jlg Doc 205 Filed 05/04/17 Entered 05/04/17 18:06:35 Main Document Pg 1 of 19. Chapter 11

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1 Pg 1 of 19 UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK x In re SquareTwo Financial Services Corporation, et al. 1 Chapter 11 Case No (JLG) (Jointly Administered) Debtors x OBJECTION 2 OF THE UNITED STATES TRUSTEE TO CONFIRMATION OF DEBTORS JOINT PREPACKAGED CHAPTER 11 PLAN 1 The Debtors in these chapter 11 cases and the last four digits of each Debtor s federal taxpayer identification number and/or Canadian equivalent are as follows: Astrum Financial, LLC (2265); Autus, LLC (2736); CA Internet Marketing, LLC (7434); CACH, LLC d/b/a Fresh View Funding (6162); CACV of Colorado, LLC (3409); CACV of New Jersey, LLC (3499); Candeo, LLC (2809); CCL Financial Inc. (7548); Collect Air, LLC (7987); Collect America of Canada, LLC (7137); Healthcare Funding Solutions, LLC (2985); Metropolitan Legal Administration Services, Inc. (6811); Orsa, LLC (2864); Preferred Credit Resources Limited (0637); ReFinance America, Ltd. (4359); SquareTwo Financial Canada Corporation (EIN: 1034; BN: 0174); SquareTwo Financial Corporation (1849); and SquareTwo Financial Services Corporation d/b/a Fresh View Solutions (5554). The Debtors executive headquarters are located at 6300 South Syracuse Way, Suite 300, Centennial, CO The Debtors extended the deadline for the United States Trustee to object or otherwise respond to the Motion to close of business on May 4, 2017.

2 Pg 2 of 19 TABLE OF CONTENTS INTRODUCTION... 2 FACTS... 3 A. General... 3 B. The Plan... 4 The Injunctions and Release Provisions... 5 Notice Procedures for Impaired Classes... 8 OBJECTION... 9 A. The Plan s Injunction Provision is Vague and Overbroad... 9 B. The Plan Improperly Imposes Third Party Releases on the Rejecting Impaired Classes.. 10 C. The Debtor Must Meet the Metromedia Standards D. The Plan Does Not Satisfy the Best Interest Test. 15 E. The Releases for the Debtors Professionals are Inappropriately Broad.. 15 CONCLUSION i

3 Pg 3 of 19 CASES PAGE(S) In re Chassix Holdings, 533 B.R. 64, 81 (Bankr. S.D.N.Y. 2015) In re Chemtura Corp., 439 B.R. 561, (Bankr. S.D.N.Y. 2010) In re DBSD North America, Inc., 419 B.R. 179, 217 (Bankr. S.D.N.Y. 2009) 12, 13 Deutsche Bank AG v. Metromedia Fiber Network (In Re Metromedia Fiber Network), 960 F.2d 285, 292 (2d Cir. 1992)....11, 12 In re Genco, 513 B.R. 233 (Bankr. S.D.N.Y. 2014) In re Karta Corp., 342 B.R. 45 (Bankr. S.D.N.Y. 2006) In re Nat l Heritage Foundation, 478 B.R. 216, 229 (Bankr. E.D.Va. 2012) In re Oneida Ltd., 351 B.R. 79, 94 (Bankr. S.D.N.Y. 2006) SEC v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 962 F.2d 148 (2d Cir. 1992) In re Spiegel, Inc., No (BRL), 2006 WL , *7 (Bankr. S.D.N.Y. Aug. 16, 2006) In re U.S. Wireless Data, 547 F.3d 484, 495 (2d Cir. 2008)...14, 15 In re XO Commc ns, Inc., 330 B.R. 394, 440 (Bankr. S.D.N.Y. 2005) ii

4 Pg 4 of 19 STATUTES 11 U.S.C. 1102(a) U.S.C U.S.C U.S.C. 1129(a)(7)...3, 14, 15 RULES N.Y. Comp. Codes R. & Regs. Tit Rule 1.8(h) (1) (2010)...15 iii.

