In Re: Metromedia Fiber Network, Inc., Debtors. Deutsche Bank Ag, London Branch and Bear, Stearns & Co., Inc. v. Metromedia Fiber Network, Inc., Debtors-Appellees

Citations: 416 F.3d 136; 54 Collier Bankr. Cas. 2d 1033; 2005 U.S. App. LEXIS 14817; 44 Bankr. Ct. Dec. (CRR) 276Docket: 04-2112-

Court: Court of Appeals for the Second Circuit; July 21, 2005; Federal Appellate Court

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Creditors Deutsche Bank AG and Bear, Stearns Co. Inc. appeal the confirmation of a Chapter 11 Plan of Reorganization for Metromedia Fiber Network, Inc. and its subsidiaries. They challenge the reallocation of stock warrants initially assigned to them and argue that an "X-Clause" in a subordination agreement allows them to retain these warrants. While they acknowledge the proper reallocation of cash and stock, they contest the reallocation of warrants. Additionally, they assert that releases within the Plan improperly protect nondebtors from creditor lawsuits.

The Reorganized Debtors counter these claims and argue that the appeal is equitably moot due to multiple transactions following the Plan's effective date and the appellants' failure to seek a stay of confirmation. Both the bankruptcy and district courts rejected the appellants' objections on the merits, but the district court noted that relief would not be precluded by equitable mootness as it could be provided without undermining the Plan.

The Court reviews the decisions de novo regarding legal conclusions and for clear error regarding factual findings. It finds the warrant reallocation appropriate but identifies an error in approving nondebtor releases. However, the appeal is deemed equitably moot, leading to an affirmation of the lower courts' decisions. The X-Clause in the indenture agreement exempts certain securities from subordination, which is critical to the appellants' argument.

Metromedia's Chapter 11 filing involved a Plan that allocated payment to appellants holding Notes through a combination of cash, common stock in the Reorganized Debtors, and stock warrants. However, according to a subordination agreement, appellants' entire distribution was reallocated to Senior Indebtedness. While appellants acknowledged the appropriate reallocation of cash and stock, they contended that the X-Clause permitted them to retain the stock warrants. The X-Clause applies if the warrants are "junior" or subordinate to the payment of all Senior Indebtedness. The clause's applicability is complex, lacking clarity without specific evidence of the drafters' intentions. 

Industry practices, as noted in the American Bar Foundation's Commentaries, suggest that subordinated note holders may retain securities only if the securities for senior note holders have a higher priority for distributions and dividends. This ensures that senior note holders are paid in full before any payments to subordinated note holders occur. The commentary indicates that the X-Clause is triggered when junior creditors receive securities that do not diminish the priority of senior creditors. 

Case law, including the Seventh Circuit's interpretation, supports this approach, allowing junior creditors to retain subordinated securities only if they do not undermine the senior creditors' priority. In this case, the question arises whether appellants can keep the stock warrants without affecting the Senior Indebtedness's priority. The conclusion is that they cannot. Since the Senior Indebtedness received cash, common stock, and identical warrants under the Plan and did not receive full payment, allowing appellants to retain their warrants would grant them equal priority for future distributions, thereby impairing the established seniority of the Senior Indebtedness.

The Kluge Trust's claims in the bankruptcy Plan involve forgiving approximately $150 million in unsecured claims against Metromedia, converting $15.7 million in senior secured claims to equity, investing about $12.1 million in the Reorganized Debtors, and purchasing up to $25 million of unsold common stock. In exchange, the Kluge Trust would receive 10.8% of the Reorganized Debtors' common stock and a comprehensive release shielding the Kluge Trust and its insiders from all claims related to Metromedia prior to the Effective Date.

Appellants contest this release and two others that bar creditors from suing nondebtors, arguing they were unauthorized under the Bankruptcy Code. The court acknowledges that while it can issue injunctions against creditors suing third parties in support of a debtor's reorganization, nondebtor releases are typically rare and require significant justification. The court notes that previous cases have indicated nondebtor releases should only occur in extraordinary circumstances, with some circuits explicitly prohibiting them outside of asbestos contexts. 

The only explicit authorization for such releases under the Bankruptcy Code is found in 11 U.S.C. 524(g), which pertains to asbestos cases with specific conditions. Section 105(a) allows courts to issue necessary orders but does not grant them the power to create substantive rights not available under the law. Consequently, without a valid provision from the Bankruptcy Code to support their claims, the appellants cannot find relief under section 105(a).

