Dewey & Leboeuf Partner Contribution Settlement Agreements Seek to Avoid the Long and Winding Road of Law Firm Bankruptcies

The anticipated long and winding road of the Dewey & Leboeuf LLP bankruptcy case was cut short on Oct. 9, 2012, less than five weeks into the case, when the United States Bankruptcy Court for the Southern District of New York (the Honorable Judge Martin Glenn presiding) issued its Memorandum Opinion and Order granting Dewey's motion seeking an order: 1) approving certain partner contribution settlement agreements and mutual releases for participating partners; and 2) denying the motion filed by an ad-hoc committee of retired partners of Lebouef Lamb to appoint an independent examiner. This article explores the process by which the key parties-in-interest in the case successfully negotiated the Partner Contribution Settlements or PCPs, the rationale behind Bankruptcy Judge Glenn's approval of the PCPs, as well as some of the issues that the United States District Court for the Southern District of New York is currently considering on appeal.

Background

The Dewey & Leboeuf LLP (Dewey) bankruptcy case, reported to be the largest law firm failure in U.S. history, garnered national attention when it filed on May 28, 2012. At the time of its filing, Dewey owed its creditors at least $315 million, and the law firm sought Chapter 11 protection after its lenders refused to extend a $100 million credit line to keep the firm operating during the midst of an exodus of partners in large numbers and public concern about the firm's financial health. Shortly after the filing, the Office of the United States Trustee appointed both an official committee of unsecured creditors (the Committee), as well as an official committee of former partners (the FPC).

In addition to the two official committees, an ad-hoc committee of LeBoeuf 1990 pension plan retirees (the Ad-Hoc Committee) organized and appeared early in the case as well. Following on the heels of other large law firm failures such as Coudert Brothers, Heller Ehrman LLP, Howrey LLP, and Brobeck, Phleger and Harrison, among others, counsel for Dewey recognized that it could take years of contested and costly litigation for creditors and trustees to investigate and ultimately pursue preferences or “claw-back” payments made to former partners as a source of money to make creditors whole. Therefore, from the outset of the filing, Dewey's attorneys immediately sought to formulate a settlement plan with its former partners to avoid years of potential litigation, curb high administration expenses and secure a pool of funds for creditor recovery.

The goal was to settle these claims at the front end of the case in order to allow former partners to move on with their lives, while providing an early payoff to creditors. After four months of what the bankruptcy court referred to as “arms-length” negotiations between Dewey, on the one hand, and its creditors, former partners, and secured lenders, on the other hand, the parties negotiated the PCPs ' a series of structured settlements ' requiring former partners to pay portions of their compensation from 2011 and 2012 in exchange for receiving general releases from estate claims and causes of action that could be asserted against them. Forms of the agreement were circulated to individual former partners so that they were given the opportunity to review and provide comments to facilitate broad participation in the settlement process.

Ultimately, more than 400 of the 670 former partners agreed to contribute funds on a sliding scale based on their respective potential liability exposure in exchange for a release from the estate. Individual payments ranged from $5,000 to $3.5 million, for a total of $71.5 million, which constituted approximately 80% of the aggregate of all partner contribution amounts sought under the PCPs. Since it is alleged that three of Dewey's senior managers played a more integral role in the downfall of the firm, the PCPs explicitly excluded Chairman Steven Davis, Executive Director Stephen DiCarmine and Chief Financial Officer Joel Sanders from participating and obtaining releases, on the one hand, while preserving Dewey's claim and right to investigate and pursue claims and causes of action against these three individuals for the benefit of the estate, on the other hand. The PCPs also do not release any direct claims held by third parties or by any non-settling partner against those participating partners or Dewey's insurance policies.

The PCPs Are Fair and Equitable

In order to determine whether the PCPs were “fair and equitable,” the bankruptcy court balanced the following interrelated factors from the Second Circuit case of Motorola, Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007): 1) the balance between the litgation's possibility of success and the settlement's future benefits; 2) the likelihood of complex and protracted litigation; 3) the paramount interests of the creditors; 4) whether other parties-in-interest supported the settlement; 5) the competency and experience of counsel and the bankruptcy court judge supporting and reviewing the settlement; 6) the nature and breadth of releases to be obtained by officers and directors, and 7) the extent to which the settlement was the product of arm's-length bargaining.