5 Pg 5 of 19 TO: THE HONORABLE JAMES L. GARRITY UNITED STATES BANKRUPTCY JUDGE: William K. Harrington, United States Trustee for Region 2 (the United States Trustee ), respectfully submits this objection to confirmation of the Joint Prepackaged Plan of Reorganization of SquareTwo Financial Services Corporation and its affiliated Debtors. ECF Doc. No. 20 (the Plan ). In support hereof, the United States Trustee respectfully states: INTRODUCTION The United States Trustee objects to confirmation of this pre-packaged plan because it adversely impacts creditors who will receive no distribution and likely have no idea that they may, in the future, be affected by these bankruptcy cases. Indeed, if the Plan is confirmed, general unsecured creditors will unknowingly release officers and directors for such things as violations of the Fair Debt Collection Practices Act and other similar state and local statutes and regulations, which is inconsistent with the concepts of notice and fairness. The Debtors primary business is to purchase, manage, and collect charged-off consumer and commercial accounts receivable. These bad debts are purchased by the Debtors from credit issuers for a fraction of the face amount of the debt. On information and belief, the purchased debt is bundled in packages, the debt is vetted by neither the seller nor the purchaser, and most of the information about the debt typically takes the form of an Excel spreadsheet listing names, social security numbers, and account balances. In fact, some of the debt that is sold no longer exists, as it (i) has been discharged in bankruptcy, (ii) has already been paid, or (iii) is outside the statute of limitations for collection actions. In addition, consumers may not find out that their debt has been sold until many years after the sale. 2

6 Pg 6 of 19 Lawsuits brought by consumers across the country against debt purchasers such as debtors SquareTwo Financial Services Corporation and CACH, LLC often assert that aggressive tactics are utilized by debt purchasers to persuade consumers to pay charged off debt. These suits often allege violations of the Fair Debt Collection Practices Act. At least two published articles refer to the tactics used by debt purchasers as ruthless. 3 Typically, prepackaged plans that come before the Court involve an exchange of a debtor s secured debt for equity with the unsecured creditors generally riding through the bankruptcy unaffected. Not so here, where unsecured creditors may suffer real harm by not having been given an opportunity to vote on the releases contained in the Plan. They are likely unaware of (i) the import of this bankruptcy filing, (ii) the effect of the releases, and (iii) the elimination of their right to sue for violations of Federal and state laws governing debt collection practices. However, even if they were aware of the same, the creditors cannot do anything because the Debtors have not solicited their input. The Plan, therefore, fails the best-interest test under 11 U.S.C. 1129(a)(7) and should not be confirmed, unless the third-party releases are severed from the Plan. FACTS A. General 1. On March 19, 2017 (the Filing Date ), the Debtors each filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code. ECF Doc. No. 1. On March 27, 2017, the Court ordered that the cases be jointly administered for procedural purposes. ECF Doc. No. 65. No trustee or examiner has been appointed in these cases. The Debtors continue to operate their 3 Ryan Bort, John Oliver Explains the Terrifying World of Debt Buying, Newsweek, June 6, 2016; Chris Fichera, Fight back against ruthless debt collectors, Consumer Reports, July 16,

7 Pg 7 of 19 businesses and manage their properties as debtors-in-possession pursuant to section 1107 and 1108 of the Bankruptcy Code. 2. The Debtors primary business is to acquire, manage, and collect charged-off consumer and commercial accounts receivable, which are accounts that credit issuers have charged off as uncollectible, but that remain owed by the borrower and subject to collection. ECF Doc. Nos. 3 at In 2009 and thereafter, certain of the Debtors were named as defendants in numerous lawsuits, some of which have been filed as class actions. Id. at 37. The lawsuits allege that certain of the Debtors and their law firms violated the Fair Debt Collection Practices Act (the FDCPA ) as well as similar state and local statutes and regulations (collectively, the Collection Practices Laws ). See id. As of the Filing Date, various lawsuits are pending against one or more of the Debtors. Id. 4. On April 7, 2017, pursuant to section 1102(a) of the Bankruptcy Code, the United States Trustee appointed the Official Committee of Unsecured Creditors. ECF Doc. No B. The Plan 5. In general terms, the Plan contemplates a restructuring involving a new money investment from Resurgent Holdings LLC (the Plan Investor ) through a chapter 11 restructuring and a Canadian Recognition Proceeding, in exchange for which the Plan Investor would receive all of the equity in certain of the Debtors (the Acquired Debtors ) and a winddown company would own the remaining Debtors (the Dissolving Debtors and, together with the Acquired Debtors, the Reorganized Debtors ). See Plan. 6. On March 3, 2017 the Debtors executed a Restructuring Support Agreement (the RSA ) with the Plan Investor and creditors representing 100 percent of the First Lien Financing 4

