IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF DELAWARE

In re:

WASHINGTON MUTUAL, INC., et al.,

Debtors.
Chapter 11

Case No. 08-12229 (MFW)

Jointly Administered








MOTION OF AURELIUS CAPITAL MANAGEMENT, LP
FOR LEAVE TO APPEAL UNDER 28 U.S.C. 158(a)
Dated: September 27, 2011
BLANK ROME LLP
Michael DeBaecke (DE No. 3186)
Victoria Guilfoyle (DE No. 5183)
1201 Market Street, Suite 800
Wilmington, Delaware 19801
Telephone: (302) 425-6400
Facsimile: (302) 425-6464
KRAMER LEVIN NAFTALIS &
FRANKEL LLP
Kenneth H. Eckstein
Alan R. Friedman
Jeffrey S. Trachtman
Daniel M. Eggermann
1177 Avenue of Americas
New York, New York 10036
Telephone: (212) 715-9100
Facsimile: (212) 715-8000


Attorneys for Aurelius Capital Management, LP and certain of its managed entities

i

TABLE OF CONTENTS
PAGE
TABLE OF AUTHORITIES ......................................................................................................... iii
PRELIMINARY STATEMENT .....................................................................................................1
STATEMENT OF PERTINENT FACTS .......................................................................................9
A. General Background ............................................................................................................9
B. The Global Settlement and First Confirmation Hearing ....................................................10
C. The Equity Committee Investigation .................................................................................10
D. The Second Confirmation Hearing and Cybergenics Standing Motion ............................11
E. The Standing Order and Confirmation Order ....................................................................14
ARGUMENT .................................................................................................................................17
I. LEAVE TO APPEAL THE STANDING ORDER SHOULD BE GRANTED,
IF NECESSARY, TO PREVENT A WASTEFUL AND DESTRUCTIVE
QUAGMIRE AND PUT THESE CASES BACK ON TRACK TOWARDS
RESOLUTION ..................................................................................................................17
A. The Appeal Presents Controlling Questions of Law on Which There are
Substantial Grounds for a Difference of Opinion ..................................................20
1. The Finding that Aurelius Helped Rather Than Harmed the Estates
Bars Any Claim for Equitable Disallowance .............................................21
2. The Bankruptcy Court Erred by Granting Standing to Pursue
Insider Trading Claims that the Debtors Themselves Would Lack
Standing to Pursue .....................................................................................23
3. The Bankruptcy Court Erred in Sustaining a Claim for Equitable
Disallowance Because Such a Remedy Is Not Recognized Under
the Bankruptcy Code ..................................................................................24
4. The Bankruptcy Court Distorted and Misapplied the Law
Governing Each Element of an Insider Trading Claim .............................27
a) The Bankruptcy Court ignored settled law in holding that
Aurelius could be found to be an insider of the Debtors
subject to potential insider trading liability under the
classical theory ...........................................................................27

TABLE OF CONTENTS
PAGE

ii

b) The Bankruptcy Court ignored the strict requirement that
an insider trading claim include allegations of facts giving
rise to a compelling inference of scienter ......................................31
c) The Bankruptcy Court changed the law of materiality to
create a new per-se no-trading rule that accorded with its
policy preferences ..........................................................................36
5. The Bankruptcy Court Failed to Determine whether the Debtors
were in Fact Reasonable in Refusing to Pursue the Insider Trading
Claims ........................................................................................................38
B. Immediate Appeal of the Standing Order Would Materially Advance the
Termination of the Litigation and Conserve Resources ........................................41
II. LEAVE TO APPEAL THE CONFIRMATION ORDER SHOULD BE
GRANTED, IF NECESSARY, TO ENSURE THAT UNSECURED
CREDITORS RECEIVE THEIR CONTRACTUAL ENTITLEMENTS
UNDER ANY PLAN OF REORGANIZATION ..............................................................42

TABLE OF AUTHORITIES
PAGE

iii


CASES
Adelphia Commcns Corp. v. Bank of Am., N.A. (In re Adelphia Commcns Corp.),
365 B.R. 24 (Bankr. S.D.N.Y. 2007) .......................................................................................26
In re Amatex Corp.,
755 F.2d 1034 (3d Cir. 1985)...............................................................................................1, 17
American Cigar Co. v. MNC Commercial Corp. (In re M. Paolella & Sons, Inc.), Adv.
Pro. No. 87-1007F, 1991 Bankr. LEXIS 1181 (Bankr. E.D. Pa. Apr. 15, 1991) ....................24
In re Armstrong World Indus., Inc.,
432 F.3d 507 (3d Cir. 2005).....................................................................................................42
Baker v. MBNA Corp.,
No. 05-272, 2007 WL 2009673 (D. Del. July 6, 2007) ...........................................................34
Basic, Inc. v. Levinson,
485 U.S. 224 (1988) .................................................................................................................36
Bateman Eichler, Hill Richards, Inc. v. Berner,
472 U.S. 299 (1985) .................................................................................................................24
In re Beck,
128 B.R. 571 (Bankr. E.D. Okla. 1991) ...................................................................................43
Benjamin v. Diamond (In re Mobile Steel Co.),
563 F.2d 692 (5th Cir. 1977) ...................................................................................................24
In re BH&P, Inc.,
949 F.2d 1300 (3d Cir. 1991)...................................................................................................18
Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723 (1975) .................................................................................................................23
In re Burlington Coat Factory Sec. Litig.,
114 F.3d 1410 (3d Cir. 1997)...................................................................................................34
Caplin v. Marine Midland Grace Trust Co. of N.Y.,
406 U.S. 416 (1972) .................................................................................................................21
Cheney v. United States Dist. Ct. for the Dist. of Columbia,
542 U.S. 367 (2004) .................................................................................................................41

TABLE OF AUTHORITIES
PAGE

iv

Citicorp Venture Capital, Ltd. v. Comm. of Creditors Holding Unsecured Claims,
160 F.3d 982 (3d Cir. 1998)...............................................................................................21, 25
Cohen v. KB Mezzanine Fund II, LP (In re Submicron Sys. Corp.),
432 F.3d 448 (3d Cir. 2006).....................................................................................................22
In re Combustion Engg, Inc.,
391 F.3d 190 (3d Cir. 2004)...............................................................................................19, 25
In re Coram Healthcare Corp.,
315 B.R. 321 (Bankr. D. Del. 2004) ........................................................................................43
Dirks v. S.E.C.,
463 U.S. 646 (1983) ...........................................................................................................27, 29
Dixon v. Am. Cmty. Bank & Trust (In re Gluth Bros. Constr.),
424 B.R. 379 (Bankr. N.D. Ill. 2009) ......................................................................................28
In re Drexel Burnham Lambert Grp.,
123 B.R. 702 (Bankr. S.D.N.Y. 1991) .....................................................................................28
Dura Pharm., Inc. v. Broudo,
544 U.S. 336 (2005) .................................................................................................................38
E.F. Hutton & Co. v. Hadley,
901 F.2d 979 (11th Cir. 1990) .................................................................................................21
In re F/S Airlease II Inc. v. Simon,
844 F.2d 99 (3d Cir. 1988).................................................................................................17, 18
First Am. Bank of N.Y. v. Sw. Gloves & Safety Equip., Inc.,
64 B.R. 963 (D. Del. 1986) ......................................................................................................19
First Fid. Bank, N.A. v. Hooker Invs., Inc. (In re Hooker Invs., Inc.),
937 F.2d 833 (2d Cir. 1991).....................................................................................................41
FSLIC v. Moneymaker (In re A&L Props.),
96 B.R. 287 (C.D. Cal. 1988) ..................................................................................................42
G-I Holdings, Inc. v. Those Parties Listed on Exhibit A (In re G-I Holdings, Inc.),
313 B.R. 612 (Bankr. D.N.J. 2004) .........................................................................................20
Hirsch v. Arthur Andersen & Co.,
72 F.3d 1085 (2d Cir. 1995).....................................................................................................21

TABLE OF AUTHORITIES
PAGE

v

Infinity Investors Ltd. v. Kingsborough (In re Yes! Entmt Corp.),
316 B.R. 141 (D. Del. 2004) ....................................................................................................19
Interface Group-Nevada, Inc. v. Trans World Airlines, Inc.
(In re Trans World Airlines, Inc.),
145 F.3d 124 (3d Cir. 1998).....................................................................................................20
Kalnit v. Eichler,
264 F.3d 131 (2d Cir. 2001).....................................................................................................33
Kane v. Johns-Manville Corp.,
843 F.2d 636 (2d Cir. 1988).....................................................................................................19
L.L. Capital Partners, L.P. v. Rockefeller Ctr. Props., Inc.,
939 F. Supp. 294 (S.D.N.Y. 1996)...........................................................................................33
LFD Operating, Inc. v. Ames Dept Stores, Inc. (In re Ames Dept Stores, Inc.),
274 B.R. 600 (Bankr. S.D.N.Y. 2002) .....................................................................................28
Licensing by Paolo, Inc. v. Sinatra (In re Gucci),
126 F.3d 380 (2d Cir. 1997).....................................................................................................19
Manus Corp. v. NRG Energy, Inc. (In re OBrien Envtl. Energy, Inc.),
188 F.3d 116 (3d Cir. 1999).....................................................................................................20
In re Market Square Inn, Inc.,
978 F.2d 116 (3d Cir. 1992).....................................................................................................17
In re Marvel Entmt Group, Inc.,
140 F.3d 463 (3d Cir. 1998)...............................................................................................17, 18
McLean v. Alexander,
599 F.2d 1190 (3d Cir. 1979)...................................................................................................33
In re Mid-American Waste Sys., Inc.,
284 B.R. 53 (Bankr. D. Del. 2002) (Walsh, J.) ........................................................................24
Natl Cable Television Coop., Inc. v. Broadstripe, LLC (In re Broadstripe, LLC),
No. 09-39, 2009 U.S. Dist. LEXIS 25690 (D. Del. Mar. 25, 2009) ............................19, 20, 41
Norwest Bank Worthington v. Ahlers,
485 U.S. 197 (1988) .................................................................................................................25
Official Comm. of Unsecured Creditors of Cybergenics Corp. v. Chinery,
330 F.3d 548 (3d Cir. 2003)............................................................................................. passim

TABLE OF AUTHORITIES
PAGE

vi

Official Comm. of Unsecured Creditors of Sunbeam Corp. v. Morgan Stanley & Co.
(In re Sunbeam Corp.),
284 B.R. 355 (Bankr. S.D.N.Y. 2002) .....................................................................................23
Official Comm. of Unsecured Creditors v. Dow Corning Corp.
(In re Dow Corning Corp.),
456 F.3d 668 (6th Cir. 2006) ...................................................................................................42
Official Comm. of Unsecured Creditors v. Foss (In re Felt Mfg. Co.),
No. 06-1171, 2007 Bankr. LEXIS 2569 (Bankr. D.N.H. July 27, 2007) ................................21
Official Comm. of Unsecured Creditors v. Halifax Fund L.P.
(In re AppliedTheory Corp.),
493 F.3d 82 (2d Cir. 2007).......................................................................................................21
Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co.,
267 F.3d 340 (3d Cir. 2001).....................................................................................................24
Official Unsecured Creditors Comm. of Broadstripe, LLC v. Highland Capital Mgmt., LP
(In re Broadstripe, LLC),
444 B.R. 51 (Bankr. D. Del. 2010) ..........................................................................................30
OHC Liquidation Trust v. Credit Suisse (In re Oakwood Homes Corp.),
356 F. Appx 622 (3d Cir. 2009) .............................................................................................24
Ruskin v. Griffiths,
269 F.2d 827 (2d Cir. 1959).....................................................................................................42
S.E.C. v. Cavanagh,
445 F.3d 105 (2d Cir. 2006).....................................................................................................38
In re Schoenberg,
156 B.R. 963 (Bankr. W.D. Tex. 1993) ...................................................................................43
Schubert v. Lucent Techs. Inc. (In re Winstar Commcns, Inc.),
554 F.3d 382 (3d Cir. 2009).....................................................................................................30
SG Cowen Sec. Corp. v. U.S. Dist. Court for the N. Dist. of Cal.,
189 F.3d 909 (9th Cir. 1999) ...................................................................................................36
In re Smith,
Case No. 03-10666, 2008 Bankr. LEXIS 7 (Bankr. W.D. Ky. Jan. 7, 2008) ..........................43
Se. Sprinkler Co. v. Meyertech Corp. (In re Meyertech Corp.),
831 F.2d 410 (3d Cir. 1987)...............................................................................................17, 18

TABLE OF AUTHORITIES
PAGE

vii

Stanziale v. Sun Natl Bank (In re Dwek),
No. 09-5046 2010 U.S. Dist. LEXIS 3203 (D.N.J. Jan. 15, 2010) ....................................20, 41
In re Suprema Specialties, Inc. Sec. Lit.,
438 F.3d 256 (3d Cir. 2006).....................................................................................................34
Tellabs, Inc. v. Makor Issues & Rights, Ltd.,
551 U.S. 308 (2007) ...........................................................................................................31, 34
Travelers Cas. & Sur. Co. of Am. v. PG&E,
549 U.S. 443 (2007) .................................................................................................................25
United States v. Brunson,
416 F. Appx 212 (3d Cir. 2011) .............................................................................................41
United States v. OHagan,
521 U.S. 642 (1997) .................................................................................................................27
Unsecured Creditors Comm. of Debtor STN Enters. v. Noyes (In re STN Enters.),
779 F.2d 901 (2d Cir. 1985).....................................................................................................20
Viking Assocs., L.L.C. v. Drewes (In re Olson),
120 F.3d 98 (8th Cir. 1997) .....................................................................................................22
Walton v. Morgan Stanley & Co.,
623 F.2d 796 (2d Cir. 1980).....................................................................................................28
In re Wash. Mut., Inc.,
442 B.R. 314 (Bankr. D. Del. 2011) ............................................................................10, 31, 43
Wilson v. Comtech Telecomm. Corp.,
648 F.2d 88 (2d Cir. 1981).......................................................................................................23
Winer Family Trust v. Queen,
503 F.3d 319 (3d Cir. 2007).....................................................................................................31
Zumpano v. Juniper Networks, Inc. (In re Juniper Networks, Inc.),
158 F. Appx 899 (9th Cir. 2005) ............................................................................................34
STATUTES & RULES
11 U.S.C. 502(b) .........................................................................................................................25
11 U.S.C. 510 ..................................................................................................................14, 22, 25

TABLE OF AUTHORITIES
PAGE

viii


11 U.S.C. 1126 ............................................................................................................................29
11 U.S.C. 1129 ............................................................................................................................29
28 U.S.C. 158 ...................................................................................................................... passim
28 U.S.C. 1292 ......................................................................................................................19, 41
Fed. R. Bankr. P. 8003 .....................................................................................................................1
OTHER AUTHORITIES
Joint Explanatory Statement of the Committee of Conference, H.R. Rep. No. 104-369
(1995) (Conf. Rep.), reprinted in 1995 U.S.C.C.A.N. 730 ......................................................35




Aurelius Capital Management, LP, on behalf of certain of its managed entities
(collectively, Aurelius) that are creditors of the above-captioned debtors and debtors in
possession (collectively, the Debtors), hereby submits this motion (the Motion) pursuant to
28 U.S.C. 158(a) and Rule 8003 of the Federal Rules of Bankruptcy Procedure (the
Bankruptcy Rules) for an order granting leave to appeal the order (the Order) and related
opinion (the Opinion) (copies of which are attached hereto as Exhibits A and B, respectively)
entered by the United States Bankruptcy Court for the District of Delaware (the Bankruptcy
Court) on September 13, 2011 denying confirmation of the Debtors modified sixth amended
plan of reorganization (the Modified Sixth Amended Plan or the Plan) and authorizing the
Official Committee of Equity Security Holders of Washington Mutual, Inc. (the Equity
Committee) to commence and prosecute an action against Aurelius and certain other creditors
on behalf of the Debtors estates, and in support thereof respectfully states as follows:
1

PRELIMINARY STATEMENT
1. Aurelius, one of the largest creditors in these bankruptcy cases, appeals from both
the Confirmation Order and the Standing Order. The Standing Order radically distorts securities
and bankruptcy law and inflicts a gross injustice. It authorizes the Equity Committee, in the
name of the Debtors, to bring unprecedented causes of action for alleged insider trading against
Aurelius and the other Settlement Noteholders where the trial court found that the estates
themselves suffered no harm, where the estates lack standing to bring these claims, and where

1
While entered as a single order, the Order actually is comprised of two separate orders that resolve two separate
and distinct contested matters: (i) an order granting in part a motion filed by the Equity Committee for derivative
standing (the Standing Motion) to pursue certain causes of action on behalf of the Debtors estates (the Standing
Order) and (ii) an order denying confirmation of the Debtors Plan (the Confirmation Order). As set forth below
at 28-31 and 79, Aurelius asserts that both the Standing Order and the Confirmation Order are final orders
under the Third Circuits pragmatic approach to finality in bankruptcy proceedings. See In re Amatex Corp., 755
F.2d 1034, 1039 (3d Cir. 1985). Aurelius nevertheless submits this Motion out of an abundance of caution.

