoria,
. One factor that the court is not required to include in its assessment is the risk of noncollection. Based on the evidence at trial, WTG and the Lenders possess sufficient assets to satisfy any judgment entered against them on account of Telesphere's avoidance claims.
. Section 202 of the Bankruptcy Reform Act of 1994 eliminates the "DePrizio" cause of action, by prohibiting the recovery by a trustee from an initial transferee that is not an insider. Bankruptcy Reform Act of 1994, Pub.L. No. 103-394, § 202, 108 Stat. 4106, 4121 (1994). This provision, however, like most of the Act, does not apply with respect to cases commenced before the date of enactment, October 22, 1994.
Id..,
§ 702(b),
. Telesphere would probably not be able to employ the direct fraudulent conveyance provisions of Section 548(a) of the Code because that section is only applicable to transfers made and obligations incurred “within one year before the filing of the petition.” The May 1990 WTG loan took place more than one year before the filing of the petitions in these cases.
. The parties have mentioned the possibility of fraudulent transfer claims under Section 544(b) of the Code, as discussed above in connection with claims against WTG. However, they have not identified any respect in which Telesphere’s recovery under Section 544(b) would be greater than its recovery under Section 548. Accordingly, only Section 548 is considered here.
. Section 548(a) provides in pertinent part that a trustee (and hence a debtor in possession):
may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year before the date of the filing of the petition, if the debtor voluntarily ...
(1) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or
(2)(A) received less than reasonably equivalent value in exchange for such transfer or obligation; and (B)(i) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (ii) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; or (iii) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured.
11 U.S.C. § 548(a).
. As noted earlier, Telesphere's controlling shareholder gave a $26 million personal guaranty to support the WTG loan. The removal of this personal liability could be seen as a kind of “cash out,” since the shareholder's liability on the WTG loan was eliminated by the transaction with the Lenders, which the shareholder did not guarantee. On the other hand, the provision of the personal guarantee tends to indicate that management genuinely believed that the acquisition of NTS was in Telesphere's best interest, at least at the time of the WTG loan.
. To determine reasonably equivalent value, a court would be required to weigh the obligations assumed by Telesphere and the securhy interests it transferred against the benefit that Telesphere received as a result of the NTS transaction.
See, e.g., In re Bundles,
Telesphere would also be likely to establish insolvency or inadequate capital as a result of the transaction. Balance sheet solvency would only have existed after the NTS transaction if NTS were accorded a value well in excess of its tangible assets. Geller Trans, at 53. And the NTS acquisition left Telesphere with only $1.3 million in working capital to use in assimilating a major telephone network. Subsequent events tend to show that this was not adequate. Within three months of the acquisition, Telesphere had depleted its working capital, and had to borrow an additional $10.7 million for its working capital needs.
. Section 548(c) states in pertinent part:
Except to the extent that a transfer or obligation voidable under [section 548(a) ] is voidable under section 544, 545, or 547 of [the Code], a transferee or obligee of such transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.
. Beyond the language of Section 548(c) itself, there is no definition of "good faith” anywhere in the Bankruptcy Code. Likewise, the legislative history related to section 548(c) never defines, and scarcely addresses, good faith. See S Rep. No. 989, 95th Cong., 2d Sess. 89-90 (1978); HR Rep. No. 595, 95th Cong., 1st Sess. 375 (1977).
. The Bankruptcy Act of 1898, § 67d, 30 Stat. 564, ch. 541 (1901), provided in pertinent part that “liens given or accepted in good faith and not in contemplation of, or in fraud upon, this act, and for a present consideration ... shall not be affected by this act.”
. Section 67d(6) provided, in relevant part, that a "purchaser, lienor, or obligee, who without actual fraudulent intent has given a consideration less than fair ... for [an interest or obligation of an insolvent debtor] may retain the property, lien, or obligation as security for repayment.”
. Tamona relies on the Seventh Circuit opinion in
Bonded Financial Services, Inc. v. European American Bank,
. Since the Lenders would be allowed to retain their liens and enforce their obligations to the extent that they gave value in good faith (pursuant to Section 548(c)), and to the extent that the liens and obligations are not avoided (because of recovery against WTG, pursuant to Section 550(c)), the Lenders would be allowed to retain all of their secured claims.
. The case law discussing equitable subordination based on the conduct of the claimant distinguishes sharply between claimants who exercised control over the debtor (insiders) and persons who did not exercise such control.