8 Pg 8 of 19 Facility, 100 percent of the 1.25 Lien Term Loan Facility, and 83 percent of the 1.5 Lien Term Loan Facility, whereby such restructuring support parties agreed to vote to accept the Plan in the Debtors chapter 11 cases. See ECF Doc. No. 21 (the Disclosure Statement ) at 4. The Injunctions and Release Provisions 7. Among other features, the Plan includes an injunction, debtor and non-debtor releases, and an exculpation provision. Plan at As set forth below, the Debtors propose to shield the Debtors directors and officers from liability to the extent they participated in violations of the Collection Practices Laws. Id. at 12.6(c). The Debtors also seek to enjoin unsecured creditors from asserting their claims (and potentially their defensive setoff and recoupment rights) against the Reorganized Debtors for violations of the Collection Practices Laws. 8. The third-party releases states: (c) Releases of Directors and Officers. Except as otherwise provided in this Plan or the Confirmation Order, and except with respect to any claims against directors that cannot be released under section 5.1(2) of the Companies' Creditors Arrangement Act (Canada), on the Effective Date, each of the directors and officers of Debtors serving in such capacities as of the Petition Date, each in their capacities as such, shall be deemed to be released from all claims, obligations, suits, judgments, demands, debts, rights, Causes of Action and liabilities whatsoever (other than the right to enforce the obligations of any party under this Plan and the contracts, instruments, releases, agreements and documents delivered under or in connection with this Plan), whether liquidated or unliquidated, fixed or contingent, matured or unmatured, known or unknown, foreseen or unforeseen, then existing or thereafter arising, in law, equity or otherwise that are based in whole or in part on any act or omission, transaction, event or other occurrence taking place on or prior to May 24, 2016 in any way relating to the Debtors. (d) Notwithstanding anything to the contrary contained herein: (i) except to the extent permissible under applicable law, as such law may be extended or interpreted subsequent to the Effective Date, the releases provided for in this Section 12.6 of the Plan shall not release any non-debtor entity from any liability arising under (x) the Internal Revenue Code, Canadian federal tax law, or any state, provincial, city or municipal tax code, or (y) any criminal laws of the United States, Canada or any state, province, city or municipality; and (ii) the releases set 5