2


the basic elements of these claims are missing.
2
The Equity Committee represents the general
interests of the Debtors stockholders, who are greatly out of the money, rather than any
individual parties that may have traded in the Debtors securities with Aurelius. The Standing
Order inexplicably overrides the judgment of the Debtors and the Official Committee of
Unsecured Creditors (the Creditors Committee) that these causes of action are meritless and
uneconomic to pursue and subjects all creditors (including Aurelius) to yet more delay and
expense in these three-year-old bankruptcy cases. Moreover, the Standing Order wreaks havoc
with well-established securities law precedent and practice and will, until overturned, invite a
substantial expansion of securities litigation (whether or not bankruptcy-related); turn bankruptcy
courts into common forums for bringing securities strike suits and (thanks to liberal discovery
procedures) conducting pre-suit fishing expeditions, and severely inhibit the negotiation by
major stakeholders of consensual reorganization plans in virtually every major corporate
bankruptcy.
2. Aurelius also appeals from the final ruling embodied in the Confirmation Order
mandating that postpetition interest in any plan must be paid at the federal judgment rate rather
than the contract rates bargained for by the parties a ruling that disregards governing law,
blocked confirmation of the Debtors Plan, and would deprive creditors in these cases of more
than $810 million in postpetition interest claims by the time any new plan can be confirmed.
3. Aurelius submits that both of these aspects of the Order are final and appealable
as of right, but in the event the Court disagrees, discretionary appellate review under 28 U.S.C.
158(a)(3) is appropriate here because the appeal presents several disputed legal issues as to

2
In addition to Aurelius, the Settlement Noteholders are Centerbridge Partners, L.P. (Centerbridge), Owl
Creek Asset Management, L.P. (Owl Creek), and Appaloosa Management L.P. (Appaloosa), each of which has
appeared in these cases on behalf of its own managed entities that also are substantial creditors of the estates.

3


which there is at least fair ground for disagreement and hearing the appeal would materially
advance resolution of the underlying disputes. Aurelius respectfully requests expedited
consideration of this Appeal in light of the severe burden and harm that otherwise will be
inflicted by the decision below on the estates, the parties, and the bankruptcy process generally.
4. In the September 13 Opinion, the Bankruptcy Court explained its reasons for
granting the Equity Committees motion under Official Comm. of Unsecured Creditors of
Cybergenics Corp. v. Chinery, 330 F.3d 548 (3d Cir. 2003), for leave to file an adversary
complaint (the Complaint) on behalf of the estates. The Bankruptcy Court held that the
Complaint stated a colorable claim that Aurelius and others violated the federal securities laws
by trading while allegedly in possession of material nonpublic information obtained from the
Debtors, and authorized the Equity Committee to seek equitable disallowance of the purported
defendants multi-hundred-million dollar holdings in the Debtors debt securities. The Opinion
has already set off shock-waves because (among other things) it premises potential insider
trading liability on facts mirroring settlement negotiation procedures relied on and used in
virtually all large bankruptcy cases:
Aurelius participated in settlement negotiations only during two brief periods one
nearly a year and the other more than three months before an agreement in principle
was announced. On both occasions, Aurelius (and other creditors) entered into
customary confidentiality agreements with the Debtors under which they were
temporarily restricted from trading in the Debtors securities while privy to
confidential information.
These agreements required the Debtors, at the conclusion of each confidentiality
period, to publicly disclose any material nonpublic information shared with Aurelius,

4


for the express purpose of allowing Aurelius to resume unrestricted trading.
Accordingly, at the end of each of these two periods, the Debtors made material
public disclosures regarding the multi-billion dollar tax refunds that the Debtors
expected to receive, and the Debtors certified to Aurelius that it was free to resume
trading. The Debtors correctly determined at the time, with the advice of experienced
securities law counsel, that the stale details of unsuccessful settlement negotiations
were not material and did not need to be disclosed.
It was undisputed that Aurelius did not engage in any improper trading during the
confidentiality periods.
This approach was modeled on procedures that have been widely accepted and successfully
employed for decades to facilitate consensual resolutions in large bankruptcies, as well as in
other settings. Until now, it would have been unthinkable that parties carefully following such
procedures in good faith could be exposed to a lawsuit for insider trading. But the Opinion
rewrote the rules for these cases retroactively invoking a series of new legal standards that
would radically remake federal securities and bankruptcy law. The court essentially declared
that (1) any creditor privy to confidential settlement negotiations at any time during a bankruptcy
case must remain permanently restricted or maintain an ethical wall for the duration of the case;
(2) any creditor receiving confidential information by participating in consensual plan
negotiations may thereby be treated as a temporary insider with fiduciary duties to the estate;
and (3) any creditor that holds, or is part of an ad hoc creditor group holding, more than one third
of a class of securities (referred to in the Opinion as a blocking position) may without more be
deemed a fiduciary for all creditors in the class and a non-statutory insider of the estates.

5


5. The Bankruptcy Court used the questionable doctrine of equitable disallowance to
transform any insider trading violation (and presumably any violation of any law by any creditor)
into a bankruptcy matter, despite well-established mechanisms for such violations to be rectified
by the Securities and Exchange Commission (the SEC) or the injured parties. The Opinion
effectively declares open season for creative and aggressive bankruptcy litigation by allowing a
deeply out-of-the-money constituency to bring a derivative suit found meritless by both the
Debtors and the Creditors Committee, despite the court expressly finding that the putative
defendants had not harmed the estates, but rather actually helped the Debtors increase the size of
the estates to the benefit of all stakeholders. Opinion at 71, 73.
6. This remarkable new paradigm, if sustained, would radically change modern
bankruptcy practice turning the members of every ad hoc group in these and other cases into
fiduciaries with potentially wide-ranging duties and legal exposure, and making it prohibitively
burdensome for major economic stakeholders to participate in plan negotiations. This would in
turn not just chill but freeze out from plan negotiations the very institutional creditors whose
votes will be needed to accept a plan, leaving debtors to propose plans that lack creditor support
and may be doomed to rejection, and inviting reorganizations to be resolved through litigation
rather than negotiation. This effect is already being felt, as law firm publications have been
issued warning clients of the new open-ended duties they may be assuming simply by stepping
forward constructively to participate in arms-length negotiations.
3
The Bankruptcy Courts
suggestion that multi-year trading restrictions would not be burdensome since official creditors
committees are already subject to such restrictions (Opinion at 137-38) in fact proves the

3
For example, attached hereto as Exhibits G, H, I and J are client alerts released in the past two weeks by Davis
Polk & Wardwell LLP, Bracewell & Giuliani LLP, Ropes & Gray LLP and Willkie Farr & Gallagher LLP,
respectively.

6


opposite: it is precisely because of such prolonged restrictions that major bondholders in most
cases do not sit on official creditors committees, as is so in these cases. That is why the practice
evolved of a non-fiduciary ad hoc creditor group; but the Opinion, if not reversed, may destroy
this useful and important mechanism for fostering consensual resolution of complex
reorganizations.
7. Aurelius will demonstrate upon full briefing that the Standing Order represents an
abuse of discretion as a matter of law because it is based on multiple legal errors, any one of
which would warrant discretionary appellate review under 28 U.S.C. 158(a)(3):
The Bankruptcy Courts finding that Aurelius (and the other Settlement Noteholders)
did not harm but actually helped the estates extinguishes any potential claim for
equitable disallowance. Regardless of the availability of any particular remedy, the
Debtors (and the Equity Committee standing in their shoes) have standing only to
seek redress for harm to the estates. None has been articulated here.
Similarly, the Debtors (and therefore the Equity Committee) have no standing to sue
for alleged insider trading in their own securities. That claim (to the extent one
exists) belongs to the parties with whom Aurelius traded, who would not benefit from
the proposed action. The Bankruptcy Courts suggestion that the Debtors would have
a defense outside of bankruptcy to the payment of their debt obligations based on
insider trading by the claimant with third parties is a radical concept with no legal
support.
In any event, the entire adversary proceeding is barred because the supposed remedy
of equitable disallowance is unavailable under modern bankruptcy jurisprudence.
While the Third Circuit has reserved judgment on the existence of the remedy, it is at
minimum a highly contested, dispositive threshold issue warranting immediate
review. Moreover, even if the remedy were theoretically available, the Bankruptcy
Court itself recognized that it should be invoked only in those extreme instances
perhaps very rare where it is necessary as a remedy. Opinion at 115. Leaving
aside the absence of any harm to the estates, the highly developed mechanisms for
rectifying insider trading violations belie any suggestion that equitable disallowance
could be necessary as a remedy here.
8. In addition, the Opinion contains a series of fundamental errors under federal
securities law:

7


The Bankruptcy Court ignored settled law in holding that Aurelius could be found to
be a temporary insider subject to liability under the classical theory of insider
trading merely because it received confidential information pursuant to an arms-
length confidentiality agreement and advanced its own economic interests in
negotiations that had the shared goal of reaching a settlement among economically
adverse parties.
The Bankruptcy Court similarly erred in holding that Aurelius could be found both to
have fiduciary duties to other creditors and to be a non-statutory insider of the
Debtors merely because it joined an informal creditor group that collectively may
have held more than one third of the securities within a particular class of securities.
The Bankruptcy Court disregarded the strict standard mandated by Congress for
pleading the scienter element of an insider trading claim, which requires
particularized facts giving rise to a cogent and compelling inference at least as
powerful as any non-culpable inference that a defendant knew or recklessly ignored
that it was trading improperly while in possession of material nonpublic information.
The court eviscerated that requirement by giving no weight to the Debtors
materiality determinations, the good faith of which was unchallenged; by ignoring
undisputed testimony regarding Aureliuss own good-faith determinations of
materiality; and by sustaining the pleading even though no inference of knowledge
(much less a powerful or cogent one) could be drawn from the allegations regarding
Aureliuss pattern of trades.
The Bankruptcy Court further unduly expanded the concept of materiality, essentially
creating a new per se rule that any creditor participating in confidential settlement
negotiations must permanently halt all trading in the debtors securities or establish
an ethical wall for the duration of the case regardless of the state of the negotiations
at the conclusion of the confidential period. Like the courts insider holdings, this
new, retroactively imposed legal rule has no precedent and, if not promptly reversed,
will cast a pall over settlement negotiations in virtually every major corporate
bankruptcy.
9. Finally, the Bankruptcy Court further erred as a matter of law by granting
standing without making the necessary finding that the Debtors unreasonably refused to pursue
the alleged insider trading claims a judgment endorsed by the Creditors Committee. Although
it acknowledged that its decision could precipitate a litigation morass (Opinion at 138), the
Bankruptcy Court never actually weighed the benefits and burdens facing the estates: the remote
chance of success and relatively modest upside (potential disgorgement of the limited profits that
could conceivably be traced to use of the alleged material nonpublic information) versus the

8


crushing expense and extended delay that would be associated with litigating the claims to
conclusion. All creditors (including Aurelius) have a strong interest in avoiding the harm to the
estates of incurring many tens of millions of dollars in legal fees to litigate these disputes to
conclusion while further complicating the already troubled effort to promulgate a confirmable
plan of reorganization. This costly quagmire (and further financial and reputational harm to
innocent parties resulting from the mere pendency of these grave but reckless accusations) can be
avoided only by entertaining this appeal and reversing the decision after full briefing.
10. Immediate and expedited review of the Opinion is necessary to halt the adverse
impact this decision will have on the bankruptcy process, and also to avoid significant harm in
these cases to the estates and their constituents. Over the last year, two plans supported by the
overwhelming majority of creditors, and embodying a settlement with JP Morgan and the FDIC
twice found to be reasonable and proposed in good faith, have both failed. During this period,
because of accrued interest that must be turned over to senior classes at the contract rate and
mounting administrative expenses, the Debtors most junior noteholder class (the PIERS), of
which Aurelius is a significant holder, has gone from a projected near full recovery after
subordination on account of their $789 million in claims for prepetition principal and accreted
interest to a recovery approaching zero under any eventual plan. Upon release of the Opinion,
the market price of the PIERS dropped from $14.50 per share to $4.08 per share. The Order
promises only to create more delay, by directing the parties to mediate both outstanding Plan
issues and the merits of the insider trading allegations, even after a week-long trial and the
Bankruptcy Courts ruling. This mediation has little chance of success, because the equity
holders are massively out of the money and could not benefit from any realistic settlement (or,
for that matter, from the proposed litigation). Even assuming (contrary to all experience to date)

9


that the Debtors could exit Chapter 11 by the end of February 2012, the common equity would
be out of the money by more than $7.6 billion, and the preferred equity by more than $165
million. For each month of delay beyond February 2012, these deficits would grow by more
than $20 million on account of postpetition interest and administrative expenses. And if the
Bankruptcy Courts erroneous ruling on postpetition interest is reversed, the above deficits
would increase by more than $810 million (so the preferred holders would be nearly $1 billion
out of the money) and would grow by more than $42 million per month of delay beyond
February 2012. Finally, complications generated by this pending dispute may well hamper a
third attempt to confirm a plan of reorganization. Immediate appellate review to correct the
errors below provides the surest path to a speedy, just, and comprehensive resolution of these
cases.
STATEMENT OF PERTINENT FACTS
A. General Background
11. Founded in 2006, Aurelius Capital Management, LP is a limited partnership that
acts as an investment manager for three separate and independent investment funds (collectively,
the Aurelius Funds).
4
Throughout these cases, the Aurelius Funds collectively have, along
with the other Settlement Noteholders, been among the largest creditors of the Debtors estates,
holding claims throughout the Debtors multi-tiered debt structure. As a result, they have had a
strong interest in maximizing the value of the Debtors estates for all stakeholders while
minimizing costs and expenses.
12. In the wake of the seizure and sale of certain subsidiaries of Debtor Washington
Mutual Inc. (WMI) by the Federal Deposit Insurance Corporation (the FDIC) and the

4
Each Aurelius Fund has its own trading history, and one did not even commence operations until February
2010.

10


commencement of these bankruptcy cases, myriad disputes involving billions of dollars arose
among the Debtors, JPMorgan Chase (JPMC), which purchased certain assets and assumed
certain liabilities of WMI, and the FDIC (both in its corporate capacity and as receiver for
Washington Mutual Bank (WMB)). Opinion at 2. For example, the parties disputed
ownership of such assets as (i) approximately $4 billion that the Debtors had on deposit in
accounts held by JPMC and (ii) approximately $5.5 to $5.8 billion in tax refunds.
B. The Global Settlement and First Confirmation Hearing
13. On March 12, 2010, the Debtors announced the material terms of a global
settlement resolving the various claims among the Debtors, JPMC, and the FDIC, eventually
memorialized, following further negotiations, in an agreement (as subsequently modified, the
Global Settlement Agreement or GSA) filed with the Bankruptcy Court on May 21, 2010.
Opinion at 3. The settlement was embodied in a plan of reorganization projected to pay
unsecured creditors in full but provide no recovery for the Debtors equity holders. The
Bankruptcy Court held an evidentiary hearing on confirmation of the Debtors Sixth Amended
Plan in early December 2010, ruling a month later that the GSA was fair and provided a
reasonable return in light of the possible results of litigation, even though it provided no
recovery for equity. In re Wash. Mut., Inc., 442 B.R. 314, 345 (Bankr. D. Del. 2011). The
Bankruptcy Court nevertheless concluded that the Sixth Amended Plan could not be confirmed
because of several legal deficiencies unrelated to the proposed litigation. Id. at 322.
C. The Equity Committee Investigation
14. Following denial of confirmation, and seeking leverage to derail a new plan, the
Equity Committee sought nearly two and one-half years into the case authority to conduct
discovery of the Settlement Noteholders under Bankruptcy Rule 2004 with respect to accusations

11


about their trading activity that had been raised (with no admissible evidence) by a pro se
security holder in connection with one of his objections to confirmation at the first confirmation
hearing an objection that the Bankruptcy Court denied for complete lack of admissible
evidence. Washington Mut., 442 B.R. at 349. The Equity Committee neither joined in that
objection nor sought discovery regarding those accusations at that time. The Bankruptcy Court
nonetheless granted the Equity Committees discovery request, and the Settlement Noteholders
produced tens of thousands of pages of documents and a representative of each sat for a full-day
deposition.
D. The Second Confirmation Hearing and Cybergenics Standing Motion
15. While the Equity Committee was conducting its investigation, the Debtors filed
and solicited votes on its Modified Sixth Amended Plan, which attempted to correct the
deficiencies identified by the Bankruptcy Court in the prior plan. Shifting their tactics, the
Equity Committee again objected to confirmation, this time contending that the Plan was the
product of a flawed process dominated by the Settlement Noteholders and favoring their interests
over those of other constituents in particular, the Debtors equity holders and that the Debtors
had intentionally facilitated improper trading by the Settlement Noteholders. The Equity
Committee then filed the Standing Motion seeking authority to commence and prosecute claims
for equitable subordination and equitable disallowance on behalf of the Debtors estates based on
the same claims of domination and insider trading under the federal securities laws.
5
The Equity
Committee specifically requested the Bankruptcy Court to assess the colorability of its claims
based on the evidence to be presented at the confirmation hearing on the Modified Sixth
Amended Plan (the Second Confirmation Hearing). Ex. C at 13.

5
A copy of the Standing Motion and Complaint are attached hereto as Exhibit C.

12


16. The Second Confirmation Hearing was held over seven days in July 2011.
6

During the hearing, the Bankruptcy Court heard extensive, consistent, unrefuted testimony from
each of the Settlement Noteholders, confirmed by the testimony of the Debtors chief
restructuring officer, William Kosturos, comprehensively refuting the unsupported allegations of
improper domination and insider trading.
17. The evidence overwhelmingly demonstrated that Aurelius and the other
Settlement Noteholders in no way dominated or controlled the Debtors during the course of these
cases, but rather were relegated to discrete and intermittent roles in settlement negotiations and
the plan process. Ex. D at 48, 78, 116-17; Ex. F at 137. Aurelius was included in confidential
settlement negotiations only twice, for limited periods in these nearly three year old cases (the
Confidentiality Periods), with each period governed by a formal written agreement (the
Confidentiality Agreements). Opinion at 66. The first Confidentiality Period lasted for only
60 days, from March 9 through May 8, 2009. Id. The second Confidentiality Period occurred
six months later and lasted for only 45 days, from November 16 through December 30, 2009. Id.
at 67. Outside of these two periods (and at times even during these two periods), Aurelius was
not included in the Debtors settlement negotiations with JPMC, the FDIC, and other parties.
The Debtors reached a first, tentative settlement in March 2010, some ten months after the first
Confidentiality Period, and three months after the second. Even that agreement required months
of additional negotiation and significant further modifications to result in a plan definite enough
to take to confirmation.
18. The evidence established that Aurelius received material nonpublic information
from the Debtors prior to the announcement of the March 2010 settlement only during the two

6
Relevant excerpts from the transcripts of the proceedings on July 18, 19, and 21 are attached hereto as Exhibits
D, E and F, respectively.

