Six Degrees Of Separation: Use Of Bankruptcy Rule 2004 Examination In Connection With Third-Party Litigation

by Cole Schotz
Contact

Court: “You know, every piece of information and fact out there is within six degrees of separation of the debtors’ assets and financial affairs. The question is where do you draw the line?”

4/20/17 Transcript of hearing in In Re SunEdison, Inc., et al, Case No. 16-10992-smb (hereinafter “TR”), page 30 lines 6-11.

The Issue.  An issue of first impression appears to have arisen recently in a case pending before United States Bankruptcy Judge Stuart Bernstein in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). In the Chapter 11 Case, In re: SunEdison Inc., et al., 16-10922 (SMB) (the “Debtors”), the Bankruptcy Court directed supplemental briefing on the question of whether a debtor is entitled to Bankruptcy Rule 2004 discovery into non-debtor litigation, because the outcome of that litigation may have an effect on the value of a significant asset of the bankruptcy estate of the Debtor. At the hearing where the issue arose, the Bankruptcy Court noted that it had been unable to find a case directly on point, and at the hearing the parties to the matter were not able to identify any such cases.  Spoiler alert—as of the date this blog was prepared, the Bankruptcy Court had not yet ruled; an update will be provided when it does so. While we hold our breath waiting for the Bankruptcy Court’s ruling, here is the background and where the six degrees of separation fit in (further spoiler alert: here, the six degrees of separation have nothing to do with Kevin Bacon).

Background: The debtor, SunEdison, Inc. (“SunE”) commenced its chapter 11 case on April 21, 2016, together with twenty-five affiliated co-debtor entities, with additional affiliated co-debtors thereafter filing voluntary petitions  (collectively, the “Chapter 11 Cases”). The Chapter 11 Cases have been consolidated for procedural purposes only and are being jointly administered.  Notably absent from the Chapter 11 filings were two entities that are referred to in the Chapter 11 Cases as the non-debtor publicly traded “YieldCo” subsidiaries of SunE, TerraForm Power, Inc. (“TERP”), and TerraForm Global, Inc. (“GLBL,” and together with TERP, the “YieldCos”). According to SunE, SunE holds a majority equity stake in TERP and approximately 33% equity stake in GLBL.

In 2014, SunE and TERP, as buyers, had entered into a contract to purchase from D.E. Shaw Composite Holdings, L.L.C. (“DESCO”) and Madison Dearborn Capital Partners IV, L.P. (“MDP” and, together with DESCO, “Plaintiffs”) a company named First Wind, an energy company that owned and developed wind and solar energy. Thereafter a dispute arose and on April 3, 2016, prior to the commencement of the Chapter 11 Cases, Plaintiffs filed a lawsuit in New York Supreme Court against TERP seeking a declaratory judgment as to TERP’s obligations (the “First Wind Litigation”). The Debtors are not a party to that litigation.  Upon SunE declaring bankruptcy in April 2016, Plaintiffs asserted that an acceleration event had occurred, and Plaintiffs filed an amended complaint in State Court asserting a claim for breach of contract for TERP’s failure to make what Plaintiffs assert is a $231 million in the aggregate “Accelerated Earnout Payment” as one of the two buyers under the purchase agreement, and for TERP’s failure to comply with its obligations as guarantor.

The Rule 2004 Motion and the Debtors’ Position.  In a motion filed jointly by the Debtors and TERP ( the “Rule 2004 Motion”), they sought the entry of an order of the Bankruptcy Court pursuant to Bankruptcy Rule 2004 seeking the production of documents by Plaintiffs and reserving the right to seek depositions[ Docket No. 2692].

According to the Debtors, on March 6, 2017, TERP and Brookfield Asset Management Inc. and its affiliates (“Brookfield”) entered into a definitive agreement under which Brookfield agreed to acquire a controlling interest in TERP (the “Brookfield Acquisition”), with SunE retaining a minority equity interest.  Pursuant to this transaction, the Debtors asserted that the Debtors’ estates stood to realize in excess of $800 million in cash and TERP equity and that, accordingly, the disposition of TERP is “critically important” to the formulation of a plan of reorganization of the Debtors, as well as to the proceeds available for distribution to secured and unsecured creditors of the estates.  Although the Brookfield Acquisition is not contingent upon resolution of Plaintiff’s claim against TERP, any liability with respect to these claims would, said the Debtors, reduce the value of the equity in TERP retained by SunE after the Brookfield Acquisition. The Debtors further contend that (a) uncertainty about the nature or magnitude of these claims could therefore complicate the financing and implementation of the Debtors’ plan of reorganization, which is premised, in part, on the value of the Debtors’ retained TERP equity; and, in addition, (b) the Brookfield Acquisition is subject to approval by TERP’s public stockholders, and the strength of Plaintiff’s claims against TERP may potentially be important to them.

The discovery is necessary, said the Debtors and TERP, so that SunE and TERP would be able to mitigate any concerns that SunE’s financing sources and TERP’s stockholders may have about the claims of Plaintiffs.  Also, contended Debtors and TERP, the discovery would demonstrate that Plaintiff’s claims against TERP were not colorable, on the basis that the First Wind Action depended entirely on Plaintiff’s interpretation of an ambiguous clause of the 2014 purchase agreement that parol evidence would not support. According to the Debtors, without discovery, Plaintiffs would be in a position to interfere with the Brookfield Acquisition and its benefits to SunE and TERP stakeholders.