9 Pg 9 of 19 forth in this Section 12.6 shall not release (x) claims against any Person to the extent such Person asserts a crossclaim, counterclaim and/or claim for setoff which seeks affirmative relief against a Debtor or any of its officers, directors, managers, managing members, or representatives and (y) claims against any Person arising from or relating to such Person's gross negligence, willful misconduct or actual fraud, each as determined by a Final Order of the Bankruptcy Court. Plan at 12.6 (c) and (d). 9. The injunction states: Except as otherwise provided in this Plan or the Confirmation Order (including with respect to Canadian Claims and Assumed U.S. Liabilities), as of the Confirmation Date, but subject to the occurrence of the Effective Date, all Persons who have held, hold or may hold Claims against or Interests in the Debtors or the Estates are, with respect to any such Claims or Interests, permanently enjoined after the Confirmation Date from (i) commencing, conducting or continuing in any manner, directly or indirectly any suit, action or other proceeding of any kind (including any proceeding in a judicial, arbitral, administrative or other forum) against or affecting the Released Parties, the Reorganized Debtors, including the Acquired Debtors, and the Dissolving Debtors, the Estates (including any of the foregoing located in Canada) or any of their property, wherever located, including Canada, or any direct or indirect transferee of any property, wherever located, of, or direct or indirect successor in interest to, any of the foregoing Persons or any property, wherever located, including Canada, of any such transferee or successor, on account of or in connection with or with respect to any released, settled, compromised, or exculpated Claims, Interests, Causes of Action or liabilities; (ii) enforcing levying, attaching (including any pre-judgment attachment), collecting or otherwise recovering by any manner or means, whether directly or indirectly, any judgment, award, decree or order against the Released Parties, the Reorganized Debtors, including the Acquired Debtors, and the Dissolving Debtors, the Estates (including any of the foregoing located in Canada) or any of their property, wherever located, including Canada, or any direct or indirect transferee of any property, wherever located, of, or direct or indirect successor in interest to, any of the foregoing Persons, or any property, wherever located including Canada, of any such transferee or successor, on account of or in connection with or with respect to any released, settled, compromised, or exculpated Claims, Interests, Causes of Action or liabilities, (iii) creating, perfecting or otherwise enforcing in any manner, directly or indirectly, any encumbrance of any kind against the Released Parties, the Reorganized Debtors, including the Acquired Debtors, the Dissolving Debtors or the Estates (including any of the foregoing located in Canada) or any of their property, wherever located, including Canada, or any direct or indirect transferee of any property, wherever located, including Canada, of, or successor in interest to, any of the foregoing Persons, on account of or in connection with or with respect to any 6

10 Pg 10 of 19 released, settled, compromised, or exculpated Claims, Interests, Causes of Action or liabilities; (iv) acting or proceeding in any manner, in any place whatsoever (including in Canada), that does not conform to or comply with the provisions of this Plan to the full extent permitted by applicable law; and (v) commencing or continuing, in any manner or in any place (including in Canada), any action that does not comply with or is inconsistent with the provisions of this Plan; provided, however, that nothing contained herein shall preclude such Persons from exercising their rights, or obtaining benefits, pursuant to and consistent with the terms of this Plan. For the avoidance of doubt, ancillary security enforcement, insolvency processes and/or other proceedings may be deployed in any relevant jurisdictions to implement the transactions set out in this Plan, including the injunctions set forth in this Section 12.5, in order to ensure that they are fully effective. Each of the Reorganized Debtors, as applicable, is expressly authorized hereby to seek to enforce such injunction. Plan at Plan at The exculpation provision provides: On the Effective Date, for good and valuable consideration, to the maximum extent permissible under applicable law, none of the Released Parties shall have or incur any liability to any holder of any Claim or Interest or any other Person for any act or omission in connection with, or arising out of the Debtors' restructuring, including the negotiation, implementation and execution of this Plan, the Chapter 11 Cases, the Canadian Proceeding, the RSA, the Plan Funding Agreement, the Disclosure Statement, the DIP Credit Agreement, the solicitation of votes for and the pursuit of confirmation of this Plan, the consummation of this Plan, or the administration of this Plan or the property to be distributed under this Plan, including all documents ancillary thereto, all decisions, actions, inactions and alleged negligence or misconduct relating thereto and all activities leading to the promulgation and confirmation of this Plan except for gross negligence or willful misconduct, each as determined by a Final Order of the Bankruptcy Court. For purposes of the foregoing, it is expressly understood that any act or omission effected with the approval of the Bankruptcy Court conclusively will be deemed not to constitute gross negligence, or willful misconduct unless the approval of the Bankruptcy Court was obtained by fraud or misrepresentation, and in all respects, the applicable Persons shall be entitled to rely on the written advice of counsel with respect to their duties and responsibilities under, or in connection with, the Chapter 11 Cases, the Plan, and the administration thereof. 11. Released Parties are defined in the Plan as: Released Parties means, collectively, and each solely in its capacity as such: (a) the Debtors and Reorganized Debtors (including the Acquired Debtors and the 7