13


Confidentiality Periods and subject to the terms of the applicable Confidentiality Agreements.
The Confidentiality Agreements required Aurelius either to refrain from trading in the Debtors
securities during the Confidentiality Period or to erect an ethical wall between the employee
receiving any material nonpublic information and all Aurelius employees trading in the Debtors
securities. Opinion at 66. Aurelius chose to erect an ethical wall during the first period and to
shut down trading during the second period. Id. at 66-67. There has been no allegation, much
less evidence, that Aurelius breached either obligation. To ensure that Aurelius and other
creditors that signed similar agreements would be permitted to resume unrestricted trading in the
Debtors securities at the termination of each Confidentiality Period, both Confidentiality
Agreements required the Debtors to disclose within the meaning of Rule 101 of Regulation
FD . . . a fair summary, as reasonably determined by the Debtors, of any Confidential
Information that constitutes material nonpublic information under U.S. federal securities law.
19. During each Confidentiality Period, Aurelius and the other Settlement
Noteholders learned certain material nonpublic business information, including the estimated
ranges of the Debtors tax refunds. Ex. D at 65, 105. This information was publicly disclosed
through the Debtors monthly operating reports published at the end of each Confidentiality
Period. Id. at 79; Ex. F at 127-28. The Debtors determined, in consultation with their securities
law counsel, that the details of settlement negotiations, which ended each time with the parties
billions of dollars apart, were not material and therefore did not have to be disclosed. Ex. F. at
127-28, 153. The Debtors explicitly confirmed orally and in writing to the Settlement
Noteholders in May and December 2009 that their disclosures satisfied the Debtors obligations

14


under the Confidentiality Agreements and that the Settlement Noteholders were free to resume
unrestricted trading.
7

E. The Standing Order and Confirmation Order
20. In its September 13, 2011 Opinion, the Bankruptcy Court recognized that the
basic facts regarding Aureliuss conduct during the two confidentiality periods as recited in the
Complaint and presented in court were largely undisputed. However, the court disregarded the
clear legal consequences of these facts, distorting, misapplying, or simply ignoring the law
governing federal insider trading claims.
21. Significantly, the Bankruptcy Court rejected the Equity Committees allegations
that Aurelius and the other Settlement Noteholders dominated or controlled the Debtors, dictated
the course of settlement negotiations, or inflicted any harm on the estates:
Despite the allegations of insider trading by the Settlement
Noteholders, the Court is unconvinced that their actions had a
negative impact on the Plan or tainted the GSA.
Rather, the actions of the Settlement Noteholders appear to have
helped increase the Debtors estates. During the First
Confidentiality Period, the Settlement Noteholders, together with
other creditors persuaded the Debtors to submit a term sheet to
JPMC that was more aggressive than the one the Debtors had
initially contemplated.
Opinion at 71 (emphasis added). The Bankruptcy Court went on to note that [i]f the Settlement
Noteholders had improperly dominated the case . . . , the Modified Plan would have elevated the
treatment of the PIERS class (in which they hold the bulk of their claims); instead the PIERS are
receiving the treatment warranted by their subordinated status. Id. at 73.

7
Other creditors beyond the Settlement Noteholders similarly relied upon this type of temporary restriction to
participate in many of the same settlement negotiations and later resume trading following termination of the
confidentiality periods and indeed an even wider circle of creditors (including the large number of senior
noteholders represented by White & Case LLP) were aware that negotiations were occurring. Ex. D at 64-65, 79,
81, 114; Ex. E at 137; Ex. F at 152-53.

15


22. The Bankruptcy Court further concluded that one of the two remedies sought in
the Complaint equitable subordination pursuant to 11 U.S.C. 510(c) is not a remedy
available to (or of much help in redressing any injury to) the shareholders because the plain
language of the statute only permits a creditors claim to be subordinated to another claim and
not to equity. Id. at 111. However, the Bankruptcy Court upheld the Equity Committees
alternative proposed remedy equitable disallowance (see id. at 115) even though most cases
hold that it is not even available under the Bankruptcy Code and the few that recognize the
doctrine stress that it must be reserved for the most extreme misconduct.
23. The Bankruptcy Court then held that the Equity Committee stated a colorable
claim for insider trading under the federal securities laws based on the Settlement Noteholders
knowledge of unsuccessful settlement offers, upholding the pleading of materiality by
substituting its hindsight judgment for the Debtors and the parties own informed and good faith
contemporaneous assessments. Id. at 118-28. The court further held that Aurelius could be
regarded as an insider subject to insider trading liability under the classical theory based
solely on having received confidential information pursuant to an arms-length confidentiality
agreement with the Debtors in order to participate in negotiations aimed at reaching a consensual
resolution of the cases, and its membership in an ad hoc group with a blocking position in one
or more classes of the Debtors securities. Id. at 128-32. And the court held that the scienter
requirement of an insider trading claim was satisfied despite uncontroverted evidence of the
Settlement Noteholders good faith reliance on the Debtors own materiality determinations and
the inconclusive inferences to be drawn from their trading patterns. Id. at 132-34.
8


8
In addition to liability under the classical theory of insider trading discussed above, the Bankruptcy Court
sustained an allegation that a single noteholder may have violated the misappropriation theory by trading after
receiving a chart from counsel that included stale details of settlement negotiations from months earlier. Opinion at
136. The Bankruptcy Court appears to have extended that holding to the other Settlement Noteholders based solely

16


24. Ultimately, the Bankruptcy Court left little doubt of its own policy preference to
tighten the restrictions on claims trading during bankruptcy cases by retroactively imposing on
all creditors participating, even fleetingly, in negotiations restrictions previously applied only to
members of official creditors committees:
[C]reditors who want to participate in settlement discussions in
which they receive material nonpublic information about the
debtor must either restrict their trading or establish an ethical wall
between traders and participants in the bankruptcy case. . . . The
Court does not believe that a requirement to restrict trading or
create an ethical wall in exchange for a seat at the negotiating table
places an undue burden on creditors who wish to receive
confidential information and give their input.
Id. at 137-38 (emphasis added).
25. Finally, the Bankruptcy Court acknowledged that it was required . . . to balance
the probability of success on the claim against the burden on the estate that would result from its
prosecution. Id. at 138. However, the court inexplicably granted the Cybergenics Standing
Motion without even attempting to quantify any potential benefits for the estates, providing no
basis to question the reasonableness of the Debtors refusal to embroil the estates in what even
the court recognized would be a litigation morass that would threaten existing creditor
recoveries. Id. The Bankruptcy Court stayed the Equity Committees action pending mediation.
See Ex. A.
26. In addition, although it reaffirmed the fairness of the GSA, the Bankruptcy Court
again denied confirmation of the Plan, principally because it concluded that the Plan improperly
contemplated the payment of postpetition interest to unsecured creditors at the applicable
contract rate. The court held that the plain language of the Bankruptcy Code mandated interest

on the Equity Committees unspecified and unsubstantiated allegation contradicted by all the evidence in the
record, including the testimony of every witness that counsel may have shared material nonpublic information
about negotiations with the Settlement Noteholders after the conclusion of the second Confidentiality Period. Id. at
137.

17


at the federal judgment rate, despite recognizing and validating subordination agreements that
mandate turnover from subordinated to senior creditors of the Debtors at the contract rate.
Opinion at 81, 83.
ARGUMENT
I.

LEAVE TO APPEAL THE STANDING ORDER SHOULD BE GRANTED, IF
NECESSARY, TO PREVENT A WASTEFUL AND DESTRUCTIVE QUAGMIRE
AND PUT THESE CASES BACK ON TRACK TOWARDS RESOLUTION
27. Leave to appeal should be granted here, if necessary, to prevent the delay,
expense, and injustice of protracted litigation over facially invalid claims that are barred by
decades of settled governing law.
28. At the outset, Aurelius submits that the Standing Order is final and appealable as
of right under 28 U.S.C. 158(a). Appellate courts take a more pragmatic and less technical
approach to finality in bankruptcy cases [t]o avoid the waste of time and resources that might
result from reviewing discrete portions of the action only after a plan of reorganization is
approved. In re Amatex Corp., 755 F.2d 1034, 1039 (3d Cir. 1985). This approach is informed
by such factors as the impact of the matter on the assets of the estate, the necessity for further
fact-finding on remand, the preclusive effect of a decision on the merits, and the interests of
judicial economy. See, e.g., Se. Sprinkler Co. v. Meyertech Corp. (In re Meyertech Corp.), 831
F.2d 410, 414 (3d Cir. 1987); In re F/S Airlease II Inc. v. Simon, 844 F.2d 99, 104 (3d Cir.
1988); In re Marvel Entmt Group, Inc., 140 F.3d 463, 470 (3d Cir. 1998).
29. All these factors favor a finding of finality here. The Standing Order will most
certainly have an impact on the assets of the Debtors estates since, absent reversal, the parties
will plunge into what even the Bankruptcy Court has acknowledged would be a litigation

18


morass that will deplete the assets of the estates and dilute creditor recoveries. Opinion at 138;
see also below at 76. An order that will have the effect of increasing administrative expenses
or otherwise depleting estate assets is more likely to be treated as final. See In re Market Square
Inn, Inc., 978 F.2d 116, 120-21 (3d Cir. 1992) (order finding lease was not terminated was final
because of impact on debtors estate); In re BH&P, Inc., 949 F.2d 1300, 1307 (3d Cir. 1991)
(order removing trustee and counsel was final where courts ruling had the more remote but no
less real effect of increasing the estates administrative costs); F/S Airlease, 844 F.2d at 104
(order authorizing estates retention of broker was final where brokers fee would impact assets
available to creditors).
30. Moreover, immediate appellate review of the Standing Order will further the
interests of judicial economy and protect both the estates and the parties from irretrievable loss.
The Standing Order is premised upon legal errors that, if reversed, will end the Equity
Committees proposed litigation. This factor weighs heavily in favor of finality. See BH&P,
949 F.2d at 1307 (order final where [r]esolution of the issues raised on appeal will eliminate the
need for further consideration of conflict of interest issues, freeing the bankruptcy court to
adjudicate the more substantive issues relating to the estates in question.); F/S Airlease, 844
F.2d at 104 (order final where [a] resolution of this discrete dispute at this time would further
the goal of judicial economy because it could obviate the need for further action by the
bankruptcy court.); Meyertech, 931 F.2d at 414 (order final where [a] decision now will . . .
preclude the necessity of further activity by the fact-finding tribunal, will obliterate the need for
more litigation and serves the ever-prevailing interest of judicial economy).
31. Finally, immediate appellate review of the Standing Order is the only meaningful
way in which that order can be reviewed by an appellate court. Review of the Bankruptcy

19


Courts legal errors after discovery and trial would simply be too late to protect the estates from
massive expense and delay. See Marvel, 140 F.3d at 470 (treating order as final and noting that
[w]ere we not to take jurisdiction at this juncture, no meaningful review of the order . . . could
ever take place as a practical matter).
32. If the Court determines that the Standing Order is not a final order, Aurelius
respectfully seeks leave to appeal, which the Court may grant in its discretion under 28 U.S.C.
158(a)(3). Courts generally grant leave to appeal decisions of a bankruptcy court where the
criteria of 28 U.S.C. 1292(b) are present i.e., where (i) a controlling question of law is
involved; (ii) the question is one as to which there is a substantial ground for difference of
opinion; and (iii) an immediate appeal would materially advance the ultimate termination of the
litigation. See, e.g., Natl Cable Television Coop., Inc. v. Broadstripe, LLC (In re Broadstripe,
LLC), No. 09-39, 2009 U.S. Dist. LEXIS 25690, at *5 (D. Del. Mar. 25, 2009). Immediate
appeal from an interlocutory order is further appropriate to avoid harm to a party pendente lite
from a possibly erroneous interlocutory order and the avoidance of possible wasted trial time and
litigation expense. First Am. Bank of N.Y. v. Sw. Gloves & Safety Equip., Inc., 64 B.R. 963,
967 (D. Del. 1986) (quoting Katz v. Carte Blanche Corp., 496 F.2d 747, 755 (3d Cir. 1974)); see
also Broadstripe, 2009 U.S. Dist LEXIS 25690, at *6.
9

33. With respect to the merits, while the Bankruptcy Code contains no explicit
authority for a committee or other party-in-interest to prosecute a derivative suit on behalf of a

9
Moreover, there can be no doubt that Aurelius qualifies as a person aggrieved by the Order with standing to
appeal it under In re Combustion Engg, Inc., 391 F.3d 190, 214 (3d Cir. 2004). A party is aggrieved by a
bankruptcy court order that diminishes their property, increases their burdens, or impairs their rights. Id. (internal
quotation marks omitted). Here, Aurelius (along with all creditors) will suffer significant pecuniary harm if the
estates are required to pay tens of millions of dollars in attorneys fees to fund the litigation morass predicted by
the Bankruptcy Court and if related delay causes further diminution in the value of its claims. See Licensing by
Paolo, Inc. v. Sinatra (In re Gucci), 126 F.3d 380, 388 (2d Cir. 1997) (creditors have standing to appeal orders that
affect assets available to pay claims); Kane v. Johns-Manville Corp., 843 F.2d 636, 642 (2d Cir. 1988) (same).

20


debtors estate, the Third Circuit has recognized a qualified right to derivative standing where
(i) the claim that the party is seeking to prosecute is colorable and (2) the debtor has
unjustifiably refused to prosecute it. See Official Comm. of Unsecured Creditors of Cybergenics
Corp. v. Chinery, 330 F.3d 548, 566-67 (3d Cir. 2003); Infinity Investors Ltd. v. Kingsborough
(In re Yes! Entmt Corp.), 316 B.R. 141, 145 (D. Del. 2004); see also Unsecured Creditors
Comm. of Debtor STN Enters. v. Noyes (In re STN Enters.), 779 F.2d 901, 905 (2d Cir. 1985).
The party seeking standing (here, the Equity Committee) bears the burden of showing that it has
met these derivative standing requirements. G-I Holdings, Inc. v. Those Parties Listed on
Exhibit A (In re G-I Holdings, Inc.), 313 B.R. 612, 629 (Bankr. D.N.J. 2004).
34. The determination by a bankruptcy court to grant standing to pursue a derivative
cause of action on behalf of a debtors estate is an exercise of its equitable powers, Cybergenics,
330 F.3d at 568, reviewable for abuse of discretion, see Interface Group-Nevada, Inc. v. Trans
World Airlines, Inc. (In re Trans World Airlines, Inc.), 145 F.3d 124, 131 (3d Cir. 1998).
However, as was the case here, [a] bankruptcy court abuses its discretion when its ruling is
founded on an error of law or a misapplication of law to the facts. Manus Corp. v. NRG
Energy, Inc. (In re OBrien Envtl. Energy, Inc.), 188 F.3d 116, 122 (3d Cir. 1999).
A. The Appeal Presents Controlling Questions of Law on Which
There are Substantial Grounds for a Difference of Opinion
35. A question of law is controlling when, if decided erroneously, it would lead
to reversal upon appeal. See Broadstripe, 2009 U.S. Dist. LEXIS 25690, at *5 n.3; Stanziale v.
Sun Natl Bank (In re Dwek), No. 09-5046 2010 U.S. Dist. LEXIS 3203, at *4-5 (D.N.J. Jan. 15,
2010). This appeal presents several such questions, any one of which would warrant granting
leave to appeal.

21


1. The Finding that Aurelius Helped Rather Than Harmed
the Estates Bars Any Claim for Equitable Disallowance
36. For several different reasons, the Debtors would lack standing to bring the claims
that the Equity Committee seeks to bring on their behalf, and each of these grounds turns on
threshold legal issues that satisfy the standard for interlocutory review. Most basically, the
Bankruptcy Courts finding that Aurelius and the other Settlement Noteholders helped rather
than harmed the estates is an absolute bar to the proposed Complaint.
37. It is well-settled that a debtor in bankruptcy lacks standing to pursue claims based
on harm to individual creditors or equity holders, but rather can only pursue claims based on
harm to the debtors estate. See Caplin v. Marine Midland Grace Trust Co. of N.Y., 406 U.S.
416, 434 (1972) (bankruptcy trustees lack standing to pursue claims of individual creditors);
Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1093-94 (2d Cir. 1995) (same); E.F. Hutton &
Co. v. Hadley, 901 F.2d 979, 986-87 (11th Cir. 1990) (same); see also Citicorp Venture Capital,
Ltd. v. Comm. of Creditors Holding Unsecured Claims, 160 F.3d 982, 991 (3d Cir. 1998)
(holding that injury caused to creditors who sold claims to insider must play no role in
determining the extent of any [equitable] subordination).
38. Official committees, similarly, can only bring claims based on general harm to the
estate not based on particularized harm to specific individuals. Official Comm. of Unsecured
Creditors v. Halifax Fund L.P. (In re AppliedTheory Corp.), 493 F.3d 82, 87 (2d Cir. 2007)
(committee lacks standing to pursue equitable subordination based on injury to particular
creditors); Official Comm. of Unsecured Creditors v. Foss (In re Felt Mfg. Co.), No. 06-1171,
2007 Bankr. LEXIS 2569, at *24 (Bankr. D.N.H. July 27, 2007) (committee has no standing to
bring claims belonging to individual creditors) (citing Caplin, 406 U.S. at 434).