Plaintiffs’ Initial Objection.  In their initial objection to the Rule 2004 Motion, Plaintiffs argued that the Rule 2004 Motion should be denied as a flagrant violation of the “pending proceeding” rule prohibiting the use of Rule 2004 to obtain or circumvent discovery in pending litigation. There was, argued Plaintiffs, no uncertainty about the nature or magnitude of Plaintiffs’ claims as the 2004 Motion alleges, the claims for breach asserted in the First Wind Litigation were unambiguous, and TERP failed to take discovery in the First Wind Litigation in the State Court.  Furthermore, according to Plaintiffs, the requested Rule 2004 discovery should also be rejected as wholly unnecessary for plan confirmation in the bankruptcy or in support of the Brookfield Acquisition [Docket No. 2783].

While Plaintiffs acknowledged that generally under Bankruptcy Rule 2004 a Bankruptcy Court may, on a motion, “order the examination of any entity” into “the acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor’s estate,” Fed. R. Bankr. P. 2004(a)-(b), it argued that even Rule 2004 examinations have limits.  As argued by Plaintiffs, under the “Pending Proceedings” limitation, parties are precluded from obtaining discovery through Bankruptcy Rule 2004 when proceedings are pending in another forum, and under those circumstances courts have held that discovery should be pursued under the Federal Rules of Civil Procedure or equivalent procedures governing discovery in state court proceedings.

The Bankruptcy Court Hearing.   At the Bankruptcy Court hearing on the Rule 2004 Motion conducted on April 20, 2017, the Bankruptcy Court played devil’s advocate with both sides.  First, as to the Debtors, the Bankruptcy Court noted that in the Rule 2004 Motion, the Debtors did not really appear to seek discovery regarding the claims filed by the Plaintiffs in the Chapter 11 Cases, but, rather, the discovery was directed at non-debtor TERP’s liability to the Plaintiffs. On this point the Bankruptcy Court queried the Debtors’ counsel:

THE COURT: Let me ask you a question. Suppose that a debtor’s most important customer is involved in litigation outside of bankruptcy, and if it loses that litigation, the customer’s going to go out of business. Would a debtor have the right to get discovery from the other party in that litigation regarding the strength of that claim? Because that’s really what you’re saying.

TR page 26, lines 11-17.

The Court pressed the point by asking Debtors’ Counsel:

THE COURT: Let’s suppose you’re an individual Chapter 11 debtor and your most significant asset is Microsoft stock. Microsoft is involved in a patent litigation in Seattle with some third party, and the outcome of that action would affect the value of your stock. Do you think you could….
insist in bankruptcy court through [Rule] 2004 that that adversary has to turn over information so you can gauge the strength of its patent claim?….

TR page 27, lines 23-25; page 281-2, 8-10.

Six Degrees of Separation.  After colloquy with Debtors’ counsel regarding the propriety of a 2004 examination in connection with third party litigation (litigation to which the debtor was not a party) on the basis that the outcome of that litigation could have an effect on the value of the debtor’s assets, with counsel for the Debtors pressing that the examination is appropriate because it concerns the Debtors assets,  the Bankruptcy Court made the statement quoted at the beginning of this article: “You know, every piece of information and fact out there is within six degrees of separation of the debtors’ assets and financial affairs. The question is where do you draw the line?”

The Bankruptcy Court likewise played devil’s advocate with Plaintiffs’ counsel and queried why couldn’t the Debtors take Rule 2004 discovery to determine the value of its interest in TERP and on why the transaction with TERP should be approved.

Bankruptcy Court’s Preliminary Ruling and Request for Supplemental Briefing. Ultimately, the Bankruptcy Court denied the Rule 2004 Motion as to TERP on the basis of the Pending Proceeding Rule.  As to the Debtors, however, after the Bankruptcy Court noted that it had looked for but had not found any cases on point, the Bankruptcy Court provided the parties with additional time to respond to the Bankruptcy Court’s questions.

The Debtors’ Supplemental Response. In the Debtors’ supplemental response (the supplemental responses were filed simultaneously), they asserted that the broad examination of third parties concerning the value of a debtor’s assets, or to aid in discovery of assets, is permitted under Rule 2004.  In support, the Debtors cited several cases that permitted such discovery, including with respect to the value of a debtor’s stock in several third parties, and the value of a debtor’s interest in real property.  The Debtors further asserted that Plaintiffs qualified as potential examinees under Rule 2004, citing this language from In re Ionosphere Clubs, Inc., 156 B.R. 414, 432 (Bankr. S.D.N.Y. 1993): “Because the purpose of the Rule 2004 examination is to aid in the discovery of assets, any third party who can be shown to have a relationship with the debtor can be made subject to a Rule 2004 investigation.” The Debtors also pointed out that the Plaintiffs were not just any third parties, as they had filed proofs of claim that were the subject of the First Wind Litigation, and therefore the First Wind Litigation was related to the Chapter 11 Cases [Docket No. 2901].

The Plaintiffs’ Supplemental Response.   In the Plaintiffs’ supplemental response, the Plaintiffs contend that Rule 2004 does not support the broad application that the Debtors urge the Bankruptcy Court to adopt, that to the extent courts have permitted Rule 2004 examinations of third parties, the purpose of such examinations was not to assess the potential outcome of a third party litigation, and allowing a Rule 2004 examination in connection with the Third Wind Litigation would be an impermissible interference in a pending litigation to which the Debtors are not a party [Docket No. 2902].

Stay Tuned. Whether the Bankruptcy Court finds the supplemental responses were in fact responsive to the questions posed by the Bankruptcy Court, and were persuasive, remains to be seen.  We will follow up once a decision is rendered by the Bankruptcy Court.  Ideally, the decision will answer the question, at least in this Bankruptcy Court, of within how many degrees of separation does an issue need to be for it to be subject to examination pursuant to Bankruptcy Rule 2004.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Cole Schotz | Attorney Advertising

Written by:

Cole Schotz
Contact
more
less

Cole Schotz on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.