11 Pg 11 of 19 Dissolving Debtors); (b) the DIP Administrative Agent and the DIP Lenders; (c) the First Lien Administrative Agent; (d) the 1.25 Lien Administrative Agent; (e) the 1.5 Lien Administrative Agent; (f) the Consenting Lenders; (g) the Plan Investor; (h) the Creditors Committee (if any) and each of its members solely in their capacity as members of the Creditors Committee; and (i) each of such parties respective predecessors, successors, assigns, subsidiaries, owners, affiliates, managed accounts or funds and their current and former officers, directors, managers, managing members, employees (other than with respect to (1) money borrowed from or owned to the Debtors by any such employees as set forth in any of the Debtor s books and records, or (2) any obligations owed by such employees to such Debtor or pursuant to written agreement), managers, members, principals, shareholders, agents, advisory board members, management companies, fund advisors, partners, attorneys, financial advisors or other professionals or representatives, together with their successors and assigns; provided, however, that such attorneys and professional advisors shall only include those that provided services related to the Chapter 11 Cases or the Canadian Proceeding and the transactions contemplated by this Plan; provided, further, that no Person shall be a Released Party if it objects to the releases provided for in Article Xii of this Plan. Notice Procedures for Impaired Classes 12. The Plan provides for six classes of creditors whose claims are treated as impaired, three of which are entitled to vote on the Plan. The remaining three classes of creditors are estimated to receive a 0% recovery and are deemed to reject the Plan (the Rejecting Impaired Classes ). See Chart below. If the Plan is confirmed, however, the releases, injunction, and exculpation provisions of the Plan would be automatically imposed against the Rejecting Impaired Classes. Class Designation Treatment Entitled to Vote? 6 Second Lien Impaired No (Deemed to Lender Claims Reject) 7A U.S. General Impaired No (Deemed to Unsecured Reject) Claims 8A Existing U.S. Interests Impaired No (Deemed to Reject) Releasing Party? Yes Yes Yes 8

12 Pg 12 of On March 27, 2017, the Court entered an Order (a) scheduling a combined hearing on adequacy of the Debtors Disclosure Statement, approval of the Solicitation Procedures and confirmation of the Prepackaged Plan, (b) approving the procedures for objecting to the adequacy of the Disclosure Statement, the Solicitation Procedures and confirmation of the Prepackaged Plan, (c) approving the form and manner of the Combined Notices, (d) waiving the requirement for filing a list of creditors and a list of equity holders, (e) authorizing the Debtors to file a consolidated list of creditors holding the thirty (30) largest unsecured claims, (f) postponing or waiving section 341(a) meeting, and (g) granting related relief (the Procedural Order ). ECF Doc. No. 66. Paragraph 9 of the Procedural Order states: Id. at 9. On March 27, 2017, the Debtors shall mail, or caused to be mail, a copy of the Non- Voting Parties Combined Notice to those classes of claims and interests that are not entitled to vote and are presumptively deemed to accept or reject the Prepackaged Plan, and any other parties on the master service list in these cases solely to the extent not duplicative of the notice parties in paragraph The Non-Voting Parties Combined Notice, which is attached as Exhibit 1 to the Procedural Order, contains a provision which states that certain injunction, exculpation, and discharge provisions of the Plan will become effective on the confirmation date. Procedural Order, Exhibit 1, Rejecting Impaired Classes are not provided with a ballot that would enable them to indicate their desire to opt in or out of the injunction, release, and exculpation provisions. OBJECTION A. The Plan s Injunction Provision is Vague and Overbroad Since the Filing Date, the United States Trustee has received inquiries from general unsecured creditors and other parties in interest on the scope of the injunction contained in 9