22


39. The Complaint alleges only two injuries neither of which can give rise to Equity
Committee standing: (i) injury caused by the Settlement Noteholders participation in a
settlement with the Debtors and JPMC that did not provide for a return to equity investors
(Complaint 56) and (ii) injury caused by their alleged insider trading (id. at 60). The
Bankruptcy Courts reaffirmation of the fairness of the Global Settlement Agreement, and its
related conclusion that the Settlement Noteholders did not harm the estates and actually helped
improve the JPMC settlement, conclusively defeats the first allegation the only one that even
attempted to link the Settlement Noteholders conduct to any actual harm to the estates.
40. With respect to the alleged insider trading, the Complaint does not plead any
plausible basis upon which a court could conclude that the Debtors estates were harmed even
assuming that Aurelius violated the federal securities laws (which it most assuredly did not).
The Settlement Noteholders traded with other individual securities holders, not with the Debtors.
Even if individual trading counter-parties were harmed by any such trading, the Debtors
themselves (and by extension, the Equity Committee as an estate representative) lack standing to
seek redress of those harms. Any individual parties that believe they were injured by Aureliuss
trading may pursue their non-bankruptcy remedies in an appropriate forum. See Viking Assocs.,
L.L.C. v. Drewes (In re Olson), 120 F.3d 98, 102 & n.4 (8th Cir. 1997) (debtor lacked standing to
challenge transfer of claims despite evidence that fiduciary had bought claims by misleading
sellers for purpose of gaining control of estates primary asset; parties who considered
themselves wronged could individually object or pursue non-bankruptcy remedies ). The Plan
proposed in these cases would not release such claims.
41. Invocation of equitable remedies does not change the basic rule that a derivative
action may only be based on actual harm to the estates. For instance, it is well-settled that the

23


remedy of equitable subordination under 11 U.S.C. 510(b) (which the Bankruptcy Court held is
unavailable here) is remedial, not penal, and may be invoked even by individual creditors only
to the extent necessary to offset specific harm that creditors have suffered on account of the
inequitable conduct. Cohen v. KB Mezzanine Fund II, LP (In re Submicron Sys. Corp.), 432
F.3d 448, 462 (3d Cir. 2006) (emphasis added; citation omitted). The same must be true for a
claim for equitable disallowance assuming such a claim is even legally cognizable. Official
Comm. of Unsecured Creditors of Sunbeam Corp. v. Morgan Stanley & Co. (In re Sunbeam
Corp.), 284 B.R. 355, 364, 369 n.3 (Bankr. S.D.N.Y. 2002) (equitable disallowance, if still
viable, would be based on the same principles as equitable subordination). Since the Debtors,
and therefore the Equity Committee, have standing to sue only for harm to the estates and not
harm to individual creditors, the rejection of allegations that Aurelius harmed the estates required
denial of the Cybergenics motion as a matter of law presenting a threshold legal issue for
review as to which there is at least a good faith basis for a difference of opinion.
2. The Bankruptcy Court Erred by Granting Standing
to Pursue Insider Trading Claims that the Debtors
Themselves Would Lack Standing to Pursue
42. A closely related threshold legal issue requiring reversal is the clear rule that the
Debtors, who were not contemporaneous traders in the securities, would lack standing to sue
Aurelius for violating the federal insider trading laws with respect to the Debtors own securities.
It is well-settled that only parties to the relevant trades have standing to bring private suits for
federal securities fraud. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 732-33
(1975) (only purchasers or sellers have standing); Wilson v. Comtech Telecomm. Corp., 648 F.2d
88, 94-95 (2d Cir. 1981) (only parties trading contemporaneously with defendant have standing

24


to sue for insider trading). As a result, the Equity Committee lacks standing to bring these
claims on behalf of the Debtors.
43. The Bankruptcy Court ignored this authority, which dooms the entire Complaint.
The court stated only that [b]ecause the Equity Committee seeks to disallow the claims of the
Settlement Noteholders under facts that suggest they violated the securities laws, the Court
believes that the Debtors would have a defense to those claims outside of the bankruptcy context
as well. Opinion at 116. But the Bankruptcy Courts speculation that an issuer has a defense to
paying a debt claim if it can show that a portion of the claim was acquired from a third party
through insider trading is utterly unsupported in the law. The authorities cited by the Bankruptcy
Court which discuss the remedies of disgorgement, interest, and civil penalties available in an
SEC enforcement action (Opinion at 116-17) are obviously irrelevant to the putative standing
of an issuer either to bring an insider trading claim or to invoke securities law violations as a
defense to paying a debt. The Debtors simply lack standing to sue Aurelius for insider trading;
and as a result, so does the Equity Committee.
10

3. The Bankruptcy Court Erred in Sustaining a Claim
for Equitable Disallowance Because Such a Remedy
Is Not Recognized Under the Bankruptcy Code
44. A third independent threshold legal issue is whether equitable disallowance is
even available as a remedy under the Bankruptcy Code. If it is not, the Complaint as limited by

10
Even if such a defense were theoretically available, it could never be enforced by the Debtors here, because the
Debtors themselves were contractually obligated to publicly disclose all material nonpublic information that they
provided to Aurelius during the Confidentiality Periods. If the Debtors breached that obligation by failing to
publicly disclose material information and, as a result, the Settlement Noteholders traded while in possession of
material nonpublic information, equitable principles of unclean hands and/or in pari delicto would preclude the
Debtors from refusing to pay the underlying debt claims of the Settlement Noteholders on the basis of such trading.
See, e.g., Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 310-11 (1985) (private right of action under
securities law may be barred based on plaintiffs own culpable conduct); OHC Liquidation Trust v. Credit Suisse (In
re Oakwood Homes Corp.), 356 F. Appx 622, 627 (3d Cir. 2009) (pari delicto bars claims by equally culpable
plaintiffs) (unpublished); Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 358-60 (3d
Cir. 2001) (pari delicto barred committee from prosecuting claims on debtors behalf). Indeed, if the Settlement
Noteholders suffer any harm as a result of any breach by the Debtors of their obligations under the Confidentiality
Agreements, the Settlement Noteholders will have administrative claims against the Debtors estates.

25


the Bankruptcy Court, does not state a colorable claim for relief.
45. Most courts that have addressed the issue have found that equitable disallowance
simply does not exist as a remedy. See, e.g., Benjamin v. Diamond (In re Mobile Steel Co.), 563
F.2d 692, 699 (5th Cir. 1977) (Equitable considerations can justify only the subordination of
claims, not their disallowance.); see also In re Mid-American Waste Sys., Inc., 284 B.R. 53, 68
(Bankr. D. Del. 2002) (Walsh, J.) (quoting Mobile Steel for proposition that equitable
considerations cannot justify claim disallowance); American Cigar Co. v. MNC Commercial
Corp. (In re M. Paolella & Sons, Inc.), Adv. Pro. No. 87-1007F, 1991 Bankr. LEXIS 1181, at
*38 (Bankr. E.D. Pa. April 15, 1991) (same).
46. This conclusion is mandated by limitations on the power of the bankruptcy courts
to create new remedies through the exercise of equitable discretion. As the Third Circuit held in
In re Combustion Engineering, Inc., 391 F.3d 190, 236 (3d Cir. 2004), [t]he general grant of
equitable power contained in 105(a) cannot trump specific provisions of the Bankruptcy Code,
and must be exercised within the parameters of the Code itself. See also Norwest Bank
Worthington v. Ahlers, 485 U.S. 197, 206 (1988) ([W]hatever equitable powers remain in the
bankruptcy courts must and can only be exercised within the confines of the Bankruptcy Code.).
Here, Section 510(c) of the Bankruptcy Code expressly creates an equitable remedy equitable
subordination that addresses creditor misconduct, and neither that section nor any other in the
Bankruptcy Code contemplates the use of the courts equitable powers to disallow a claim.
Indeed, Section 502(b) of the Bankruptcy Code enumerates the nine grounds upon which a claim
may be subject to disallowance. Notably, those grounds do not include any equitable
considerations. The Supreme Court has confirmed that these constitute the only permissible

26


grounds on which a court may disallow a claim. Travelers Cas. & Sur. Co. of Am. v. PG&E, 549
U.S. 443, 449 (2007).
47. Despite the absence of a single reported case applying the doctrine of equitable
disallowance, the Bankruptcy Court nevertheless upheld the potential availability of the doctrine,
citing a footnote in Citicorp Venture Capital, Ltd. v. Comm. of Creditors Holding Unsecured
Claims, 160 F.3d 982 (3d Cir. 1998), in which the Third Circuit declined to address the issue.
Opinion at 112. The Bankruptcy Court also relied on decisions in the Adelphia bankruptcy
upholding the theoretical availability of equitable disallowance. See id. at 112-15. While the
Travelers case appears to close the door left open in Citicorp, that debate may await full briefing.
It suffices for present purposes to note that this is yet another dispositive threshold legal issue as
to which there is at the very least substantial ground for difference of opinion warranting
immediate review by an appellate court.
48. A closely related question is whether this remedy, even if theoretically available,
could ever be imposed based on the facts alleged in these cases. The Bankruptcy Court noted
Judge Gerbers observation in Adelphia that the severe step of actually disallowing, rather than
merely subordinating, a claim on equitable grounds could be taken only in those extreme
instances perhaps very rare where it is necessary as a remedy. See Adelphia Commcns
Corp. v. Bank of Am., N.A. (In re Adelphia Commcns Corp.), 365 B.R. 24, 73 (Bankr. S.D.N.Y.
2007) (emphasis added); see also Opinion at 115.
49. Here, the Bankruptcy Court has already found that Aurelius did not harm but
actually helped the estates by urging the Debtors to seek and obtain a larger settlement from
JPMC, which redounded to the benefit of all stakeholders in the cases. Opinion at 71. The only
remaining injury even theoretically requiring a remedy is the supposed harm to creditors that

27


sold securities to Aurelius based on Aureliuss supposed possession of material nonpublic
information. Even assuming that any such harm could be established (along with all of the other
elements of an insider trading claim), the federal securities laws provide a well-developed set of
standards and potential remedies that may be pursued by the parties actually claiming injury, as
well as by the SEC. The draconian remedy of equitable disallowance clearly is not appropriate,
much less necessary, in such circumstances.
50. Accordingly, there is substantial ground for difference of opinion both as to the
existence of equitable disallowance as a remedy and whether, as a matter of law, it could ever be
imposed in this context. Immediate appellate review is warranted to answer these questions.
4. The Bankruptcy Court Distorted and Misapplied the
Law Governing Each Element of an Insider Trading Claim
51. The Bankruptcy Court misstated or ignored well-settled legal principles
governing each of the elements of an insider trading claim. Again, any one of these legal issues,
properly decided, would mandate reversal of the Cybergenics ruling.
a) The Bankruptcy Court ignored settled law in
holding that Aurelius could be found to be an
insider of the Debtors subject to potential
insider trading liability under the classical theory
52. First, the Bankruptcy Court erred in upholding the allegations that Aurelius was
an insider of the Debtors, a necessary step in alleging a breach of duty since there is no
allegation that Aurelius breached any contractual duty. For an individual or entity to become
liable for insider trading under Section 10(b) of the Securities Exchange Act of 1934 and SEC
Rule 10b-5, it must trade on material, nonpublic information in violation of a fiduciary duty and
while employing manipulation or deception. See Dirks v. S.E.C., 463 U.S. 646, 653-54 (1983).
Trading by a non-fiduciary does not violate the securities laws unless done in breach of a duty to

28


the source of the information. See id. at 657. The need for a breach of duty flows from the
requirement of deception or manipulation as an element of securities fraud. The party
misappropriating inside information must be guilty of deception of those who entrusted him
with access to confidential information. United States v. OHagan, 521 U.S. 642, 652 (1997).
It is well settled that where the recipient of information discloses to the source that he plans to
trade on it, there is no deceptive device and thus no section 10(b) violation. Id. at 655.
53. A straightforward application of this threshold breach of duty requirement bars
insider trading liability here. Neither Aurelius nor the other Settlement Noteholders were
fiduciaries; they acted solely on behalf of themselves. See In re Drexel Burnham Lambert Grp.,
123 B.R. 702, 706 (Bankr. S.D.N.Y. 1991) (ad hoc groups, unlike members of officially
appointed committees, have no fiduciary obligations under the Bankruptcy Code); see also
Dixon v. Am. Cmty. Bank & Trust (In re Gluth Bros. Constr.), 424 B.R. 379, 390 (Bankr. N.D.
Ill. 2009) ([C]reditors have no fiduciary duty to debtors or other creditors.). Aureliuss
obligations to the Debtors were assumed contractually, through the Confidentiality Agreements.
Under New York law, the existence of an arms-length contract bars any inference of an
additional fiduciary duty. See LFD Operating, Inc. v. Ames Dept Stores, Inc. (In re Ames Dept
Stores, Inc.), 274 B.R. 600, 626 (Bankr. S.D.N.Y. 2002). Moreover, receipt of confidential
information does not by itself create a fiduciary duty, particularly where parties operate under an
arms-length agreement. See Walton v. Morgan Stanley & Co., 623 F.2d 796, 799 (2d Cir.
1980).
54. Aurelius indisputably satisfied all of its contractual duties to the Debtors, and any
obligations it had under the Confidentiality Agreements with respect to trading terminated with
those agreements. The very structure of the Confidentiality Agreements, requiring the Debtors at

29


the end of the Confidentiality Periods to publicly disclose any material nonpublic information
provided, reflects that the parties understood and expected that the Settlement Noteholders would
resume unrestricted trading once those agreements terminated. This understanding was
confirmed in undisputed testimony at the Second Confirmation Hearing. Ex. F at 152-53.
Aurelius cannot be liable for insider trading based on misappropriation where it breached no duty
and deceived no one.
55. Notwithstanding the fundamental failure of this critical element, the Bankruptcy
Court remarkably determined that Aurelius could be considered an insider of the Debtors with
fiduciary duties to shareholders and the estates, making it subject to liability under the classical
theory of insider trading. Opinion at 128-32. The court illogically held that Aurelius may have
assumed fiduciary duties that overrode its expressly limited contractual obligations simply
because it was provided with confidential information pursuant to those very contracts to
facilitate negotiations with the common goal of reaching a consensual resolution. See id. at 130.
This unprecedented holding stretches beyond recognition the temporary insider doctrine under
Dirks, 463 U.S. at 655 n.14 which applies only to those who actually become insiders of a
debtor on a temporary basis, such as accountants, lawyers, and consultants and ignores the
authority cited above (at 53) holding that receipt of confidential information pursuant to an
arms-length contract does not create fiduciary duties. On this theory, anyone negotiating
anything confidentially with an issuer would become a temporary insider simply because they
share a common goal of reaching a deal, and would retain that status following failed
negotiations so long as there was any prospect that negotiations might resume months or even
years later.

30


56. The Bankruptcy Court further held that, based on their mere status as alleged
holders of blocking positions in two classes of the Debtors debt structure, the Settlement
Noteholders could be found to have assumed fiduciary duties to all other members of those
classes. Opinion at 132.
11
This holding by itself would impose fiduciary duties on most ad hoc
creditor groups a radical concept that would render even the formation of such a group self-
defeating and unviable, and thereby disrupt and chill the settlement negotiation process in
countless in-court bankruptcy cases and out-of-court restructurings.
12

57. But the Opinion goes further. The Bankruptcy Court held that based solely on
this purported duty to other creditors, Aurelius and the other Settlement Noteholders could be
viewed as non-statutory insiders with even broader fiduciary duties. Id. at 132. This holding
again completely ignores the governing legal standards; it is well-settled (even in the cases cited
by the Bankruptcy Court) that non-statutory insider status requires a non-arms-length
relationship and some ability to dominate a debtor or dictate its business decisions. See, e.g.,
Schubert v. Lucent Techs. Inc. (In re Winstar Commcns, Inc.), 554 F.3d 382, 396-97 (3d Cir.
2009) (non-statutory insider status found where party controlled important business decisions
of debtor and had ability to coerce it into unfavorable contracts and involve its employees in
improper transactions); Official Unsecured Creditors Comm. of Broadstripe, LLC v. Highland

11
The phrase blocking position is something of a misnomer. It merely refers to the ability to cause one class of
creditors to be considered a rejecting class under 11 U.S.C. 1126(c). But being a rejecting class does not
block a plan of reorganization, or anything else for that matter. Section 1129(b) of the Bankruptcy Code permits a
court to confirm a plan of reorganization over the objection of a rejecting class so long as the plan does not
discriminate unfairly and is fair and equitable with respect to that rejecting class. Ex. D at 164-65. In any event,
none of the Settlement Noteholders individually held a blocking position in any class, and the undisputed testimony
was that there were no voting agreements among the four separate noteholders. See Ex. D at 50.
12
If, as the Bankruptcy Court appears to contemplate, members of ad hoc groups would assume all the duties and
restrictions that apply to members of official creditors committees, this would preclude group members from
pursuing their own economic interests and bar them from trading for the duration of the case even if they were not in
possession of material nonpublic information. But these restrictions are precisely what deters most large
bondholders from sitting on official committees, as is the case here. Expanding these restrictions to all groups
holding a potential blocking position would functionally eliminate ad hoc groups as an important tool in bankruptcy
and out-of-court restructuring negotiations.

