Opinion
CIVIL ACTION NO. 02-11987-PBS
September 26, 2003
MEMORANDUM AND ORDER
Appellants Peter Bos and Ars Brook LLC, creditors of chapter 11 debtor ServiSense.com, Inc. ("Debtor"), appeal from an order of the United States Bankruptcy Court for the District of Massachusetts approving a settlement between Craig Jalbert, the liquidating supervisor of Debtor, and David Dane, the former president of Debtor. In re ServiSense.com, Inc., No. 01-16539, slip op. at 2 (Bankr. D. Mass. Aug. 20, 2002) (hereinafter "Bankruptcy Court Order").
After a hearing and review of the record, the Court AFFIRMS the ruling of the bankruptcy court.
I. FACTS
Except where noted, the facts described below are not in dispute.
Debtor was engaged in the business of reselling telecommunications services to residential consumers. Debtor hired Dane in March of 2000 pursuant to an employment agreement (the "Employment Agreement"), under which Dane was entitled to an annual salary of $115,000. The Employment Agreement also provided that after twelve consecutive months of employment, Dane would receive "12 months salary and benefits if terminated without cause." In June of 2000, Dane earned promotions that increased his salary to $135,000, effective October 2000. In June of 2001, the board of directors of Debtor (the "Board") announced that all employees would have to choose between a 50% reduction in salary and voluntary dismissal. Dane voluntarily reduced his salary to $67,500.
Debtor filed for relief under chapter 11 of the Bankruptcy Code on August 20, 2001 (the "Petition Date"). Dane continued to work for Debtor throughout the bankruptcy proceedings. In November of 2001, Dane negotiated with counsel for Debtor for a restoration of his salary to $135,000. Dane did not obtain approval from the court for the restoration of his salary; nor did he obtain court approval of an assumption of his pre-petition employment agreement. However, having obtained assent from Debtor's counsel and counsel for the Official Committee of Unsecured Creditors (the "Creditors' Committee"), in December of 2001, Dane instructed Debtor's bookkeeper to increase his salary to $135,000, effective December 1. In late December of 2001, Debtor filed a motion for approval to sell substantially all of its assets.
Dane also negotiated in November of 2001 with counsel for Debtor and counsel for the Creditors' Committee for eventual payment of the amounts he anticipated would be due to him as a severance payment under the Employment Agreement. As a result of these negotiations, on January 9, 2002, Debtor filed "Debtor's Assented-to Motion for Order Approving Retention Payment Agreement and Settlement of Severance Agreement" (the "Debtor's Settlement Motion"), seeking "authority to enter into a retention payment agreement (`RPA') with Dane which will ensure his continued employment through the end of the sale process and which will also effectuate a resolution of claims which will otherwise arise in connection with Dane's severance agreement with the Debtor." Debtor's Settlement Motion at 3. Debtor represented that it needed Dane's assistance in consummating a sale of its assets in a variety of ways, "all of which are invaluable to maximizing recovery of the assets' value for the benefit of the estate." (Id.) This motion, which was signed by Debtor's counsel and counsel for the Creditors' Committee, sought, inter alia, permission to settle Dane's approximately $150,000 administrative claim by granting Dane a $35,000 allowed priority claim for a retention payment, deducting this amount from the $150,000 administrative claim for severance, and allowing the remainder of the $150,000 administrative claim as a general unsecured claim, with the proviso that Dane's allowed administrative claim would be reduced were he to accept employment by a successful bidder.
In late January of 2002, the bankruptcy court approved the proposed sale of Debtor. According to the bankruptcy court, all employees of Debtor, including Dane, were terminated on February 1 (a fact disputed by appellants). Bankruptcy Court Order at 19. On February 2, 2002, appellant Peter Bos, who acted as an officer and director of Debtor, sent Dane a termination letter, explaining that Bos was terminating Dane for self-dealing and failure to observe the corporate hierarchy. Dane continued to assist with the liquidation of Debtor, and on February 20, 2002, the bankruptcy court approved an unopposed motion seeking to hire Dane to assist in the liquidation of Debtor, effective February 1.