Applying the business judgment standard to its Rule 9019 analysis, rather than the heightened scrutiny of the entire fairness doctrine advocated by the FPC, the bankruptcy court addressed each of the foregoing Iridium factors and ultimately concluded as follows: 1) the PCPs “would avoid the costs of expensive and time-consuming litigation, conserve the Debtor's resources to pursue claims against those most likely to have mismanaged the firm, and minimize the risk of expending the Debtor's liability insurance policy on unnecessary defense costs” while bringing roughly $70 million into the estate for the benefit of creditors; 2) the secured lenders, the Committee (despite the fact that the settlement would result in only a “twenty cent plan” for its constituents) and a majority of former partners each favored the settlements; 3) Dewey's legal and financial advisors had been actively engaged in prior large law firm bankruptcies; 4) the releases exchanged by Dewey and the participating partners ' of claims held by the estate against the participating partners and claims held by participating partners against the estate ' were reasonable and necessary to accomplish the purposes of the PCPs and, importantly, did not include any third-party non-debtor releases; and 5) the PCPs were developed by independent professionals and were negotiated with partners at arms' length. The bankruptcy court therefore concluded that application of the Iridium factors mandated a finding that the PCPs were both fair and equitable and, as a result, approved the 9019 motion.

The Denial of the Examiner Motion

While many practitioners reviewing the bankruptcy court's opinion will focus on the court's analysis and ultimate approval of the PCPs, the court's denial of the motion to appoint an independent examiner to evaluate the merits of the PCPs, filed by the Ad-Hoc Committee and supported by the FPC, is noteworthy as well. The bankruptcy court first analyzed whether, pursuant to section 1104(c)(2) of the Bankruptcy Code, Dewey had fixed, liquidated, unsecured debts, other than debts for goods, services or taxes, or owing to insiders, that exceeded $5 million.

While the foregoing condition is usually satisfied in many large Chapter 11 cases where there is outstanding unsecured funded debt, the bankruptcy court found that the Ad-Hoc Committee and the FPC were unable to meet their burden at trial to prove that Dewey had satisfied this condition given the unique facts and circumstances of the case.

Thereafter, the bankruptcy court concluded that even assuming the satisfaction of the $5 million condition in section 1104(c)(2), the appointment of an examiner was neither mandatory nor in the best interests of the estate, finding that: 1) it was in its discretion to determine if the appointment of an examiner was required under the facts of the case; 2) the examiner motion was filed for an improper purpose as a clear litigation tactic to derail approval of the PCPs; and 3) the expense of an examiner and the delay required to complete the examiner investigation and report would only add needless expense and delays and given the precarious financial situation, would cause this case to convert to a case under Chapter 7 as well as result in a possible administrative insolvency.

Judge Glenn joins Delaware bankruptcy court Judges Christopher L. Sontchi (In re Visteon Corp., Case No. 09-11786 (Bankr. D. Del. May 12, 2010)) and Kevin S. Carey (In re Spansion, Inc., 426 B.R. 114, 128 (Bankr. D. Del. 2010)), among others, who also agree that the appointment of an examiner is not mandatory, notwithstanding the language in section 1104(c)(2) which, on its face, appears to mandate such appointment in cases where the $5 million unsecured debt threshold is satisfied.

The Appeal

Both the FPC and the Ad-Hoc Committee have appealed the bankruptcy court's order approving the PCPs, and have raised the following issues presented on appeal, among others: 1) whether the bankruptcy court erred when it found that the PCPs were not related-party transactions that would trigger the applicability of the entire fairness doctrine to the court's analysis of the PCPs under Bankruptcy Rule 9019; 2) whether the bankruptcy court erred by approving the PCPs notwithstanding Dewey's admitted failure to investigate tort claims against released partners; 3) whether the bankruptcy court erred when it denied the motion to appoint an examiner under section 1104(c)(1) or (2), and (4) whether the bankruptcy court erred to the extent it approved the 9019 motion outside of and prior to a plan of liquidation.

Conclusion

The approval of the PCPs has generated quite a bit of attention primarily because it was constructed at the front end of the bankruptcy and approved within a few months after the bankruptcy filing. Indeed, as noted by the bankruptcy court, there was also a significant amount of cooperation between the former partners, the secured lenders and the creditors to reach a consensus in a relatively short time, in order to avoid the tortured and twisted trail traveled by other fallen firms. Depending upon its success, the PCP architecture constructed in the Dewey case could provide a potential model for future law firm bankruptcies. Needless to say, all eyes are on the district court as it considers the following question: “Dewey” or don't we affirm the partner contribution settlements?

Steven B. Smith is a partner and Joy L. Monahan is an attorney in the Restructuring & Insolvency department at Edwards Wildman Palmer LLP. Smith is a member of this newsletter's Board of Editors. They are resident in New York and Chicago, respectively and may be reached at [email protected] and [email protected].