13 Pg 13 of 19 section 12.5 of the Plan. Specifically, it is unclear from the Plan whether an unsecured creditor will be prevented from asserting its defensive rights of setoff or recoupment if the Reorganized Debtors assert a collection claim against the unsecured creditor post-confirmation. It is also unclear whether under the Plan an unsecured creditor can sue a collection attorney that was retained as an ordinary course professional for the Debtors 4 for violations of the Collection Practices Laws. In addition, in certain cases the identity of the Released Parties are unclear, as when the Debtors seek to release predecessors, successors, and assigns. See Plan at The Plan should be amended to clarify these issues and the United States Trustee and parties in interest should be given an opportunity to object, if necessary. To the extent that the injunction acts as a third-party release with respect to all non-debtor parties, all of the arguments in part B, C, and D below apply. B. The Plan Improperly Imposes Third-Party Releases On the Rejecting Impaired Classes In In re Chassix Holdings, the Court (J. Wiles) explained that any time a third-party release is part of a proposed plan, a creditor should have a right to affirmatively opt in to such release. 533 B.R. 64, 81 (Bankr. S.D.N.Y. 2015). The Court noted that while courts have often treated a vote in favor of a plan as consent to third-party releases, there is no public policy reason to do so, and in fact, the Second Circuit has admonished that third-party releases should be only granted in rare circumstances. Id. at The Chassix Court distinguished the situation where a creditor is impaired and explained that when a creditor rejects a plan, that creditor must be deemed to reject the releases, or at the very least, be given an opportunity to affirmatively opt in to the releases to make such 4 See ECF Doc. Nos. 81,

14 Pg 14 of 19 provision binding on the impaired creditors. Id at 79. The Court further held that if a creditor is deemed to reject the plan and given no opportunity to vote or to opt in, it would defy common sense to conclude that those parties had consented to releases. Id; see also, In re Chemtura Corp., 439 B.R. 561, (Bankr. S.D.N.Y. 2010) (J. Gerber) (stating that third-party releases are unenforceable when creditors were not provided with a mechanism to express their desire to grant or withhold such release); In re Oneida Ltd., 351 B.R. 79, 94 (Bankr. S.D.N.Y. 2006) (J. Gropper) (although the equity committee had raised, but then abandoned, an objection to the validity of the non-debtor third-party releases, the Court found that the releases were acceptable because all of the affected creditors had consented by affirmatively checking a box on the ballot indicating their willingness to grant the releases). Here, the Debtors seek approval of releases that bar non-consenting creditors from independent actions against the Debtor s directors and officers. For example, the releases prevent the Rejecting Impaired Classes from suing a director or officer of the Debtors who is individually liable under the Collection Practices Laws, based on the individual s participation in the violation, and not simply because of their association with the collection agency. 5 Unless these third-party releases are severed from the Plan, the Plan should not be confirmed as the Rejecting Impaired Classes have not opted in or otherwise provided consent to have their rights against third-parties further stripped from them. C. The Debtors Must Meet the Metromedia Standards The Debtors have also not met their burden under Second Circuit law showing that this is a rare case and that there are unusual circumstances justifying the approval of the third-party releases. Deutsche Bank AG v. Metromedia Fiber Network (In re Metromedia Fiber Network), 5 The release does not apply to a claim against a director or officer relating to such person s gross negligence, willful misconduct, or actual fraud. 11

15 Pg 15 of F.3d 136, (2d Cir. 2005) ( Metromedia ). The Second Circuit articulated at least two reasons for its reluctance to approve these releases: Id. at 142. First, the only explicit authorization in the Code for non-debtor releases is 11 U.S.C. 524(g), which authorizes releases in asbestos cases when specified conditions are satisfied, including the creation of a trust to satisfy future claims, [and]... Second, a non-debtor release is a device that lends itself to abuse. By it, a nondebtor can shield itself from liability to third parties. In form, it is a release; in effect it may operate as a bankruptcy discharge without a filing and without the safeguards of the Code. The potential for abuse is heightened when releases afford blanket immunity. The Second Circuit held that [i]n bankruptcy cases, a Court may enjoin a creditor from suing a third-party, provided the injunction plays an important part in the Debtors reorganization plan. Id. at 141 (quoting SEC v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 960 F.2d 285, 292 (2d Cir. 1992)). The appellate court cautioned, however, that a third-party release is not considered to be adequately supported by consideration simply because the non-debtor contributed something to the reorganization and the enjoined creditor took something out. Metromedia, 416 F.3d at 143. Rather, [a] non-debtor third-party release should not be approved absent a finding by the court that truly unusual circumstances exist that render the release terms important to the success of the plan. Id. Subsequent cases further clarify the Metromedia requirements. For example, in In re DBSD North America, Inc., the Court stated: As the Second Circuit s decision in Metromedia and my earlier decision in Adelphia provide, exculpation provisions (and their first cousins, so-called third party releases ) are permissible under some circumstances, but not as a routine matter. They may be used in some cases, including those where the provisions are important to a debtor s plan; the claims are channeled to a settlement fund rather than extinguished; the enjoined claims would indirectly impact the debtor s reorganization by way of indemnity or contribution; the released party provides 12