The Debtor's Settlement Motion provoked objections from Bos and from Christopher McKeown, who also was an officer and director of Debtor. In their objections, McKeown and Bos argued that Debtor acted without authority from the Board when filing the Debtor's Settlement Motion, and that Dane had violated his fiduciary duty to Debtor when submitting the Debtor's Settlement Motion. They also argued that Dane was not entitled to an administrative claim for severance for two main reasons: the Employment Agreement was never explicitly or implicitly assumed by Debtor, and the post-petition payments of Dane's restored salary were the sole consideration for Dane's post-petition services.
The bankruptcy court approved the Debtor's Settlement Motion after a hearing on February 20, 2002, relying on minutes from meetings of the Board submitted by Dane's counsel that purported to show that the Board had considered the Debtor's Settlement Motion and decided to take no action. Bos filed a motion to reconsider and vacate (the "Reconsideration Motion"), claiming that the minutes were taken out of context.
On March 13, 2002, Debtor filed its disclosure statement and liquidating plan of reorganization (the "Plan"). The Plan was confirmed on April 10, 2002. The order confirming the Plan provided that Craig R. Jalbert of Verdolino Lowey, P.C. would become the estate representative and liquidating supervisor (the "Liquidating Supervisor"). The Plan provides that the Liquidating Supervisor may resolve Contested Claims, a term whose definition encompasses Dane's claim, following the procedures set forth in the Plan and the Liquidating Supervisor Agreement.
On March 21, 2002, Dane filed a request for payment of his administrative claim in the amount of $147,500. Ars Brook LLC and Bos, both creditors of Debtor, filed an objection to Dane's claim, arguing, inter alia, that Dane was not entitled to severance because he had been terminated for cause on February 2. The Liquidating Supervisor filed a motion on April 25 for approval of a stipulation of settlement with Dane regarding Dane's administrative expense claim (the "Supervisor's Settlement Motion"), stating that the Liquidating Supervisor had settled the claim and agreed to pay Dane $35,000 as an administrative expense. The remaining amount would be classified a non-priority claim. Ars Brook LLC and Bos filed objections to the Supervisor's Settlement Motion, repeating their prior arguments.
After a hearing on May 8, 2002, the bankruptcy court granted the Reconsideration Motion. In the Bankruptcy Court Order, issued on August 20, 2002, the bankruptcy court granted the Supervisor's Settlement Motion. Bos and Ars Brook LLC then brought this appeal.
II. DISCUSSION
A. Standard of Review of the Approval of a Settlement
The approval of a compromise of a bankruptcy claim "is within the sound discretion of the bankruptcy judge, and [courts] will not upset it absent a clear showing the bankruptcy judge abused his discretion." Jeremiah v. Richardson, 148 F.3d 17, 23 (1st Cir. 1998). This abuse of discretion standard is applied against the understanding that "`compromises are favored in bankruptcy.'" In re Mailman Steam Carpet Cleaning Corp., 212 F.3d 632, 635 (1st Cir. 2000) (citing Hicks, Muse Co., Inc. v. Brandt (In re Healthco International, Inc.), 136 F.3d 45, 50 n. 5 (citation omitted)). District courts review de novo bankruptcy court rulings of law. See Mailman Steam, 212 F.3d at 636.
In deciding whether to approve a compromise, bankruptcy courts should consider a number of factors, including: "`(i) the probability of success in the litigation being compromised; (ii) the difficulties, if any, to be encountered in the matter of collection; (iii) the complexity of the litigation involved, and the expense, inconvenience and delay attending it; . . . (iv) the paramount interests of the creditors and a proper deference to their reasonable views in the premise,'" Jeremiah, 148 F.3d at 23 (citations omitted); and (v) "the experience and competence of the fiduciary proposing the settlement."Healthco, 136 F.3d at 50. In considering these factors, the responsibility of the bankruptcy judge "is not to decide the numerous questions of law and fact raised by appellants but rather to canvass the issues and see whether the settlement `fall[s] below the lowest point in the range of reasonableness.'" Healthco, 136 F.3d at 51 (citing Cosoff v. Rodman (In re W.T. Grant Co.), 699 F.2d 599, 608 (2d Cir. 1983) (citation omitted)).