The anticipated long and winding road of the Dewey & Leboeuf LLP bankruptcy case was cut short on Oct. 9, 2012, less than five weeks into the case, when the United States Bankruptcy Court for the Southern District of New York (the Honorable Judge Martin Glenn presiding) issued its Memorandum Opinion and Order granting Dewey's motion seeking an order: 1) approving certain partner contribution settlement agreements and mutual releases for participating partners; and 2) denying the motion filed by an ad-hoc committee of retired partners of Lebouef Lamb to appoint an independent examiner. This article explores the process by which the key parties-in-interest in the case successfully negotiated the Partner Contribution Settlements or PCPs, the rationale behind Bankruptcy Judge Glenn's approval of the PCPs, as well as some of the issues that the United States District Court for the Southern District of New York is currently considering on appeal.

Background

The Dewey & Leboeuf LLP (Dewey) bankruptcy case, reported to be the largest law firm failure in U.S. history, garnered national attention when it filed on May 28, 2012. At the time of its filing, Dewey owed its creditors at least $315 million, and the law firm sought Chapter 11 protection after its lenders refused to extend a $100 million credit line to keep the firm operating during the midst of an exodus of partners in large numbers and public concern about the firm's financial health. Shortly after the filing, the Office of the United States Trustee appointed both an official committee of unsecured creditors (the Committee), as well as an official committee of former partners (the FPC).

In addition to the two official committees, an ad-hoc committee of LeBoeuf 1990 pension plan retirees (the Ad-Hoc Committee) organized and appeared early in the case as well. Following on the heels of other large law firm failures such as Coudert Brothers, Heller Ehrman LLP, Howrey LLP, and Brobeck, Phleger and Harrison, among others, counsel for Dewey recognized that it could take years of contested and costly litigation for creditors and trustees to investigate and ultimately pursue preferences or “claw-back” payments made to former partners as a source of money to make creditors whole. Therefore, from the outset of the filing, Dewey's attorneys immediately sought to formulate a settlement plan with its former partners to avoid years of potential litigation, curb high administration expenses and secure a pool of funds for creditor recovery.

The goal was to settle these claims at the front end of the case in order to allow former partners to move on with their lives, while providing an early payoff to creditors. After four months of what the bankruptcy court referred to as “arms-length” negotiations between Dewey, on the one hand, and its creditors, former partners, and secured lenders, on the other hand, the parties negotiated the PCPs ' a series of structured settlements ' requiring former partners to pay portions of their compensation from 2011 and 2012 in exchange for receiving general releases from estate claims and causes of action that could be asserted against them. Forms of the agreement were circulated to individual former partners so that they were given the opportunity to review and provide comments to facilitate broad participation in the settlement process.

Ultimately, more than 400 of the 670 former partners agreed to contribute funds on a sliding scale based on their respective potential liability exposure in exchange for a release from the estate. Individual payments ranged from $5,000 to $3.5 million, for a total of $71.5 million, which constituted approximately 80% of the aggregate of all partner contribution amounts sought under the PCPs. Since it is alleged that three of Dewey's senior managers played a more integral role in the downfall of the firm, the PCPs explicitly excluded Chairman Steven Davis, Executive Director Stephen DiCarmine and Chief Financial Officer Joel Sanders from participating and obtaining releases, on the one hand, while preserving Dewey's claim and right to investigate and pursue claims and causes of action against these three individuals for the benefit of the estate, on the other hand. The PCPs also do not release any direct claims held by third parties or by any non-settling partner against those participating partners or Dewey's insurance policies.

The PCPs Are Fair and Equitable

In order to determine whether the PCPs were “fair and equitable,” the bankruptcy court balanced the following interrelated factors from the Second Circuit case of Motorola, Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007): 1) the balance between the litgation's possibility of success and the settlement's future benefits; 2) the likelihood of complex and protracted litigation; 3) the paramount interests of the creditors; 4) whether other parties-in-interest supported the settlement; 5) the competency and experience of counsel and the bankruptcy court judge supporting and reviewing the settlement; 6) the nature and breadth of releases to be obtained by officers and directors, and 7) the extent to which the settlement was the product of arm's-length bargaining.