16 Pg 16 of 19 substantial contribution; and where the plan otherwise provides for full payment of the enjoined claims. In re DBSD N. Am., Inc., 419 B.R. 179, 217 (Bankr. S.D.N.Y. 2009) (footnotes omitted); In re Motors Liquidation Co., 477 B.R. 198, 220 (Bankr. S.D.N.Y. 2011) ( Although (since the Code is silent on the matter) third-party releases aren t inconsistent with the applicable provisions of this title, the Second Circuit has ruled that they re permissible only in rare cases, with appropriate consent or under circumstances that can be regarded as unique, some of which the Circuit listed. But where those circumstances haven t been shown, third-party releases can t be found to be appropriate ). 6 In In re Nat l Heritage Foundation, a case with similar facts to the instant case, the United States Bankruptcy Court of the Eastern District of Virginia, held that a release of directors and officers was not enforceable against a class which was not receiving any distribution under the plan B.R. 216, 229 (Bankr. E.D.Va. 2012). Specifically, the Court considered that the officers and directors right to indemnification and advancement of legal expenses could have a materially negative impact on the debtor s ability to successfully complete its reorganization. 8 Id. 6 Other examples include: (i) In re Genco Shipping & Trading Ltd., 513 B.R. 233 (Bankr. S.D.N.Y. 2014) (J. Lane) (approving third-party releases based on a finding that three actions... taken together amounted to such substantial consideration the agreement of certain secured creditors to forego consideration to which they otherwise would be entitled, the furnishing of new value, and the agreement by certain pre-petition creditors to receive equity in exchange for debt in the reorganized Genco debtors); (ii) In re Karta Corp., 342 B.R. 45 (S.D.N.Y. 2006) (framing inquiry as whether a significant non-debtor financial contribution plus other unusual factors render a situation so unique that the non-debtor third-party releases are appropriate ). Id. at 55; (iii) In re Spiegel, Inc., No (BRL), 2006 WL , *7 (Bankr. S.D.N.Y. Aug. 16, 2006) (plan s non-debtor third-party releases and injunctions were critical components of the settlement that played a vital part in the plan and were necessary to the proposed reorganization of the Debtors and the successful administration of their estates ); and (iv) In re XO Commc ns, Inc., 330 B.R. 394, 440 (Bankr. S.D.N.Y. 2005) (J. Gonzalez) (non-debtor third-party releases were permissible where the non-debtors provided significant consideration, the non-debtors were integral to the plan, and the non-debtors interests aligned with those of the debtors with regard to the claims). 7 To be clear, this class of claimants, the Donor Class, held disallowed claims and were therefore not permitted to vote under the plan. 8 The other factors considered by the Court were that (i) it was unlikely that the officers and directors would leave en masse, solely because of the assertion of claims against them, (ii) the officers and directors were not contributing anything financially towards the reorganization, (iii) that there was no support from the affected class, (iv) there was 13