See, e.g., Kham & Nate’s Shoes,
. In arguing in favor of subordination, Tamona relies principally on
In re O’Day Corp.,
. The general unsecured claim of the Lenders is a deficiency claim arising from their loan. Tele-sphere maintains that the deficiency is either $40 million or $42 million. See, e.g., Geller Trans. 51-52 & 111-12; Counsel Trans, at 4. The Lenders contend that their deficiency claim approaches $52 million. See Geller Trans. 111-12; Counsel Trans, at 3-4. Both appear to be mistaken. First, the Lenders arrive at a $52 million deficiency by failing to include in their collateral a $12 million sales escrow to which they are probably entitled. See, e.g., Geller Trans. 111-12; Counsel Trans, at 3-4. Second, another escrow, in the amount of $1.6 million, held for payment of taxes, would also likely be available to the Lenders in the absence of a settlement, even though the proposed settlement waives the Lenders’ claims to this fund. See Geller Trans, at 102. This may be the source of the confusion between $40 and $42 million, and would indicate, that, in the absence of a settlement, the Lenders' would have only a $40 million deficiency. Finally, all of the parties appeared to have failed to consider another fund, in excess of $2 million, arising from a 900-number escrow fund. Counsel Trans, at 5. This would also be available to the Lenders, reducing their unsecured claims to about $38 million.
. There is no dispute regarding the amount of this claim. See Geller Trans. 95-96.
. There is no material dispute that WTG's general unsecured claim approximates $190 million, see Geller Trans. 95-96, 99-100, 110-11. However, it should be noted that if a recovery against WTG were based solely on a preferential repayment of the WTG loan, WTG would be entitled to assert an additional unsecured claim in the amount of any judgment paid to Telesphere. See pp. 14-15, above. The $190 million claim amount is thus conservative.
. Telesphere and Tamona did not contest that the amount of administrative claims of creditors, other than WTG and the Lenders, approaches $4.5 million. Nemmer Trans, at 115-17. They did not, however, provide any estimate of the administrative expenses to be allowed in the future. The court has estimated an additional $2 million in administrative expenses to cover the expected costs of completing the general case administration and of pursuing avoidance claims against parties other than WTG and the Lenders.
. Telesphere and Tamona do not materially dispute that $65 million is the expected aggregate
. The potential for a double recovery here can be seen most easily in the context of the payment for Haan’s NTS stock. Formally, this was a two-stage transaction: first, Telesphere borrowed funds from the Lenders (assuming obligations and transferring security interests for cash); second, Telesphere bought Haan’s stock (transferring cash for stock). However, in order to recover against the Lenders, Telesphere must collapse the transaction, and view it as one in which Telesphere assumed obligations and transferred security interests to the Lenders in direct exchange for Haan’s stock. Then, if the stock was worthless, those obligations, and the accompanying transfer of security interests, could be entirely avoided, with Telesphere owing nothing to the Lenders, but being required to return the stock to them. To recover against Haan, Telesphere must not collapse the transaction. It must instead focus on the second step — the exchange of cash for stock — and assert that the stock was not worth the cash paid, allowing avoidance of the second step of the transaction only, with Tele-sphere taking back the cash and surrendering the stock to Haan but retaining an obligation to the Lenders. To the extent Telesphere recovers from the Lenders on the collapsing theory, it cannot recover from Haan. To allow such a result would both give Telesphere the cash it paid to Haan and relieve Telesphere of the obligation to repay the loan that generated the cash.
. The estate available for distribution in this situation would be $47 million ($26 million net from the WTG loan, and $21 million for the NTS stock purchase). The unsecured claims against this estate would be $287 million — consisting of WTG's $190 million claim, the non-settling creditors' claims of $65 million, and a $32 million claim for the Lenders (their $38 million deficiency claim reduced only by the $6 million in professional fees paid from the loan proceeds). The non-settling creditors’ share of the estate is about 23% (65/292) or $10.6 million.
. The settlement calls for the Lenders to make a new $1.5 million loan to help fund the $6.7 million priority payment to non-settling credi- • tors. TS ¶ 5(b).
. Although the Lenders agree in the settlement to give up their claims to the tax escrow, thus decreasing the collateral available to support their claims, they have agreed to the same $38 million secured claim that the court found would be in effect without the settlement. TS ¶ 6(b).
. As part of the settlement, WTG agreed to reduce its administrative claim from $4.1 million to $1.7 million. TS ¶ 6(d).
.- The settlement provides that WTG waive its entire unsecured claim. TS ¶ 6(c).