31


Capital Mgmt., LP (In re Broadstripe, LLC), 444 B.R. 51, 80 (Bankr. D. Del. 2010) (listing
customary indicia of non-statutory insider status, including ability to select management for
debtor, control over management decisions, and pre-existing relationship stemming from other
than arms-length transaction).
58. The facts alleged by the Equity Committee fell far short of establishing insider
status under either of these doctrines. But the Bankruptcy Courts own findings that Aurelius
and the other Settlement Noteholders helped the estate and did not improperly dominate or skew
the Plan process (Opinion at 71-73) rendered the courts insider holdings truly inexplicable
particularly since the Bankruptcy Court earlier held that the Settlement Noteholders could not
obtain a release under the Sixth Amended Plan because they were not acting in this case in any
fiduciary capacity; their actions were taken solely on their own behalf; not others. Wash. Mut.,
442 B.R. at 349. On information and belief, the Bankruptcy Courts insider rulings are already
having an impact on the willingness of parties in major bankruptcies and out of court to
participate in ad hoc groups and engage in confidential negotiations. Immediate appellate review
is necessary to prevent these rulings from causing even more widespread damage.
b) The Bankruptcy Court ignored the strict requirement
that an insider trading claim include allegations of
facts giving rise to a compelling inference of scienter
59. The Bankruptcy Court further compounded its error by ignoring the strict
standard for the pleading of scienter in a securities fraud complaint, failing to require that the
Equity Committee plead facts giving rise to a strong inference that Aurelius acted with
fraudulent intent and knew or recklessly disregarded that it was trading while in possession of
material nonpublic information. The Private Securities Litigation Reform Act of 1995 (PSLRA)
set forth stringent new pleading requirements that the Supreme Court construed in Tellabs, Inc.

32


v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007). Tellabs requires that a plaintiff plead with
particularity facts showing not just that an inference of knowledge or recklessness rationally
could be drawn, but rather facts giving rise to a powerful or cogent inference. Id. at 323.
And a court also must consider plausible nonculpable explanations for the defendants
conduct, such that a complaint will not be sustained unless a reasonable person would deem
the inference of scienter cogent and at least as compelling as any opposing inference one could
draw from the facts alleged. Id. at 324; see also Winer Family Trust v. Queen, 503 F.3d 319,
328-29 (3d Cir. 2007) (affirming dismissal of scienter pleading under Tellabs standard).
60. The Equity Committees proposed Complaint certainly fails to (and could not
even be amended to) satisfy Congresss stringent standard, which the Bankruptcy Court failed
even to acknowledge while giving no weight to the plausible, indeed overwhelming, non-
culpable explanations for the defendants conduct. It is undisputed that Aurelius and the Debtors
specifically agreed in the confidentiality agreements that the Debtors would disclose any material
nonpublic information at the end of each Confidentiality Period. It is also factually undisputed
that the Debtors, in consultation with their experienced securities counsel, Weil, Gotshal &
Manges LLP, actually made informed, good faith judgments about what information did and did
not have to be disclosed. Ex. F at 127-28, 153. Aureliuss reasonable, good faith reliance on the
Debtors contractual duties and the Debtors actual judgments in performing those duties
undercuts any reasonable inference of scienter, let alone a cogent or compelling one, particularly
given the undisputed testimony that Aurelius independently confirmed the Debtors conclusions
based on its own understanding and experience. Ex. D at 113-14.
61. The Bankruptcy Court did not question any of these facts, but merely stated that
good faith reliance does not constitute an exception to the scienter element of insider trading

33


(Opinion at 134) as if the burden were on Aurelius to disprove scienter rather than on the
Equity Committee to plead scienter with particularity. The Bankruptcy Court circularly
suggested that Aurelius cannot use its good faith reliance on the Debtors and their professionals
as a shield if it violated its own internal insider trading policies (id. at 135) failing to explain
how Aureliuss careful conduct (which included its own good-faith judgments that information in
its possession about settlement negotiations was not material) in any way violated those polices
in the first place, much less why the policies themselves could somehow alter Aureliuss legal
duties.
62. The Bankruptcy Courts holding comes dangerously close to equating a finding of
materiality with a showing of scienter. But as one court aptly observed:
[I]t would be folly to hold . . . that the knowing failure to disclose a
material fact in and of itself necessarily gives rise to a strong
inference of fraud. There are far too many circumstances in which
a material omission would evidence no such mental state. The
person or entity responsible might have held a perfectly reasonable
and good faith, if ultimately mistaken, belief that the fact omitted
was not material, to name but one.
L.L. Capital Partners, L.P. v. Rockefeller Ctr. Props., Inc., 939 F. Supp. 294, 299 (S.D.N.Y.
1996). Where, as here, a complaint does not present facts indicating a clear duty to disclose
in light of Aureliuss reasonable reliance on the scope of its contractual duties plaintiffs
scienter allegations do not provide strong evidence of conscious misbehavior or recklessness.
Kalnit v. Eichler, 264 F.3d 131, 144 (2d Cir. 2001) (emphasis added). Moreover, contrary to the
Bankruptcy Courts statement that the statute only requires that the Settlement Noteholders
have knowledge that they were in possession of material nonpublic information (Opinion at
134), the scienter element further requires knowing deception. See McLean v. Alexander, 599
F.2d 1190, 1197 (3d Cir. 1979) (scienter element requires conscious deception or . . . a

34


misrepresentation so recklessly made that the culpability attaching to such reckless conduct
closely approaches that which attaches to conscious deception.) (internal citation omitted).
63. In any event, the dubious materiality of the information in Aureliuss possession
itself further undercuts the strength of any inference of scienter. Even the Bankruptcy Court
implicitly recognized that the fitful, frustrating, and inconclusive settlement negotiations
(established through detailed and uncontradicted testimony) were not material throughout, but
only may have shifted towards the material end of the spectrum at some unspecified point.
Opinion at 128. The undisputed facts simply do not support a strong inference that Aurelius
which participated in those negotiations only during two brief periods that were ten and three
months prior to a first, tentative settlement being reached knew or recklessly ignored that it
was improperly trading while in possession of material nonpublic information.
64. The Bankruptcy Court further erred in failing to scrutinize the Equity
Committees allegations regarding Aureliuss trading patterns to ensure that they could support a
cogent and compelling inference of guilty knowledge absent which, allegations regarding
trading cannot support a pleading of scienter. See In re Burlington Coat Factory Sec. Litig., 114
F.3d 1410, 1424 (3d Cir. 1997) (declining to infer fraudulent intent from trading in the normal
course of events); see also Zumpano v. Juniper Networks, Inc. (In re Juniper Networks, Inc.),
158 F. Appx 899, 901 (9th Cir. 2005) (granting motion to dismiss based on failure to allege that
defendants stock sales were inconsistent with prior trading histories). Here, the Complaint
alleges only that Aurelius bought certain of the Debtors securities at the conclusion of the
Confidentiality Periods, but offers no reason to infer that this trading was unusual or driven by
knowledge of stale settlement offers rather than the contemporaneous public disclosure of
material new information about the company (e.g., the size of expected tax refunds) and thus

35


no basis to conclude, as Tellabs requires, that the facts could support a powerful or cogent
inference of scienter that is at least as compelling as the non-culpable inferences. See Tellabs,
551 U.S. at 323-24; see also Baker v. MBNA Corp., No. 05-272, 2007 WL 2009673, at *7 (D.
Del. July 6, 2007) (strong inference of scienter may not be based on sale of relatively small
proportion of holdings, adopting 30 percent figure as useful guide based on In re Suprema
Specialties, Inc. Sec. Lit., 438 F.3d 256, 278 (3d Cir. 2006)).
65. The Bankruptcy Court was unable to draw any conclusions itself from the trading
patterns with respect to materiality (see Opinion at 127-28), and with respect to scienter, merely
recited the Equity Committees conclusory allegations about the general volume of trades
without explaining (in light of the highly material information that was disclosed at the
conclusion of each Confidentiality Period and undisputed evidence that the trading was
consistent with pre-existing patterns) what facts actually gave rise to a compelling inference of
scienter (id. at 133-34).
66. In this connection, the Bankruptcy Court simply brushed aside as irrelevant many
other undisputed facts highly inferential of nonculpability, e.g., that certain Aurelius Funds sold
securities to their substantial detriment just days before the settlement was publicly
announced; that the Aurelius Funds purchases and sales of PIERS closely corresponded to the
Debtors public announcements regarding billions of dollars of tax refunds, as well as the ebbs
and flows of important tax legislation bearing on that issue; that the Settlement Noteholders were
frequently trading in opposite directions to each other; and that there were important
transcendent factors (such as the tumultuous markets of 2009 and the inflows of capital into the
Aurelius Funds) that could plausibly explain why the Aurelius Funds made the purchases they
did. Moreover, the trading records that the Bankruptcy Court reviewed plainly reveal that a

36


significant part of the supposed buying spree (Opinion at 126) by two of the Aurelius Funds in
May 2009 (the third fund did not yet exist) consisted of simply rotating from low coupon to high
coupon bonds of the same class.
67. In essence, the court punted on scienter, leaving the issue to be developed
through discovery but that is precisely what the stringent facial pleading requirements of the
PSLRA are meant to prevent. The entire point of the PSLRA is to protect defendants from
abusive practices committed in private securities litigation,
13
by requiring a heightened and
particularized pleading of scienter before a plaintiff is permitted to proceed with discovery.
Indeed, granting discovery to permit a plaintiff to try to meet this standard as the Bankruptcy
Court appears to have done here is grounds for mandamus. See SG Cowen Sec. Corp. v. U.S.
Dist. Court for the N. Dist. of Cal., 189 F.3d 909, 912-19 (9th Cir. 1999) (granting mandamus to
restore discovery stay in insider trading case where district court had rejected pleadings for
insufficient particularity, but nonetheless authorized limited discovery). This distortion of
Congresss intent requires immediate reversal.
c) The Bankruptcy Court changed the law of
materiality to create a new per-se no-trading
rule that accorded with its policy preferences
68. The Bankruptcy Courts discussion of materiality focused largely on case law
drawn from the merger context, e.g., Basic, Inc. v. Levinson, 485 U.S. 224 (1988), where the
mere existence, or early progress, of negotiations not known or suspected by the marketplace
may be material. See Opinion at 119-20. The Bankruptcy Court ignored the reality that brief,
intermittent negotiations often occurring months apart and ultimately spanning a year or more,
as was the case here are part and parcel of the bankruptcy process; that the existence of

13
Joint Explanatory Statement of the Committee of Conference, H.R. Rep. No. 104-369, at 41 (1995) (Conf.
Rep.), reprinted in 1995 U.S.C.C.A.N. 730.

37


negotiations itself is rarely surprising or material; and that all parties in large, complex
bankruptcies understand that until a deal takes shape, intermediate, non-binding bargaining
positions of the parties are simply not material. In any event, the record overwhelmingly
established that the settlement discussions to which Aurelius was privy during 2009 left the
parties billions of dollars apart and could not be used to predict the contours of the multi-party
settlement that ultimately emerged, and that the pendency of negotiations was widely known.
14

69. While the details of that record are beyond the scope of this Motion,
15
what is
relevant is that the Bankruptcy Court despite devoting ten pages of its Opinion to discussing
materiality (Opinion at 118-28) ultimately made clear that it believed the situation should be
governed by a per se rule that parties participating in confidential settlement negotiations by
definition become permanently restricted. Such parties, the court declared, are required to adopt
permanent trading restrictions (either shutting down trading or maintaining an ethical wall for the
duration of the case) a requirement previously imposed only upon members of official
bankruptcy committees and other fiduciaries. See id. at 137-38.
70. The retroactive imposition of this extreme, per se rule is unfair to the parties in
this case, who relied upon customary practice and acted scrupulously and with a high level of
care, and will have a destructive effect on the bankruptcy process in other cases, where parties
that are not in a position to assume ongoing trading restrictions or the burdens of maintaining an

14
Ex. D at 69, 118-19; Ex. E at 129-30, 165.
15
However, some of the inferences credited by the Bankruptcy Court are facially unreasonable. For example, the
court seemed to accept an argument that the Settlement Noteholders request to terminate the Second Confidentiality
Period one day early, on December 30, 2009, is evidence that they wanted to trade based on the details of
unsuccessful settlement negotiations from November (Opinion at 126), even though (1) trading was obviously
driven at the end of December by highly material tax refund information then being publicly disclosed, and (2)
undisputed testimony established that the reason for the request was not to facilitate trading but to allow the market
to absorb the tax refund information before year end, so that audited financial statements (which are prepared as of
December 31 for the Aurelius Funds and many other institutions) could be valued using the normal marked-to-
market method. See Ex. E at 52-53.

38


ethical wall are likely to eschew participation in settlement negotiations to the detriment of the
core purpose of chapter 11 of fostering consensual reorganizations. For this reason as well,
immediate appellate review of the Standing Order is warranted.
5. The Bankruptcy Court Failed to Determine
whether the Debtors were in Fact Reasonable
in Refusing to Pursue the Insider Trading Claims
71. Both the Debtors and the Creditors Committee reviewed the discovery record
promulgated by the Equity Committee and determined that the insider trading charges were
wholly without merit and should not be prosecuted. Implicit in that judgment was the conclusion
that, even if the claims could be shown to have any merit, the scant likelihood of success was
outweighed by the significant costs and burdens of financing and participating in the litigation.
72. Having concluded, contrary to the responsible fiduciaries, that the Equity
Committee alleged colorable claims against the Settlement Noteholders, the Bankruptcy Court
acknowledged that it was required . . . to balance the probability of success on the claim against
the burden on the estate that would result from its prosecution. Opinion at 138. While
recognizing that these cases would likely devolve into a litigation morass (id.), the Bankruptcy
Court inexplicably granted the Standing Motion without engaging in the required analysis. If it
had, the conclusion would have been inescapable that the Debtors could and did reasonably
decide that the litigation simply was not worth pursuing.
73. On the benefit side of the ledger would have to be weighed, first, the highly
unlikely prospect (in light of the Complaints multiple infirmities) that the claims could survive a
formal motion to dismiss, summary judgment, or trial. And even if the Equity Committee were
to prevail, the damages that it could recover from the Aurelius Funds on behalf of the estates
would be quite modest limited to disgorgement of profits directly resulting from use of the

39


wrongfully acquired material nonpublic information. See, e.g., S.E.C. v. Cavanagh, 445 F.3d
105, 116 n.25 (2d Cir. 2006) (Because the remedy is remedial rather than punitive, the court
may not order disgorgement above [the] amount [of money acquired through wrongdoing
. . . plus interest.]). Moreover, the damage calculation would have to exclude increases in the
value of securities purchased attributable to factors other than the alleged material nonpublic
information. See Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 343 (2005) (civil securities fraud
damage calculation must consider the tangle of factors affecting price).
74. Here, if a trial court were to find liability, it would be required to calculate the
portion of the profits of each of the Aurelius Funds relating only to purchases after Aurelius was
provided with material nonpublic information but before it was publicly disclosed (at most, a
period of ten months) and directly attributable to trading on particular material nonpublic
information eliminating, for starters value attributable to (1) the passage of legislation in
November 2009 that added billions of dollars of value to the estates by expanding the Debtors
eligibility for NOL carry-back tax deductions; (2) the Debtors public disclosures in April and
December 2009 of the likely size of its tax refunds; and (3) the continued accrual of postpetition
interest. Moreover, to the extent it is shown that the Aurelius Funds trades were with other
Settlement Noteholders (as appears likely from a comparison of trading records in evidence) or
other sophisticated institutional investors, many of which participated in or knew of settlement
negotiations, the trial court will have to determine whether, in fact, the Aurelius Funds had a
material advantage over its seller in knowledge about the state of settlement negotiations. This
inquiry would lead to very limited damages, if any. Regardless, the Equity Committee made no
showing on the issue, and the court made no finding on it.

40


75. Moreover, even if the estates could overcome all of these hurdles and recover
something on these putative claims, it is virtually impossible for any benefit from such recovery
to flow down to the parties on whose ultimate behalf the Equity Committee purports to labor.
Common stockholders are more than $7.6 billion out of the money. Even preferred stockholders
will be at least $165 million out of the money by February 2012, an extremely optimistic target
for the effective date of a new plan. Any delay thereafter pushes equity further out of the money
by $20 million per month or $42 million per month if the Bankruptcy Courts interest rate
ruling is reversed (an event that would itself add more than $810 million in postpetition interest
claims to be paid before equity holders can receive a recovery).
76. Against this remote and (at most) modest upside, the Debtors could reasonably
weigh the grave costs and harms that would flow from full litigation of the insider trading
charges. First, the attorneys fees of this enterprise alone are likely to exceed the ultimate
potential damages. The Debtors would be responsible at minimum for the fees and expenses of
the Equity Committee in prosecuting the action; their own fees in defending it (since the
Debtors own conduct is at issue and they will be liable to the Settlement Noteholders if it is
determined that the Debtors breached the Confidentiality Agreements); the fees of the Creditors
Committee, which participated in the settlement negotiations; and potentially the fees of other
parties receiving fee reimbursements that ultimately are required to participate in the litigation.
Moreover, the scope of the litigation in which all these parties would have to participate would
be massive. Many creditors other than the Settlement Noteholders (including, for example,
certain senior noteholders represented by White & Case LLP and holders of Trust Preferred
Securities, Litigation Tracking Warrants, and WMB bonds) participated in or have been made
privy to the existence and details of confidential negotiations of one type or another and then

41


resumed unrestricted trading in the Debtors securities conduct that may be relevant to many
issues touching on liability and damages. Under the Bankruptcy Courts Opinion, many of these
parties would be considered estate fiduciaries that should have restricted their trading. Any
differential treatment in the bankruptcy between such parties and the Settlement Noteholders
would obviously be hotly litigated. The aggregate cost to the estates to litigate all of these
intertwined matters to conclusion will be at least many tens of millions of dollars. Beyond that,
pendency of the litigation is likely to complicate efforts to confirm a reorganization plan in these
cases, imposing further cost and delay on the estates and their creditors.
77. In short, even if it were not so obvious that the Complaint fails to state a colorable
claim, the Debtors were entirely reasonable in refusing to pursue claims that could only mire the
estates in endless, pointless, fruitless litigation. Immediate, expedited appeal is necessary to
prevent these harms and burdens from being imposed on the estates and the parties.
B. Immediate Appeal of the Standing Order Would Materially Advance
the Termination of the Litigation and Conserve Resources
78. The final prong of the interlocutory appeal standard under 28 U.S.C. 1292 is
easily satisfied here. An immediate appeal of the Standing Order will lead to reversal and put an
end to this baseless, harassing litigation, freeing the Debtors to proceed expeditiously with
another revised plan of reorganization. See Stanziale v. Sun Natl Bank (In re Dwek), No. 09-
5046, 2010 U.S. Dist. LEXIS 3203, at *7 (D.N.J. Jan. 15, 2010) (granting leave to appeal ruling
on motion to dismiss where reversal would alleviate need to litigate certain claims). This would
avoid a waste of the limited resources of the parties, and more importantly, the judiciary. See

42


Broadstripe, 2009 U.S. Dist. LEXIS 25690, at *7 (granting leave to appeal interlocutory order to
avoid wasted trial time and litigation expense).
16

II.