17 Pg 17 of 19 at The Court, however, determined that this single factor alone cannot by itself justify the release provision. Id. at 232. The Court stated: The single factor in favor of the Release provisions the potential for an obligation to indemnify the officers and directors cannot by itself justify the Release Provisions. If it did, then third party releases would be the norm, not the exception, in Chapter 11 cases. This would contravene the now-universally accepted proposition that third party releases are to be granted in exceptional cases. Here, the Disclosure Statement fails to provide any justification for the non-debtor releases. Instead, all the Disclosure Statement provides is that the Reorganized Debtors (i) have an obligation to indemnify or limit the liability of directors or officers as of the Filing Date and (ii) shall not terminate or reduce coverage under any directors and officers insurance policies in effect on the Filing Date. See Disclosure Statement at 50. This disclosure in itself does not provide information as to whether the Reorganized Debtors are required to indemnify or limit the liability of its directors or officers if they are liable under the Collection Practices Laws for their own acts, and not simply based on their association with the collection agency. In addition, the Debtors have not disclosed the terms of the directors and officers insurance policies and whether all claims made under such policies would require the insurance companies to seek indemnification from the Debtors. Finally, as set forth above, the Debtors need to assert more than the fact that the directors and officers have indemnification rights against the Debtors which could impact the Debtors financial situation. Thus, absent adequate explanation from the Debtors as to their justification, the proposed releases should be disallowed. no mechanism within the plan for the affected class to be paid anything, and (v) there was no ability for the affected class to recover anything under the plan if the plan release provisions remained in place. 14

18 Pg 18 of 19 D. The Plan Does Not Satisfy the Best Interest Test A plan may be confirmed only if every non-assenting creditor receives at least as much value as if a chapter 7 liquidation had taken place. 11 U.S.C. 1129(a)(7); see also, In re U.S. Wireless Data, 547 F.3d 484, 495 (2d Cir. 2008)(plan may not be confirmed unless each holder of an impaired claim accepts the plan or receives not less than it would receive in chapter 7). Under the Plan, the Rejecting Impaired Classes are not expected to receive any recovery. Despite what the Liquidation Analysis attached to the Disclosure Statement states, the Rejecting Impaired Classes will receive less under the Plan with its injunctions and non-debtor releases than if the Debtors were converted to chapter 7 and a chapter 7 trustee pursued the sale. In such a scenario, the Rejecting Impaired Classes would receive the same distribution ($0), but would be free to pursue any causes of action they may have. The proposed Plan, therefore, fails the best interest test set forth in 11 U.S.C (a)(7) and should not be confirmed, unless the thirdparty releases are severed from the Plan. E. The Releases for the Debtors Professionals are Inappropriately Broad Rule 1.8(h)(1) of the New York Rules of Professional Conduct (the New York Rule ) provides that a lawyer shall not make an agreement prospectively limiting the lawyer s liability to a client for malpractice. See N.Y. Comp. Codes R. & Regs. Tit Rule 1.8(h) (1) (2010). Although the Exculpation provision carves out acts of gross negligence or willful misconduct from the release afforded to the attorneys for the Debtors, see Plan 12.7, neither the Plan nor the Disclosure Statement contain any provision to ensure compliance with the New York Rule and ensure that the Debtors counsel s exculpations are appropriately limited. The Plan, therefore, should not be approved until it is amended to include the following 15

19 Pg 19 of 19 provision: Nothing in the Plan shall limit the liability of the professionals of the Debtors to their respective clients pursuant to Rule 1.8(h) of the New York Rules of Professional Conduct. In addition, the Exculpation clause exculpates individuals and entitles from liabilities connected to the Debtors restructuring. This wording is such that it could be interpreted to apply to Debtors pre-bankruptcy restructuring, including the exchange of the Second Lien Notes, rather than only acts and omissions connected to the Debtors formulation and solicitation of the Plan. To the extent the Plan provides protection for such prepetition conduct, it is improper. The Exculpation clause must be narrowed or the Plan should not be confirmed. CONCLUSION WHEREFORE, the United States Trustee respectfully submits that the Court (1) should require the Debtors to clarify the scope of the injunction and exculpation provisions of the Plan, (2) require the Debtors to strike the third-party releases and/or require compliance with the law of this Circuit and the Bankruptcy Code; and (iii) grant such other relief as is just. Dated: New York, New York May 4, 2017 Sincerely, WILLIAM K. HARRINGTON UNITED STATES TRUSTEE By: /s/ Susan A. Arbeit Susan A. Arbeit Richard C. Morrissey Trial Attorneys U.S. Department of Justice Office of the United States Trustee U.S. Federal Office Building 201 Varick Street, Room 1006 New York, NY Tel. (212)