[co-author: Anahita Anvari]

In In re Beach v. Beach, the Fifth Circuit elaborated on its standard of review for adversary litigation settlements.  No. 17-10481 (5th Cir. May 16, 2018).

In this case, Debtor, a Dallas oil-and-gas businessman, formed a partnership to drill oil with a New York investment firm (“Creditor”).  Following a dispute between Debtor and Creditor, Debtor filed for bankruptcy.

Creditor and Trustee filed an adversary proceeding against Debtor, claiming he was not entitled to a discharge of his debts under Section 727 of the Bankruptcy Code. The Complaint alleged that Debtor fraudulently transferred assets from a family trust to a new trust to shield the assets from creditors. Section 727 prevents discharge of the debtor where the debtor has fraudulently transferred assets to hinder, delay, or defraud creditor or officer of the estate. 11 U.S.C. § 727(a)(2).

In mediation, Trustee reached an agreement with Debtor (the “Settlement”) while representatives of Creditor were not present.  Creditor objected to the Settlement, arguing that it did not maximize value for the creditors.  After a two-day hearing, the bankruptcy court approved the settlement.  Creditor appealed to the district court, which affirmed.

The bankruptcy court weighed the overall costs and benefits of the exchange, reasoning that Trustee would likely win the precise settlement amount in litigation, and that litigation would be complex and costly. As to Creditor’s argument that the Settlement did not maximize the value of one of Debtor’s assets, the bankruptcy court reasoned that the value was merely speculative and did not render the Settlement unfair.

The Fifth Circuit reviewed the bankruptcy court’s approval of the Settlement for any abuse of discretion. The Court held that “a trial court abuses its discretion when it makes an error of law or clearly erroneous assessment of evidence.”  The Court found that the bankruptcy court made findings showing its consideration of the three-part balancing test to determine if the Settlement is in the best interest of the estate. Specifically, the bankruptcy court considered: (1) the probability of success in litigation of the adversary claim; (2) the complexity and likely duration of litigation; and (3) other factors including (i) the best interest of the creditors and (ii) the extent to which the settlement is a product of bargaining, and not fraud or collusion.

The Fifth Circuit affirmed the findings of the lower courts.  In so ruling, the Court considered the evidence provided by Creditor, including costs and likely outcome of litigation. The Court reasoned that the bankruptcy court adequately considered the three-part test, and did not abuse its discretion or make any legal errors or clearly erroneous factual findings or assessments of the evidence.

Anahita Anvari is a summer associate in the firm’s Philadelphia office.

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