B. This Case
Canvassing the issues of law and fact in light of these factors, this Court concludes that the proposed settlement does not fall below the lowest point in the range of reasonableness.
i. Probability of Success
The first factor to be considered is the probability of success in the litigation. Appellants argue that Dane was not entitled to an administrative claim for any payments for three reasons. First, they contend he violated his fiduciary duty to Debtor. The bankruptcy judge held that Dane had at least a colorable claim that he owed a fiduciary duty to the creditors, given that Debtor was insolvent, and that he fulfilled this duty by negotiating with and obtaining the approval of counsel to Debtor and counsel to the Committee. See Bankruptcy Court Order at 20 (quoting Lasalle Nat'l Bank v. Perelman, 82 F. Supp.2d 279, 290 (D. Del. 2000) for the proposition that "[u]nder Delaware law, officers and directors of a corporation generally do not owe a fiduciary duty to the creditors of the corporation unless the corporation is insolvent"). The bankruptcy judge additionally noted that Dane could not comply with Bos's demand that Dane hire an accountant without running afoul of the Bankruptcy Code. This argument raises complex legal and factual issues.
Second, Appellants claim that Dane was fired for cause, and so the obligation to pay severance was never triggered. This Court finds reasonable the bankruptcy judge's ruling that Dane likely could demonstrate that he was terminated on February 1, 2002, as were the remainder of Debtor's employees. The fact that the final pay checks were dated through February 2, 2002 is not determinative of the matter, especially given that the employees were given their checks on February 1 and told that it was their last day. Therefore, the bankruptcy judge acted within his discretion in finding that Dane had a reasonable likelihood of showing that he was terminated without cause, as required by the Employment Agreement.
Third, and most significantly, Appellants argue that Dane is entitled only to a pre-petition claim for the amounts owed under the Employment Agreement, rather than to an administrative claim, and that his pre-petition claim should be allowed in the amount of approximately $75,000, as the doubling of his salary was not authorized by the Board. They point out that Dane received post-petition compensation for his role in the liquidation. The bankruptcy judge concluded that Dane was reasonably likely to succeed in his argument that his severance payment should be classified as an administrative claim, and did not reach the issue of the amount of the claim, noting however that Dane "would also argue that the settlement amount is 50% of the salary amount that Bos and McKeown would apply." Bankruptcy Court Order at 19-20. In so doing, the bankruptcy judge relied on Cramer v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.), 536 F.2d 950, 955 (1st Cir. 1976), a decision under the Bankruptcy Act, for the proposition that a former employee is entitled to administrative priority for a severance claim if he or she was an employee in good standing at the time of his or her termination.
Subsequent to the bankruptcy court's order in this case, the First Circuit handed down its decision in Mason v. Official Comm. of Unsecured Creditors (In re FBI Distribution Corp.), 330 F.3d 36 (1st Cir. 2003), clarifying the law that applies to the classification of severance payments as administrative claims under 11 U.S.C. § 365 (a). It held: "Subsection 365(a) allows a debtor in possession, subject to the Court's approval, to assume or to reject a pre-petition executory contract." Id. at 42. Generally speaking, a former employee isnot entitled to administrative priority for severance payments absent a court-approved assumption of the underlying employment contract except to the extent that "the consideration supporting the claim was supplied to the debtor in possession during the reorganization and was beneficial to the estate." Id. at 46-49. Whether a claim for severance benefits is entitled to administrative priority depends, in part, on the consideration provided by the employee. In FBI Distribution, which involved a severance agreement similar to Dane's, the court stated:
We hold that the consideration supporting [the employee's] claim for severance benefits was not "being an employee in good standing at the time of the discharge" but rather her agreement to forgo other employment opportunities, . . . which she provided prepetition to debtor the minute she signed the Employment Agreement in May 1999.Id. at 46. The court contrasted the appellant's severance with severance or vacation benefits geared to length of service, describing the latter as "benefits that clearly constitute a part of an employee's wages for services rendered. . . ." Id. at 46-47. The Court addressed the following dictum in Mammoth Mart:
If an [unrejected] employment contract provides that all discharged employees will receive severance pay equal to their salaries for a specified period, the consideration supporting the claim being an employee in good standing at the time of the discharge will have been supplied during the arrangement, and the former employee will be entitled to priority.536 F.2d at 955. Contrary to the appellant's claim that because of this language, she was entitled to severance as an employee in good standing, the court explained that "[w]e find it unlikely that [theMammoth Mart decision] was referring to severance provisions in executive employment contracts, like the one here." 330 F.3d at 46. Under the appellant's argument, "an executive would be entitled to administrative priority for lump-sum severance pay, no matter how astronomical, simply by working one day for the debtor in possession so long as she was in `good standing at the time of the discharge.'" Id. The First Circuit held that "we cannot accept this conclusion." Id.