A nondebtor release allows a nondebtor to escape liability to third parties and can function like a bankruptcy discharge without the protections of the Bankruptcy Code. This mechanism is prone to abuse, especially when it grants broad immunity from a wide array of claims against the debtor, including tort, fraud, contract violations, and securities laws, regardless of their nature or status. Courts have approved nondebtor releases under specific conditions: substantial consideration received by the estate, claims being directed to a settlement fund rather than completely extinguished, claims indirectly affecting the debtor's reorganization, and full payment provisions for those claims. Consent from affected creditors can also justify such releases. However, no case has allowed nondebtor releases without unique circumstances. Historical reorganizations often involved global settlements facilitated by significant financial contributions from non-debtor co-liable parties, enabling claimants to be compensated in exchange for liability releases. In this instance, while the Kluge Trust's contribution to the estate is noted, there is no evidence presented that the Kluge Comprehensive Release was crucial to the reorganization plan, nor was the extensive scope of this release adequately justified. The bankruptcy court's findings were deemed insufficient, emphasizing that nondebtor releases require unique circumstances and clear evidence of their necessity for the plan's success. Consideration for enjoined creditors is important but not mandatory, as illustrated in the Drexel Burnham case where creditors received no proceeds from settlements.

Appellants' allocation of a Plan distribution does not equate to consideration for nondebtor releases, as the distribution was based on their Notes rather than claims against nondebtors. Nondebtor releases require more than mere contribution to the reorganization; they need adequate consideration. The court agrees with appellees that the appeal should be dismissed as equitably moot, meaning that though relief could be theoretically granted, it would be impractical and inequitable due to the circumstances. Equitable mootness is distinct from constitutional mootness and serves to prevent disruptions to already implemented reorganization plans. The doctrine arises from the recognition that significant time elapsed post-judgment can render effective relief impractical. The merits of the case may still be assessed before addressing equitable mootness, which is necessary for crafting appropriate remedies. A plan is deemed "substantially consummated" when key actions, such as property transfers and business assumption, have occurred. The court finds that Metromedia’s Plan has been substantially consummated since its effective date, and appellants have not contested this on appeal. Given this status, dismissal of the appeal is warranted unless specific conditions are met, as reorganization plans should only be altered for compelling reasons.

Under Chateaugay II, a primary consideration is whether the appellant sought a stay of confirmation. If such a stay was requested, relief may be granted unless it disrupts the authorization of past transactions, creating chaos for the Bankruptcy Court. If no stay was sought, the court evaluates whether this omission makes relief inequitable. A party is expected to seek a stay, even if it seems unlikely to be granted, as failure to do so weakens their litigation position. In this case, the appellants did not request a stay or expedited review for their appeal, which has been pending for over a year. The appellants argued that effective relief could be provided without disturbing the Plan, but the court disagreed, emphasizing that fairness concerns must be considered beyond just the feasibility of providing relief.

Even if the court could exclude the appellants' claims from nondebtor releases, it would not, as these claims might have influenced the original settlement terms. The court highlighted the importance of not undermining Bankers Trust's negotiated benefits and stated that any relief would require vacatur and remand for further proceedings. However, this would disrupt the Kluge Trust's settlement, a key element of the Plan, which involved significant financial concessions and commitments that have already been executed. The court cannot predict the consequences of altering this settlement, and because the appellants did not seek a stay or expedited appeal, they bear the resulting uncertainty. This lack of action weighs heavily in favor of finding the appeal equitably moot, as there is a strong presumption that their challenges have become moot due to their failure to seek a stay.

The appeal is determined to be equitably moot, leading to the affirmation of the district court's judgment. The Honorable Jed S. Rakoff of the Southern District of New York presided over the case. The term "MFN" is defined as Metromedia Fiber Network, Inc. The court has previously referenced Commentaries for interpreting indenture provisions, citing cases such as Elliott Assocs. v. J. Henry Schroder Bank and Sharon Steel Corp. v. Chase Manhattan Bank. A model X-Clause in the Commentaries is noted to closely resemble the X-Clause relevant to this case, particularly concerning the subordination of securities in relation to Senior Debt and the preservation of rights for Senior Debt holders. The Kluge Trust is identified as a trust involving John W. Kluge and others as trustees, with "Kluge Insiders" defined under 11 U.S.C. 101(31). There are releases that bar claims against current or former Metromedia personnel related to the company's bankruptcy actions prior to the Plan's Effective Date, except for claims based on gross negligence or willful misconduct. A second similar release protects these personnel from claims related to Metromedia and the Plan. Each release has exceptions for certain actions that are not pertinent to this appeal. During the confirmation hearing, AboveNet's COO was uncertain about the implications of the Kluge Settlement if the Kluge Comprehensive Release was not granted.