LEAVE TO APPEAL THE CONFIRMATION ORDER SHOULD BE GRANTED, IF
NECESSARY, TO ENSURE THAT UNSECURED CREDITORS RECEIVE THEIR
CONTRACTUAL ENTITLEMENTS UNDER ANY PLAN OF REORGANIZATION
79. Aurelius asserts that the Confirmation Order is a final order appealable as of right
under the pragmatic and less technical approach to finality in bankruptcy cases. See
authorities cited above at 28-31. Indeed, in In re Armstrong World Indus., Inc., 432 F.3d 507
(3d Cir. 2005), the Third Circuit held that an order denying confirmation of a plan of
reorganization was final where (i) the distribution of assets between different creditor classes
was affected; (ii) no additional fact-finding was required; (iii) discrete questions of law were
presented and (iv) practical considerations of judicial economy were present. Id. at 511. So too
here. The Bankruptcy Courts denial of confirmation was premised on an erroneous legal
conclusion that a creditors entitlement to postpetition interest in a solvent estate is limited as a
matter of law to the federal judgment rate. See Opinion at 81.

16
In the event the Court determines that review on appeal is unavailable here, Aurelius respectfully requests in the
alternative that the Court exercise its power to treat this application as a petition for a writ of mandamus and issue a
writ reversing the Standing Order. See, e.g., First Fid. Bank, N.A. v. Hooker Invs., Inc. (In re Hooker Invs., Inc.),
937 F.2d 833, 837 (2d Cir. 1991) (Although we do not have jurisdiction over the Banks attempted appeal as a
matter of right from the non-final bar order, we may in appropriate circumstances treat an unsuccessful attempt to
appeal as a petition for a writ of mandamus.). Mandamus may be appropriate where (i) the petitioning party has no
other means to obtain relief, (ii) the lower court committed clear and indisputable error, and (iii) issuance of the writ
is appropriate in the circumstances. See Cheney v. United States Dist. Ct. for the Dist. of Columbia, 542 U.S. 367,
380-81 (2004); United States v. Brunson, 416 F. Appx 212, 221 (3d Cir. 2011) (unpublished).
Here, absent reversal of the Standing Order, Aurelius will have no other means to prevent the Equity Committees
wasteful and vexatious litigation campaign from inflicting upon Aurelius, the estates, and other parties the massive
costs and expenses of this litigation morass. The pendency of these accusations does not just exact a dollar cost
it leaves a cloud over Aurelius, its honorable and hard-working professionals, and the other Settlement Noteholders.
The toll of this reputational damage is likely to be significant even if, as is overwhelmingly likely, the claims are
eventually dismissed. As set forth in detail above, the Bankruptcy Courts Standing Order is based on multiple clear
errors of law, such that a writ of mandamus would be entirely appropriate in the circumstances of these cases.

43


80. That conclusion is in direct conflict with case law holding that the contract rate is
presumptively required. See, e.g., Official Comm. of Unsecured Creditors v. Dow Corning
Corp. (In re Dow Corning Corp.), 456 F.3d 668, 679 (6th Cir. 2006) (holding that absent
compelling equitable considerations, the bankruptcy courts role is to enforce contractual rights
of parties with respect to postpetition interest); Ruskin v. Griffiths, 269 F.2d 827, 832 (2d Cir.
1959) (awarding post-petition interest at contract rate and noting that where there is no showing
that the creditor entitled to the increased interest caused any unjust delay in the proceedings, it
seems to us the opposite of equity to allow the debtor to escape the expressly-bargained-for
result of its act); see also FSLIC v. Moneymaker (In re A&L Props.), 96 B.R. 287, 290 (C.D.
Cal. 1988) (awarding post-petition interest at contract rate); In re Smith, Case No. 03-10666,
2008 Bankr. LEXIS 7, at *2 (Bankr. W.D. Ky. Jan. 7, 2008) (same); In re Schoenberg, 156 B.R.
963, 972 (Bankr. W.D. Tex. 1993) (same); In re Beck, 128 B.R. 571, 573 (Bankr. E.D. Okla.
1991) (same).
81. Indeed, the Bankruptcy Court twice recognized that enforcement of bargained-for
contract rates was permissible under the Bankruptcy Code and appropriate if supported by the
equities in a particular case first in In re Coram Healthcare Corp., 315 B.R. 321, 346 (Bankr.
D. Del. 2004) (holding that contract rate may be payable depending on specific facts dictating
which rate is fair and equitable), and more recently in its January opinion in these cases, Wash.
Mut., 442 B.R. at 358-59. The Bankruptcy Court departed sharply from these prior holdings in
concluding now that the federal judgment rate is legally mandated. That conclusion could have a
significant impact on the distribution of estate assets as it results in the improper elimination of
more than $810 million of postpetition interest claims. Resolution of this discrete legal issue
requires no further fact-finding and will expedite resolution of these cases as it will obviate the

44


need for further appeals in connection with any alternative plan that does not respect creditors
contractual rights to postpetition interest.
82. In the event the Court concludes that the Confirmation Order is not final, the
Court should nevertheless grant leave to appeal as the appeal would undoubtedly involve a
controlling question of law for which there is a substantial ground for difference of opinion
namely, whether the Debtors creditors are entitled to postpetition interest at the applicable
contract rate. Resolution of this issue now will expedite the resolution of these cases by
correcting a legal error that will otherwise render any subsequently confirmed plan subject to
reversal on appeal.

45


WHEREFORE, Aurelius respectfully requests that the Court enter an Order
substantially in the form attached hereto as Exhibit K or in the alternative grant vacatur through
the issuance of a writ of mandamus; set an expedited schedule for the briefing of this appeal; and
grant such further and other relief as the Court deems appropriate.

Dated: Wilmington, Delaware
September 27, 2011

BLANK ROME LLP
/s/ Michael D. DeBaecke
Michael D. DeBaecke (No. 3186)
Victoria Guilfoyle (No. 5183)
1201 Market Street, Suite 800
Wilmington, Delaware 19801
Telephone: (302) 425-6400
Facsimile: (302) 425-6464
E-mail: Debaecke@BlankRome.com
Guilfoyle@BlankRome.com

-and-

Kenneth H. Eckstein
Alan R. Friedman
Jeffrey S. Trachtman
Daniel M. Eggermann
KRAMER LEVIN NAFTALIS & FRANKEL LLP
1177 Avenue of Americas
New York, New York 10036
Telephone: (212) 715-9100
Facsimile: (212) 715-8000
E-mail: keckstein@kramerlevin.com
afriedman@kramerlevin.com
jtrachtman@kramerlevin.com
deggermann@kramerlevin.com

Attorneys for Aurelius Capital Management, LP
and certain of its managed entities