Applying the business judgment standard to its Rule 9019 analysis, rather than the heightened scrutiny of the entire fairness doctrine advocated by the FPC, the bankruptcy court addressed each of the foregoing Iridium factors and ultimately concluded as follows: 1) the PCPs “would avoid the costs of expensive and time-consuming litigation, conserve the Debtor's resources to pursue claims against those most likely to have mismanaged the firm, and minimize the risk of expending the Debtor's liability insurance policy on unnecessary defense costs” while bringing roughly $70 million into the estate for the benefit of creditors; 2) the secured lenders, the Committee (despite the fact that the settlement would result in only a “twenty cent plan” for its constituents) and a majority of former partners each favored the settlements; 3) Dewey's legal and financial advisors had been actively engaged in prior large law firm bankruptcies; 4) the releases exchanged by Dewey and the participating partners ' of claims held by the estate against the participating partners and claims held by participating partners against the estate ' were reasonable and necessary to accomplish the purposes of the PCPs and, importantly, did not include any third-party non-debtor releases; and 5) the PCPs were developed by independent professionals and were negotiated with partners at arms' length. The bankruptcy court therefore concluded that application of the Iridium factors mandated a finding that the PCPs were both fair and equitable and, as a result, approved the 9019 motion.

The Denial of the Examiner Motion

While many practitioners reviewing the bankruptcy court's opinion will focus on the court's analysis and ultimate approval of the PCPs, the court's denial of the motion to appoint an independent examiner to evaluate the merits of the PCPs, filed by the Ad-Hoc Committee and supported by the FPC, is noteworthy as well. The bankruptcy court first analyzed whether, pursuant to section 1104(c)(2) of the Bankruptcy Code, Dewey had fixed, liquidated, unsecured debts, other than debts for goods, services or taxes, or owing to insiders, that exceeded $5 million.

While the foregoing condition is usually satisfied in many large Chapter 11 cases where there is outstanding unsecured funded debt, the bankruptcy court found that the Ad-Hoc Committee and the FPC were unable to meet their burden at trial to prove that Dewey had satisfied this condition given the unique facts and circumstances of the case.

Thereafter, the bankruptcy court concluded that even assuming the satisfaction of the $5 million condition in section 1104(c)(2), the appointment of an examiner was neither mandatory nor in the best interests of the estate, finding that: 1) it was in its discretion to determine if the appointment of an examiner was required under the facts of the case; 2) the examiner motion was filed for an improper purpose as a clear litigation tactic to derail approval of the PCPs; and 3) the expense of an examiner and the delay required to complete the examiner investigation and report would only add needless expense and delays and given the precarious financial situation, would cause this case to convert to a case under Chapter 7 as well as result in a possible administrative insolvency.

Judge Glenn joins Delaware bankruptcy court Judges Christopher L. Sontchi (In re Visteon Corp., Case No. 09-11786 (Bankr. D. Del. May 12, 2010)) and Kevin S. Carey (In re Spansion, Inc., 426 B.R. 114, 128 (Bankr. D. Del. 2010)), among others, who also agree that the appointment of an examiner is not mandatory, notwithstanding the language in section 1104(c)(2) which, on its face, appears to mandate such appointment in cases where the $5 million unsecured debt threshold is satisfied.

The Appeal

Both the FPC and the Ad-Hoc Committee have appealed the bankruptcy court's order approving the PCPs, and have raised the following issues presented on appeal, among others: 1) whether the bankruptcy court erred when it found that the PCPs were not related-party transactions that would trigger the applicability of the entire fairness doctrine to the court's analysis of the PCPs under Bankruptcy Rule 9019; 2) whether the bankruptcy court erred by approving the PCPs notwithstanding Dewey's admitted failure to investigate tort claims against released partners; 3) whether the bankruptcy court erred when it denied the motion to appoint an examiner under section 1104(c)(1) or (2), and (4) whether the bankruptcy court erred to the extent it approved the 9019 motion outside of and prior to a plan of liquidation.

Conclusion

The approval of the PCPs has generated quite a bit of attention primarily because it was constructed at the front end of the bankruptcy and approved within a few months after the bankruptcy filing. Indeed, as noted by the bankruptcy court, there was also a significant amount of cooperation between the former partners, the secured lenders and the creditors to reach a consensus in a relatively short time, in order to avoid the tortured and twisted trail traveled by other fallen firms. Depending upon its success, the PCP architecture constructed in the Dewey case could provide a potential model for future law firm bankruptcies. Needless to say, all eyes are on the district court as it considers the following question: “Dewey” or don't we affirm the partner contribution settlements?

Steven B. Smith is a partner and Joy L. Monahan is an attorney in the Restructuring & Insolvency department at Edwards Wildman Palmer LLP. Smith is a member of this newsletter's Board of Editors. They are resident in New York and Chicago, respectively and may be reached at [email protected] and [email protected].