In light of the First Circuit's clarification of the law, the bankruptcy court turned out to be overly pessimistic in its conclusion that under Mammoth Mart, the Liquidating Supervisor would not be likely to succeed against Dane on his claim for full severance and salary as a priority claim. Bankruptcy Court Order at 19. The Liquidating Supervisor would have had a strong argument that Dane had given the complete consideration required for receipt of the severance payment as soon as he had been employed twelve months with Debtor, that is in March 2001, which is before the filing of the petition. Therefore, under the rationale of FBI Distribution, Dane arguably held only a contingent claim against Debtor at the Petition Date, which should have been classified as pre-petition debt. At the Petition Date, the argument would go, Dane was entitled to file a contingent non-priority claim for severance in the amount of approximately $75,000. There might be a counter-argument that the $35,000 also functioned as a post-petition retention payment to Dane, and that Dane therefore is entitled to an allowed administrative claim for this amount. Although the Liquidating Supervisor's hand was significantly enhanced by FBI Distribution, he was not holding a royal straight flush.
The problem with this Monday-morning quarterbacking is that the bankruptcy judge did not have the benefit of FBI Distribution to weigh the merits of the point/counterpoint when he approved the settlement. Under Mammoth Mart, Dane had a plausible argument of implied acceptance, relied on by the bankruptcy judge: "Because the Employment Agreement provided that Dane would receive severance equal to his salary for a specified period, under the foregoing [passage fromMammoth Mart] he would be entitled to a priority claim for his severance if he was an employee in good standing at the time of his termination." Bankruptcy Court Order at 19.
Therefore, it was not unreasonable to have settled this claim for short money.
ii. Difficulty and Expense of Litigation
This Court's inquiry does not end with this finding, as several factors remain to be examined. The parties do not dispute that there would be no difficulty in collection. The next factor is the difficulty of the litigation involved and the expense, inconvenience and delay attending it. As the First Circuit has stated in the chapter 7 context, "When augmentation of an asset involves protracted investigation or potentially costly litigation, with no guarantee as to the outcome, the trustee must tread cautiously — and an inquiring court must accord him wide latitude should he conclude that the game is not worth the candle." Mailman Steam, 212 F.3d at 634.
The bankruptcy court noted that litigating the issues covered by the settlement would require a retelling of the story surrounding the bankruptcy and liquidation of Debtor via affidavit and deposition, a retelling that, based on the parties' prior animosity (which I observed as well), would likely be rife with disputes. The bankruptcy court also noted that the expense of such litigation would be certain to exceed the settlement amount of $35,000. Appellants do not dispute these findings, and I find that the bankruptcy court acted within its discretion in making them.
iii. Liquidating Supervisor
While no evidence was presented as to the experience and competence of the Liquidating Supervisor, this Court agrees with the bankruptcy judge that the fact that no party objected to the appointment of the Liquidating Supervisor or his counsel is an indication that the parties do not see him as partial or untrustworthy. It should be pointed out that the Liquidating Supervisor, who bears a fiduciary duty to the creditors, has not changed his position subsequent to the decision in FBI Distribution. See generally William L. Norton, Jr., Norton Bankruptcy Law and Practice 2d § 145:2 (1997) ("Between the time that the [settlement] motion is filed and the hearing is held, events may change which no longer make the settlement advantageous for the estate. Under these circumstances, it has been held to be appropriate for the debtor to oppose its own motion to compromise.").
iv. Creditors
The final factor to be examined is the paramount interests of the creditors. The bankruptcy court found that the creditors' interests would be best served by approving the settlement, given that the costs inherent in fighting for the creditors' views would likely exceed the cost of settlement. Additionally, the Creditors' Committee assented to the original settlement and has not filed an objection noting a change of view.
ORDER
The Court AFFIRMS the ruling of the Bankruptcy Court.