EXHIBIT A
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
In re: Chapter 11
WASHINGTON MUTUAL, INC., et al., Case No. 08-12229 {MFW}
Debtors. Jo ly Administered
o R D E R
AND NOW this 13th day of SEPTEMBER, 2011, upon consideration
of the Modified Sixth Amended Joint Plan of Affil Debtors
Pursuant to Chapter 11 of the United States Bankruptcy Code,
filed on March 16, 2011, as modified on March 25, 2011 {the
"Modified Plan"}, for the reasons articulated in the accompanying
Opinion, it is hereby
ORDERED that confirmation of the Modified Plan is DENIED;
and it is further
ORDERED that the motion of the Equity Committee for standing
to prosecute claim for equitable disallowance is GRANTED but
STAYED PENDING MEDIATION; and it is further
..
ORDERED that a status hearing will be held on October 7,
2011, at 11:30 a.m. to consider the issues to be referred to a
mediator in this case.
BY THE COURT:
Mary F. Walrath
United States Bankruptcy Judge
cc: Mark D. Collins, Esquire
1
1 Counsel shall serve a copy of the Order and the
accompanying Opinion on all interested parties and file a
Certificate of Service with the Court.
SERVICE LIST
Mark D. Collins, Esquire
Chun I. Jang, Esquire
Lee E. Kaufman, Esquire
RICHARDS, LAYTON & FINGER, P.A.
920 North King Street
Wilmington, DE 19801
Counsel for the Debtors
Brian S. Rosen, Esquire
Marcia L. Goldstein, Esquire
Michael F. Walsh, Esquire
WElL GOTSHAL & MANGES, LLP
767 Fifth Avenue
New York, NY 10153
Counsel for the Debtors
Rafael X. Zahralddin-Aravena, Esquire
Neil R. Lapinski, Esquire
Shelley A. Kinsella, Esquire
ELLIOTT GREENLEAF
1105 North Market Street, Suite 1700
Wilmington, DE 19801
Special Litigation and Conflicts
Counsel for the Debtors
Peter E. Calamari, Esquire
Michael B. Carlinsky, Esquire
Susheel Kirpalani, Esquire
David Elsberg, Esquire
QUINN EMANUEL URQUHART &
SULLIVAN, LLP
51 Madison Avenue, 22nd Floor
New York, NY 10010
Special Litigation and Conflicts
Counsel for the Debtors
Robert S. Brady, ire
M. Blake Cleary, Esquire
Jaime N. Luton, Esquire
YOUNG CONAWAY STARGATT & TAYLOR, LLP
The Brandywine Building
1000 West Street, 17th Floor
Wilmington, DE 19801
Counsel for FDIC-Receiver
Thomas R. Califano, Esquire
John J. Clark, Jr., Esquire
DLA PIPER LLP
1251 Avenue of the Americas
New York, NY 10020
Counsel for FDIC-Receiver
Jeffrey M. Schlerf, Esquire
Eric M. Sutty, Esquire
FOX ROTHSCHILD LLP
919 North Market Street
Suite 1600
Wilmington, DE 19801
Counsel for Washington Mutual, Inc.
Noteholders' Group
David S. Rosner, Esquire
Adam L. Shiff, Esquire
Paul M. O'Connor, Esquire
Seth A. Moskowitz, Esqu
KASOWITZ, BENSON, TORRES & FRIEDMAN LLP
1633 Broadway
New York, NY 10019
Counsel for Washington Mutual, Inc.
Noteholders' Group
David B. Stratton, Esquire
Evelyn J. Meltzer, Esquire
PEPPER HAMILTON LLP
Hercules Plaza, Suite 5100
1313 Market Street
Wilmington, DE 19801
Coun for Official Committee of
Unsecured Creditors
Fred S. Hodara, Esquire
Robert A. Johnson, Esquire
AKIN GUMP STRAUSS HAUER & FELD LLP
One Bryant Park
New York, NY 10036
Counsel for Official Committee of
Unsecured Creditors
Jane M. Leamy, Esquire
OFFICE OF THE UNITED STATES TRUSTEE
J. Caleb Boggs Building
844 King Street, Suite 2207
Lockbox 35
Wilmington, DE 19801
Adam G. Landis, Esquire
Matthew B. McGuire, Esquire
LANDIS, RATH & COBB, LLP
919 North Market Street, Suite 1800
Wilmington, DE 19899
Counsel JP Morgan Chase Bank, N.A.
Robert A. Sacks, Esquire
Stacey R. Friedman, Esquire
Brian D. kstein, Esquire
SULLIVAN & CROMWELL LLP
125 Broad Street
New York, NY 10004
Counsel for JP Morgan Chase Bank, N.A.
Brent J. McIntosh, Esquire
SULLIVAN & CROMWELL LLP
1701 Pennsylvan Avenue, NW
Washington, DC 20006
Counsel JP Morgan Chase Bank, N.A.
Bernard G. Conoway, Esquire
Marla Rosoff Eskin, Esquire
Kathleen Campbell Davis, Esquire
CAMPBELL & LEVINE LLC
800 North King Street, Suite 300
Wilmington, DE 19809
Counsel for TPS Holders
Sigmund S. Wissner-Gross, Esquire
Robert J. , Esquire
Katherine S. Bromberg, Esquire
BROWN RUDNICK LLP
Seven Times Square
New York, NY 10036
Counsel TPS Holders
James W. Stoll, Esquire
Jeremy B. Coffey, Esquire
Jennifer M. Recht, Esquire
Ryan S. Moore, Esquire
Daniel J. Brown Esquire
BROWN RUDNICK LLP
One Financial Center
Boston, MA 02111
Counsel for TPS Holders
Mark E. Felger, Esquire
COZEN O'CONNOR
1201 N. Market Street, Suite 1400
Wilmington, DE 19801
Co-Counsel for Broadbill Investment Corp.
Paul N. Siverstein, Esquire
Jeremy B. Reckmeyer, Esquire
ANDREWS KURTH LLP
450 Lexington Avenue
New York, NY 10017
Coun for Broadbill Investment Corp.
Scott J. Leonhardt, Esquire
Frederick B. Rosner, Esquire
THE ROSNER LAW GROUP LLC
1000 N. West Street, Suite 1200
Wilmington, DE 19801
Counsel for Nantahala Capital
Partners LP and Blackwell Capital
Partners LLC
Arthur Steinberg, Esquire
KING & SPALDING
1185 Avenue of the Americas
New York, NY 10036
Counsel for Nantahala Capital
Partners LP and Blackwell Capital
Partners LLC
Jonathan Hochman, Esquire
SCHINDLER COHEN & HOCHMAN LLP
100 Wall Street
New York, NY 10005
Counsel for Nantahala Capital
Partners LP and Blackwell Capital
Partners LLC
David P. Primack, Esquire
DRINKER BIDDLE & REATH LLP
1100 N. Market Street, Suite 1000
Wilmington, DE 19801
Counsel for WMB Noteholders
Jeffrey M. Schwartz, Esquire
191 N. Wacker Drive, Suite 3700
Chicago, IL 60606
Counsel for WMB Noteholders
Jay W. Eisenhofer, Esquire
Geoffrey C. Jarvis, Esquire
Christ M. Mackintosh
GRANT & EISENHOFFER P.A.
1201 N. Market Street, Suite 2100
Wilmington, DE 19801
Counsel for WMB Noteholders
Michael P. Migliore, Esquire
SMITH, KATZENSTEIN & JENKINS LLP
800 Delaware Avenue
Suite 1000, P.O. Box 410
Wilmington, DE 19899
Counsel to North America National
Insurance Company, American National
Property and Casualty Company,
Farm Family Life Insurance Company,
Farm Family Casualty Insurance Company,
and, National Western Life Insurance
Company
Andrew J. Mytelka, Esquire
Frederick E. Black, Esquire
Tara B. Annweiler, Esquire
James M. Roquemore, Esquire
One Moody Plaza, 18th Floor
Galveston, Texas 77550
Counsel to North America National
Insurance Company, American National
Property and Casualty Company,
Farm Family fe Insurance Company,
Farm Family Casualty Insurance Company,
and, National Western fe Insurance
Company
Philip Schnabel (Pro se)
Steinstrasse 6
01454 Radeberg
Germany
Objector to Confirmation
Ronald S. Gellert, Esquire
Byra M. Keilson, Esquire
ECKERT SEAMANS CHERIN & MELLOTT, LLC
300 Delaware Avenue
Suite 1210
Wilmington, DE 19801
Counsel for Truck Insurance Company
and Fire Insurance Company
Matthew Feldman, Esquire
Robin Spigel, Esquire
WILLKIE FARR & GALLAGHER LLP
787 Seventh Avenue
New York, New York 10019-6099
Counsel for Truck Insurance Company
and Fire Insurance Company
Edward W. Ciolko, Esquire
Joshua C. Schumacher, Esquire
BARROWAY TOPAZ KESSLER MELTZER & CHECK, LLP
280 King of Prussia Road
Radnor, Pennsylvania 19087
Counsel for Objectors to Confirmation,
Robert Alexander & James Lee Reed
William P. Bowden, Esquire
Gregory A. Taylor, Esquire
Stacy L. Newman, Esquire
'ASHBY & GEDDES, P.A.
500 Delaware Avenue, 8th Floor
P.O. Box 1150
Wilmington, DE 19899
Counsel for the Official Committee
of Equity Security Holders of Washington
Mutual, Inc. et al.
Stephen D. Susman, Esquire
Seth D. Ard, Esquire
SUSMAN GODFREY, L.L.P.
654 Madison Avenue, 5th Floor
New York, NY 10065
Counsel for the Official Committee
of Equity Security Holders of Washington
Mutual, Inc. et al.
Parker C. Foise, Esquire
Edgar Sargent, Esquire
Justin A. Nelson, re
SUSMAN GODFREY, L.L.P .
1201 Third Avenue, Su 3800
Seattle, Washington 98101
Counsel for the Offic I Committee
of Equity Security Holders of Washington
Mutual, Inc. et al.
Jeffrey S. Schultz (Pro se)
Vice President/Trust Investment Officer
American National Bank
2732 Midwestern Parkway
Wichita Falls, TX 76308
Objector to Confirmation
Nate Thoma (Pro se)
105 South Jefferson Street
Wenonah, New Jersey 08090
Objector to Confirmation
Donna L. Harris, Esquire
PINCKNEY, HARRIS & WEIDINGER, LLC
1220 North Market Street, Suite 950
Wilmington, DE 19801
Counsel to Sonterra Capital Partners
and Sonterra Capital LLC
Robert T. Scott, Esquire
AXICON PARTNERS, LLC
1325 Avenue of the Americas, 27th Floor
New York, New York 10019
Counsel to Sonterra Capital Partners
and Sonterra Capital LLC
EXHIBITB
THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
In re: Chapter 11
WASHINGTON MUTUAL, INC., et al., Case No. 08-12229 (MFW)
Debtors. Jointly Administered
OPINION
1
Before the Court is the request of Washington Mutual, Inc.
("WMI") and WMI Investment Corp. (collectively the "Debtors") for
confirmation of the Modified Sixth Amended Joint Plan of
Affiliated Debtors (the "Modified Plan"). For the reasons stated
below, the Court will deny confirmation of the Modified Plan.
I . BACKGROUND
WMI is a bank holding company that formerly owned Washington
Mutual Bank ("WMB"). WMB was the nation's largest savings and
loan association, having over 2,200 branches and holding $188.3
billion in deposits. Beginning in 2007, revenues and earnings
decreased at WMB, causing WMI's asset portfolio to decline in
value. By September 2008, in the midst of a global credit
crisis, the ratings agencies had significantly downgraded WMI's
and WMB's credit ratings. A bank run ensued; over $16 billion in
This Opinion constitutes the findings of fact and
conclusions of law of the Court pursuant to Rule 7052 of the
Federal Rules of Bankruptcy Procedure, which is made applicable
to contested matters by Rule 9014 of the Federal Rules of
Bankruptcy Procedure.
deposits were withdrawn from WMB in a ten-day period beginning
September 15, 2008.
On September 25, 2008, WMB's primary regulator, the Office
of Thrift Supervision (the "OTSH) , seized WMB and appointed the
Federal Deposit Insurance Corporation (the "FDIC
H
) as receiver.
The FDIC's takeover of WMB marked the largest bank failure in the
nation's history. On the same day, the FDIC sold substantially
all of WMB's assets, including the stock of WMB's subsidiary, WMB
fsb, to JPMorgan Chase Bank, N.A. (\\JPMC
H
) through a Purchase &
Assumption Agreement (the "P&A Agreement"). Under the P&A
Agreement, JPMC obtained substantially all of the assets of WMB
for $1.88 billion plus the assumption of more than $145 billion
in deposit and other liabilities of WMB. The FDIC, as the
receiver of WMB, retained claims that WMB held against others.
On September 26, 2008, the Debtors filed petitions under
chapter 11 of the Bankruptcy Code. Early in the bankruptcy case
disputes arose among the Debtors, the FDIC, and JPMC regarding
ownership of certain assets and various claims that the parties
asserted against each other. Those disputes (and disputes
between the Debtors and other claimants) were the subject of
litigation in this Court,2 as well as in the United States
2 See, e.g., <Black Horse Capital LP, et al. v. JPMorcran
Chase Bank, N.A., Bankr. No. 08-12229, Adv. No. 10-51387 (Bankr.
D. Del. July 6, 2010) (the "TPS AdversaryH) i Broadbill Investment
Corp. v. Wash. Mut., Inc., Bankr. No. 08-12229, Adv. No. 10-50911
(Bankr. D. Del. Apr. 12, 2010) (the "LTW AdversaryH) i Wash. Mut.,
2
District Court for the District of Columbia (the "DC Court"),3
and in the Federal Court of Claims.4
On March 12, 2010, the parties announced that they had
reached a global settlement agreement (the "GSA"). The GSA
resolved issues among the Debtors, JPMC, the FDIC in its
corporate capacity and as receiver for WMB, certain large
creditors (the "Settlement Noteholders"),5 certain WMB Senior
Noteholders, and the Creditors' Committee. The GSA was
incorporated into the Sixth Amended Plan which was originally
filed on March 26, 2010, and modified on May 21 and October 6,
2010.
Hearings on confirmation of the Sixth Amended Plan, as well
as argument on summary judgment motions in the related LTW and
TPS Adversaries, were held on December 1-3 and 6-7, 2010. The
Inc. v. JPMorgan Chase Bank, N.A., Bankr. No. 08-12229, Adv. No.
09-50934 (Bankr. D. Del. Apr. 27, 2009); JPMorgan Chase Bank,
N.A. v. Wash. Mut., Inc., Bankr. No. 08-12229, Adv. No. 09-50551
(Bankr. D. Del. Mar. 24, 2009).
3 Am. Nat. Ins. Co. v. JPMoraan Chase & Co., 705 F. Supp.
2d 17,21 (D.D.C. 2010) (the "ANICO Litigation"); Wash. Mut.,
Inc. v. F.D.I.C., No. 1:09-cv-00533 (D.D.C. January 7, 2010).
4 Anchor Savings Bank FSB v. United States, No. 95-039C
(Fed. Cl. 1995) (hereinafter the "Anchor Litigation"); American
Savings Bank, F.A. v. United States, No. 92-872C (Fed. Cl. 1992)
(hereinafter the "American Savings Litigation").
5 The Settlement Noteholders are Appaloosa Management, L.P.
("Appaloosa"), Aurelius Capital Management LP ("Aurelius"),
Centerbridge Partners, LP ("Centerbridge"), and Owl Creek Asset
Management, L.P. ("Owl Creek"), and several of their respective
affiliates.
3
matter was taken under advisement. In an Opinion and Order dated
January 7, 2011, the Court concluded that the GSA was fair and
reasonable, but declined to confirm the Debtors' Sixth Amended
Plan because of certain deficiencies. In re Wash. Mut., Inc.,
442 B.R. 314, 344-45, 365 (Bankr. D. Del. 2011) (the "January 7
Opinion"). By separate Opinion and Order, the Court found that
certain purported holders of the Trust Preferred Securities (the
"TPS") no longer had any interest in the TPS because their
interests had been converted to interests in preferred stock of
WMI. In re Wash. Mut., Inc., 442 B.R. 297, 304 (Bankr. D. Del.
2011). In another Opinion and Order issued that day, the Court
held that it was unable to grant WMI's motion for summary
judgment in the LTW Adversary, because there are genuine issues
of material fact in dispute. In re Wash. Mut., Inc., 442 B.R.
308, 313-14 (Bankr. D. Del. 2011). Trial on the LTW Adversary
has been scheduled for September 12-14, 2011.
The Sixth Amended Plan and the GSA were modified on March 16
and 25, 2011, in an attempt to address the Court's concerns
expressed in the January 7 Opinion. (D 255i D 253.)6 The
Modified Plan is supported by the Debtors, JPMC, the FDIC, the
6 References to pleadings on the Docket at "D.l. ti" the
Transcripts of the hearings are "Tr. d a t e i ~ the Debtors' trial
exhibits are "D ti" the Debtors' demonstrative exhibits are "D
Demo ti" the Equity Committee's exhibits are "EC ti" Aurelius'
exhibits are "Au #i" the TPS Consortium's exhibits are "TPS #i"
the Appaloosa/Owl Creek exhibits are "AOC ti" and the WMl Senior
Noteholders' Group exhibits are "WMI NG #."
4
Creditors' Committee, the WMI Senior Noteholders' Group, the
Plaintiffs in the ANICO Litigation, and the Indenture Trustees of
the Senior, the Senior Subordinated, and the PIERS?
(collectively, the "Plan Supporters").8 The Modified Plan is
still opposed by the Equity Committee, the putative holders of
the TPS,9 holders of Litigation Tracking Warrants (the "LTW
Holders"), certain WMB Noteholders, Normandy Hill Capital L.P.,
and several individual shareholders and creditors
10
(collectively, the "Plan Objectors"). Hearings were held on July
13-15 and 18-21, 2011, to consider confirmation of the Modified
Plan. Post-hearing briefs were filed by interested parties on
August 10, 2011, and oral argument was heard on August 24, 2011.
The matter is now ripe for decision.
7 The PIERS are Preferred Income Equity Redeemable
Securities issued by the Washington Mutual Capital Trust 2001
("WMCT 2001"). The proceeds received by WMCT 2001 were used to
purchase junior subordinated deferrable interest debentures
issued by WMI. (See WMI NG 7.)
g Many of the Plan Supporters do, however, request certain
changes to the Modified Plan, some of which conflict with other
requested changes.
9 The TPS holders have now divided into two groups, with
separate counsel, making separate arguments. They are referred
to herein as the TPS Group and the TPS Consortium.
W The individual Plan Objectors include Philipp Schnabel,
William Duke, James Berg, Kermit Kubitz, Charles McCurry, and
Bettina M. Haper.
5
II. JURISDICTION
Congress has legislated that the Bankruptcy Court has core
subject matter jurisdiction over approval of settlements of
claims and counterclaims and confirmation of plans of
reorganization. 28 U.S.C. 1334 & 157 (b) (2) (A), (B), (C), (K),
(L), (M), (N), & (0).
The TPS Consortium contends, however, that the Court cannot
enter a final order on confirmation for two reasons. rst, the
TPS Consortium argues that the Bankruptcy Court lacks
jurisdiction to confirm the Modified Plan because to do so the
Court must decide the estate's claims against JPMC and the FDIC,
over which only an Article III court has jurisdiction. Stern v.
Marshall, 131 S. Ct. 2594, 2609 (2011). At the commencement of
the confirmation hearings, the TPS holders acknowledged that the
Bankruptcy Court had authority to conduct the confirmation
hearing but asserted that the Court could not enter a final
order. Instead, the TPS Consortium contended that the Bankruptcy
Court must present proposed findings of fact and conclusions of
law to the District Court, for consideration de novo. 28 U.S.C.
157 (c) (1).
Second, the TPS Consortium argues that the Bankruptcy Court
has been divested of jurisdiction over the disputed TPS because
the TPS Consortium has appealed the Court's ruling in the TPS
Adversary that they no longer have any interest in the TPS but
6
only have an interest in WMI preferred stock. Wash. Mut., 442
B.R. at 304. It contends that, as a result, the Court must order
that the TPS be escrowed (and not transferred to JPMC pursuant to
the GSA and the Modified Plan) until the District Court rules on
the pending appeal.
A. Effect of Stern v. Marshall
The TPS Consortium argues that under the Supreme Court's
recent decision in Stern v. Marshall, the Bankruptcy Court does
not have jurisdiction over the claims the estate has against JPMC
or the FDIC (and does not have jurisdiction to approve any
settlement of those claims) because the underlying claims are
stuff of the traditional actions at common law tried by the
courts at Westminster" and must be decided by an Article III
court. 131 S. Ct. at 2609 (quoting N. Pipeline Constr. Co. v.
Marathon Pipe Line Co., 458 U.S. 50, 90 (1982)). The TPS
Consortium argues that Stern v. Marshall is directly applicable
in this case because the underlying disputes with JPMC and the
FDIC are typical of causes of action which only Article III
courts can adjudicate, involving state corporate law, tort law,
fraudulent conveyance law, as well as federal intellectual
property and tort claims. The TPS Consortium argues that this is
not a matter within the area of law" with which
bankruptcy courts typically deal and are considered experts at
resolving. Id. at 2615. It contends that this is so even though
7
Congress has expressly granted core jurisdiction to this Court
pursuant to section 157 (b) (2). Id. at 2608 (holding that
bankruptcy court did not have jurisdiction over state law
counterclaim to a filed proof of claim despite core jurisdiction
designation in 28 U.S.C. 157 (b) (2) (C)).
The Plan Supporters disagree with the TPS Consortium's
reading of the Stern v. Marshall decision. They note that the
Supreme Court itself recognized the narrowness of its ruling.
131 S. Ct. at 2620 (finding that Congress had exceeded Article
Ill's limitation "in one isolated respect" and finding only that
the bankruptcy court lacked authority to enter a final judgment
on a counterclaim arising under state law which did not need to
be resolved in order to rule on the proof of claim). See also
Salander O'Reilly Galleries, No. 07-30005, 2011 WL 2837494, at *6
(Bankr. S.D.N.Y. July 18, 2011) (concluding that the Supreme
Court's opinion in Stern v. Marshall emphasizes that it is
limited to the particular circumstances surrounding the estate's
counterclaim in that case).
In Stern v. Marshall, the Supreme Court held that to find
bankruptcy court jurisdiction the court must consider "whether
the action at issue stems from the bankruptcy itself or would
necessarily be resolved in the claims allowance process." 131 S.
Ct. at 2618. The concurring opinion also suggested that in
instances where there is "a firmly established historical
8
practice" allowing non-Article III judges to make a
determination, they should be permitted to continue doing so.
Id. at 2621 (concurring opinion) .
The Court concludes that the Stern v. Marshall decision does
not support the TPS Consortium's contention that the Court lacks
jurisdiction over the GSA or confirmation of the Modified Plan
for several reasons.
1. Historical context
Approval of settlements by bankruptcy courts is "a firmly
established historical practice" that stretches back before the
enactment of the Bankruptcy Code to the Bankruptcy Act and,
therefore, the bankruptcy court may continue to exercise that
jurisdiction. Id.
Currently, Rule 9019 provides the court with the authority
to "approve a compromise or settlement." Fed. R. Bankr. P.
9019(a). Bankruptcy Rule 9019 is the successor to Bankruptcy
Rule 919, which provided "on application by the trustee or
receiver and after hearing on notice to the creditors . the
court may approve a compromise or settlement." Fed. R. Bankr. P.
919 (a) (1982) (repealed). See Magill v. Springfield Marine Bank
(In re Heissinger Res. Ltd.), 67 B.R. 378, 382 (C.D. Ill. 1986)
(noting that Bankruptcy Rule 9019 is similar to Rule 919, "which
had been interpreted to give the bankruptcy court broad authority
to approve compromises"). Rule 919 was based on section 27 of
9
the Bankruptcy Act which stated that receiver or trustee
may, with approval of the court, compromise any controversy
arising in the administration of the estate upon such terms as he
may deem for the best interest of the estate." 11 U.S.C. 50
(1976) (repealed 1978) .
Compromises were routinely approved under the Bankruptcy Act
and continue to be approved by bankruptcy courts in the context
of almost every bankruptcy case. See, e.g., Protective Comm. for
Indep. Stockholders of TMT Trailer Ferry, Inc. v. Anderson, 390
U.S. 414, 424 (1968) (holding that are 'a normal
part of the process of reorganization.' ") (quoting Case v. L.A.
Lumber Prods. Co., 308 U.S. 106, 130 (1939)); Myers v. Martin (In
re Martin), 91 F. 3d 389, 393 (3d Cir. 1996) minimize
litigation and expedite the administration of a bankruptcy
estate, '[c]ompromises are favored in bankruptcy.' ... Indeed,
it is an unusual case in which there is not some litigation that
is settled between the representative of the estate and an
adverse party.") (quoting 9 Collier on Bankruptcy 9019.03[1]
(15th ed. 1993)); In re Okwonna-Felix, No. 10-31443-H4-13, 2011
WL 3421561, at *4 (Bankr. S.D. Tex. Aug. 3, 2011) (holding that
Stern v. Marshall does not preclude a bankruptcy court from
exercising jurisdiction to consider a settlement which is based
on federal bankruptcy law (both [Rule 9019] and the
case law instructing how to apply the Rule)"); In re Drexel
10
Burnham Lambert Grp., Inc., 138 B.R. 723, 758 (Bankr. S.D.N.Y.
1992) ("Compromises are favored by the Courts because they allow
the estate to avoid the expenses and burdens associated with
litigating contested claims.") (citations omitted). See
generally Reynaldo Anaya Valencia, The Sanctity of Settlements
and the Significance of Court Approval: Discerning Clarity from
Bankruptcy Rule 9019, 78 Or. L. Rev. 425, 431-32 (1999) ("The
glue that often holds the bankruptcy process together is the
ability of paities to resolve disputes by settlement instead of
litigation. If bankruptcy judges had to try a much larger
percentage of matters than they currently do, the system would
surely bog down. Thus, the sanctity of settlements can hardly be
overemphasized.") (footnotes omitted).
Settlements are often included in a plan of reorganization.
Valencia, The Sanctity of Settlements, 78 Or. L. Rev. at 447.
Indeed, section 1123(b) (3) (A) of the Bankruptcy Code expressly
states that "a plan may provide for the settlement or
adjustment of any claim or interest belonging to the debtor or to
the estate." 11 U.S.C. 1123(b) (3) (A). Confirmation of a plan
of reorganization is within the bankruptcy court's core
jurisdiction. 28 U. S. C. 157 (b) (2) (L). See also In re AOV
Indus., Inc., 792 F.2d 1140, 1145-46 (D.C. Cir. 1986) ("The
approval of a disclosure statement and the confirmation of a
reorganization plan are clearly proceedings at the core of
11
bankruptcy law. . . . Accordingly, we find that the bankruptcy
court had jurisdiction to approve [them] .ff).
2. Nature of settlement approval
Second, there is a fundamental difference between approval
of a settlement of claims (which the Court is being asked to do
here) and a ruling on the merits of the claims. See, e.g.,
Matsushita Elec. Indus. Co., Ltd. v. Epstein, 516 U.S. 367, 382
(1996) (holding that a Delaware Chancery Court judgment settling
shareholders' state and federal claims was entitled to preclusive
effective because U[w]hile it is true that the state court
assessed the general worth of the federal claims in determining
the fairness of the settlement, such assessment does not amount
to a judgment on the merits of the claims.").
As an initial matter, a court does not have to have
jurisdiction over the underlying claims in order to approve a
compromise of them. See, e.g., Matsushita Elec., 516 U.S. at 381
(holding that U[w]hile 27 prohibits state courts from
adjudicating claims arising under the Exchange Act, it does not
prohibit state courts from approving the release of Exchange Act
claims in the settlement of suits over which they have properly
exercised jurisdiction, i.e., suits arising under state law or
under federal law for which there is concurrent jurisdiction.");
Grimes v. Vitalink Commc'ns Corp., 17 F.3d 1553, 1563 (3d Cir.
1994) (stating that "[w]hile this rule of law may seem anomalous
12
at first glance, it is widely recognized that courts without
jurisdiction to hear certain claims have the power to release
those claims as part of a judgment" approving a settlement
including "federal courts entering judgments that release state
claims that they would not have jurisdictional competency to
entertain in the first instance" because "[t]his rule of law
serves the important policy interest of judicial economy by
permitting parties to enter into comprehensive settlements")
(citations omitted). Cf. Musich v. Graham (In re Graham), Adv.
No. 11-01073, 2011 WL 2694146, at *3 n.27 (Bankr. D. Colo. July
11, 2011) (analyzing Stern v. Marshall decision and concluding
that bankruptcy court had statutory and constitutional
jurisdiction to determine dischargeability of a criminal/tort
claim over which it did not have jurisdiction) .
The standards which a court must apply in considering a
settlement establish that the court is not rendering a final
decision on the merits of the underlying claims being
compromised. See, e.g., TMT Trailer Ferry, 390 U.S. at 424
(finding that a bankruptcy judge should form "an educated
estimate of the complexity, expense, and likely duration of such
litigation, the possible difficulties of collecting on any
judgment which might be obtained, and all other factors relevant
to a full and fair assessment of the wisdom of the proposed
compromise.") (emphasis added); In re W.T. Grant Co., 699 F.2d
13
599, 608 (7th Cir. 1989) (in approving a settlement, the
responsibility of the bankruptcy court "is not to decide the
numerous questions of law and fact raised . . . but rather to
canvass the issues and see whether the settlement 'fall[s] below
the lowest point in the range of reasonableness.'H) (citations
omitted); In re Martin, 212 B.R. 316, 319 (B.A.P. 8th Cir. 1997)
(stating that "it is not necessary for a bankruptcy court to
conclusively determine claims subject to a compromise, nor must
the court have all of the information necessary to resolve the
factual dispute, for by so doing, there would be no need of
settlement. H) .
The "lowest point in the range of reasonableness" is far
from the standard required for an Article III court to enter a
final determination on the merits of the claims. The Court's
conclusion in the January 7 Opinion was not a decision on the
merits of the underlying claims but merely a determination that
the settlement of those claims by the Debtors on the terms of the
GSA was reasonable. Wash. Mut., 442 B.R. at 345.
3. Nature of claims compromised
Third, the approval of the GSA in this case is particularly
within the core jurisdiction of the Bankruptcy Court because it
deals with a determination of what is property of the estate.
See 11 U.S.C. 541(a) (stating that "[t]he commencement of a
case under ... this title creates an estate [which] is
14
comprised of all the following property, wherever located and by
whomever held . . . [including] all legal or equitable interests
of the debtor in property.").
In this case, the claims which are resolved by the GSA
largely relate to who owned specific property: the bank deposits
in the name of WMI at WMB and WMB, fsb; the tax refunds due for
the consolidated tax group which included WMI and WMBi the TPSi
intellectual property'; employee related assets (including pension
plans and insurance policies)i the goodwill litigation that was
the subject of the Litigation Tracking Warrants (the "LTWs"); and
various other miscellaneous assets. Wash. Mut., 442 B.R. at 330
44.
It is without ques on that bankruptcy courts have exclusive
jurisdiction over property of the estate. See 28 U.S.C.
1334(e) (stating that the court in which a case under title 11 is
commenced or is pending "shall have exclusive jurisdiction - (1)
of all the property, wherever located, of the debtor as of the
commencement of such case, and of property of the estate"). See
also, Cent. Va. Cmty. ColI. v. Katz, 546 U.S. 356, 363-64 (2006)
(stating that "[c]ritical features of every bankruptcy proceeding
are the exercise of exclusive jurisdiction over all of the
debtor's property ....").
That jurisdiction includes jurisdiction to decide whether
disputed property is, in fact, property of the estate. See,
15
Salander O'Reilly Galleries, 2011 WL 2837494, at *12-13
(concluding that the bankruptcy court had core jurisdiction to
decide priority of estate's and creditor's asserted interests in
a piece of art and denying request for arbitration of issue);
Mata v. Eclipse Aerospace, Inc. (In re AE Liguidation, Inc.), 435
B.R. 894, 904-05 (Bankr. D. Del. 2010) (holding that the
bankruptcy court had exclusive jurisdiction to determine whether
or not disputed aircraft was property of the estate at the time
of its sale); Williams v. McGreevey (In re Touch Am. Holdings,
Inc.), 401 B.R. 107, 117 (Bankr. D. Del. 2009) (stating
approvingly that courts have concluded that matters
requiring a declaration of whether certain property comes within
the definition of 'property of the estate' as set forth in
Bankruptcy Code 541 are core proceedings.").
For all the above reasons, the Court concludes that it has
jurisdiction to decide confirmation of the Modified Plan which
incorporates the GSA resolving the disputed claims to putative
property of the Debtors' estate.
B. Effect of Appeal of TPS Ruling
The TPS Consortium argues further that the Court is
precluded from confirming the Modified Plan by the Divestiture
Rule which provides that an appeal divests the lower court of any
further jurisdiction over the subject of the appeal. See, e.g.,
Griggs v. Provident Consumer Disc. Co., 459 U.S. 56, 58 (1982)
16
("The filing of a notice of appeal is an event of jurisdictional
significance - it confers jurisdiction on the court of appeals
and divests the district court of its control over those aspects
of the case involved in the appeal.
H
); Venen v. Sweet, 758 F.2d
117, 120-21 (3d Cir. 1985) ('''Divest' means what it says - the
power to act, in all but a limited number of circumstances, has
been taken away and placed elsewhere.
H
); Bialac v. Harsh Inv.
Corp. (In re Bialac), 694 F.2d 625, 627 (9th Cir. 1982) ("Even
though a bankruptcy court has wide latitude to reconsider and
vacate its own prior decisions, not even a bankruptcy court may
vacate or modify an order while on appeal.
H
); In re Whispering
Pines Estates, 369 B.R. 752, 757 (B.A.P. 1st Cir. 2007) ("It is
well established that the filing of a notice of appeal is an
event of jurisdictional significance in which a lower court loses
jurisdiction over the subject matter involved in the appeal. The
purpose of the general rule is to avoid the confusion of placing
the same matter before two courts at the same. time and preserve
the integrity of the appeal process.
H
) (citations omitted); In re
DeMarco, 258 B.R. 30, 32 (Bankr. M.D. Fla. 2000) ("The parties
appear to agree that the Court does not have jurisdiction to
consider matters which would interfere with the appeal and the
jurisdiction of the appellate court, but that the Court does have
jurisdiction over, and should proceed with, other aspects of the
case.
H
); In re Strawberry Square Assocs., 152 B.R. 699, 701
17
(Bankr. E. D. N. Y. 1993) (noting that "the bankruptcy court [may
not] exercise jurisdiction over those issues which, although not
themselves on appeal, nevertheless so impact those on appeal as
to effectively circumvent the appeal process.").
The TPS Consortium specifically objects to the provisions
of the Modified Plan that authorize the transfer of the TPS from
the Debtors to JPMC
ll
because ownership of the TPS is the subject
of the appeal. The TPS Consortium argues that the Modified Plan
must recognize the limits of this Court's ability to deal with
the TPS by providing that the TPS will be held in escrow until
the appeal is resolved.
The Plan Supporters disagree with theTPS Consortium's
articulation of the Divestiture Rule as applied in bankruptcy
cases. They note that in the bankruptcy context the appeal of
one ruling does not mean that the entire bankruptcy case is
stayed. The Bankruptcy Rules make this clear by providing that
during an appeal, "the bankruptcy judge may suspend or order the
continuation of other proceedings in the case under the Code or
make any other appropriate order during the pendency of an appeal
11 Specifically, the TPS Consortium argues that the Modified
Plan provides that the TPS will be transferred pursuant to
section 363 to JPMC, which will be a good faith purchaser and
entitled to the protections of section 363(m). (D 255 at
2.1 (c) (i) & 38.1 (a) (10) .) The Modified Plan also provides that
the Debtors, JPMC, and the FDIC will be released from any claims
related to the TPS which are held by any third party claiming
through the Debtors. (Id. at 2.I(c), 23.2, 43.2, 43.6, 43.7,
43.9 & 43.12; D 255H at 2.3, 3.2.)
18
on such terms as will protect the rights of all parties in
interest." Fed. R. Bankr. P. 8005. See also In re Haael, 184
B.R. 793, 798-99 (B.A.P. 9th Cir. 1995) (holding that Rule 8005
"does not provide that the bankruptcy court must stay all
proceedings" but that it has discretion to stay any proceedings) .
The Plan Supporters argue that contrary to the suggestion of
the TPS Consortium, absent a stay pending appeal,12 the lower
court may take all actions necessary to implement or enforce the
order from which an appeal has been taken. See, e.g., Hope v.
Gen. Fin. Corp. of Ga. (In re Kahihikolo), 807 F.2d 1540, 1542-43
(11th Cir. 1987) (dismissing appeal as moot because, absent stay
pending appeal, the secured lender was free to treat order
granting relief from stay as final and sell the collateral); In
re VII Holdings Co., 362 B.R. 663, 666 n.3 (Bankr. D. Del. 2007)
(holding that "absent a stay pending appeal, [the lower court]
may retain jurisdiction 'to decide issues and proceedings
different from and collateral to those involved in the appeal
.. [and] may also 'enforce the order or judgment appealed.'")
12 The Plan Supporters argue that the logical extension of
the TPS Consortium's argument would effectively be to eliminate
the need to ask for (or to comply with the requirements of) a
stay pending appeal. They contend that to get a stay pending
appeal of the order entered in the TPS Adversary, the TPS
Consortium would have to post a supersedeas bond. Fed. R. Bankr.
P. 7062. 10 Collier on Bankruptcy ~ 8005.03 (2011) {"the
procedure mandates that an appellant desiring the stay of a
(judgment] determining an interest in property should present to
the bankruptcy court a supersedeas bond in an amount adequate to
protect the appellee").
19
(citations omitted); In re Bd. of Dir. of Hopewell Int'l Ins.
Ltd., 258 B.R. 580, 583 (Bankr. S.D.N.Y. 2001) (holding that "a
bankruptcy court retains jurisdiction, while an appeal is pending
and in the absence of a stay, to enforce the [appealed] order or
judgment") .
The Court agrees with the Plan Supporters. The TPS
Consortium's argument that the Divestiture Rule provides that an
appeal divests the bankruptcy court of all jurisdiction over the
matter is too broad. As explained by the Court in Whispering
Pines:
As courts have noted, however, a bankruptcy case
typically raises a myriad of issues, many totally
unrelated and unconnected with the issues involved in
any given appeal. The application of a broad rule that
a bankruptcy court may not consider any request filed
while an appeal is pending has the potential to
severely hamper a bankruptcy court's ability to
administer its cases in a timely manner.
369 B.R. at 758.
The correct statement of the Divestiture Rule is that so
long as the lower court is not altering the appealed order, the
lower court retains jurisdiction to enforce it. See, e.g., In re
Dadashti, No. CC-07-1311, 2008 WL 8444787, at *6 (B.A.P. 9th Cir.
Feb. 12, 2008) (stating that "when there is no stay pending
appeal, the bankruptcy court retains jurisdiction to enforce an
order that is on appeal, on condition that in doing so, the
bankruptcy court does not significantly alter or expand upon the
terms of that order.H); Hagel, 184 B.R. at 798 ("courts have
20
recognized a distinction between acts undertaken to enforce the
judgment which are permissible, and acts which expand upon or
alter it, which are prohibited.").
The cases on which the TPS Consortium relies do not change
this general rule and are easily distinguishable.
13
In
Whispering Pines, for example, the lower court modified the order
that was on appeal (confirmation of the lender's plan that gave
the trustee time to sell the property before the lender could
foreclose on it) by granting the lender immediate relief from the
stay to foreclose. 369 B.R. at 759. In Bialac, the bankruptcy
court enjoined the secured lender from foreclosing while the
order granting the lender relief from the stay to foreclose was
on appeal. 694 F.2d at 627. In both instances, the bankruptcy
court was not merely enforcing the appealed order but was
13 Most of the cases cited by the TPS Consortium merely
stand for the proposition that approval of a settlement is a
final order for purposes of appeal or has res judicata effect.
See, e.g., United States v. Kellogg (In re West Tex. Mktg.
Corp.), 12 F.3d 497, 501 (5th Cir. 1994) (concluding that while
bankruptcy court approval of settlement was not a final order
because no separate order was entered on the docket other than a
dismissal of the adversary, the ruling was entitled to res
judicata effect); SEC v. Drexel Burnham Lambert Grp., Inc. (In re
Drexel Burnham Lambert Grp., Inc.), 960 F.2d 285, 289 (2d Cir.
1992) (finding that order approving settlement agreement, which
was contingent on later confirmation of a plan, was final for
purposes of appeal); In re Beaulac, 294 B.R. 815, 818 (B.A.P. 1st
Cir. 2003) (considering order approving settlement as final for
purposes of appeal).
21
modifying it.14 In DeMarco, the bankruptcy court acknowledged
that it should consider confirmation of the debtor's chapter 13
plan if it did not interfere with the appeal but declined to do
so because it found that confirmation might render the appeal
moot. 258 B.R. at 36.
Unlike the Court in DeMarco, the Court declines to exercise
its discretion under Rule 8005 not to consider the Modified Plan
simply because it might render moot the TPS Consortium's appeal
of the decision in the TPS Adversary. The TPS Consortium could
have avoided this by seeking a stay pending appeal. To do as the
TPS Consortium requests would preclude the Court from dealing
with confirmation of any plan of reorganization that implicates
the TPS and possibly stall these bankruptcy cases indefinitely.
Further, in considering confirmation of the Modified Plan,
the Court is not being asked to modify the order that is on
appeal (which held that the Debtors own the TPS). Wash. Mut.,
442 B.R. at 305-06. Rather, the Court is being asked to enforce
its order by approving the Modified Plan that provides for the
transfer or sale of the TPS by the Debtors to JPMC as part of the
GSA. Therefore, the Court concludes that it has jurisdiction to
14 The other cases cited by the TPS Consortium are also
inapplicable. See, e.g., Grigas, 459 U.S. at 61 (holding that
notice of appeal filed while motion to alter judgment was pending
was a nullity); Venen, 758 F.2d at 120, 123 (holding that trial
court did not have jurisdiction to grant motion for
reconsideration and vacate order that was on appeal) .
22
consider confirmation of the Modified Plan, including the
transfer of the TPS, notwithstanding the pendency of an appeal
from its prior order determining that the Debtors own them. See,
~ , Kahihikolo, 807 F.2d at 1542-43; VII Holdings, 362 B.R. at
666 n.3; Bd. of Dir. of Hopewell Int'l, 258 B.R. at 583.
III. DISCUSSION
A. Modifications Made per January 7 Opinion
The Plan Supporters assert that the Debtors have made
corrections to the Modified Plan to fix all of,the deficiencies
identified by the Court in its January 7 Opinion. Specifically,
they contend that (1) the release, injunction, and exculpation
provisions of the Modified Plan now are limited to releases by
the Debtors, (2) the release and exculpation language and parties
have been changed to reflect only those the Court felt were
entitled to be released or exculpated, and (3) the activities
related to the LTWs have been excluded from the exculpation
provision. Compare Wash. Mut., 442 B.R. at 348-56 with D 255 at
28.15, 43.5, 43.7, 43.8, 43.9, 43.12.
The Modified Plan also contains provisions for Court
approval of fees to be paid by the Debtors. Compare 442 B.R. at
365 with D 255 at 3.2, 32.12 & 43.18. The LTW Holders
complain, however, that the fees of some of the parties (notably
the WMB Noteholders and the Liquidating Trustee) are being paid
23
without Court approval. (D 255 at 21.1, 28.11.) The Court
agrees that Court approval of those fees is also required. 11
U.S.C. 1129(a} (4).
In addition, the Modified Plan provides that late-filed
claims will be paid before post-petition interest is paid on
unsecured claims. Compare 442 B.R. at 357 with D 255 at 16.2 &
Ex. G. In the Modified Plan, the Debtors also revised the
definition of unsecured claims and provided that if the LTW
Holders are determined to hold allowed unsecured claims that are
not subordinated under section 510, then they will be treated in
Class 12. Compare 442 B.R. at 357 with D 255 at 1.209 & 25.1.
The Debtors also solicited stock elections from the LTW Holders
and other disputed claims, so that those creditors would have the
same rights as others in the event their claims are allowed.
Compare 442 B.R. at 362 with D.I. 7081.
The Debtors did not, however, include in the Modified Plan
that smaller PIERS holders would have the same right to
participate in the rights offering as the larger PIERS holders.
442 B.R. at 360-61. Instead the rights offering was eliminated.
The Debtors explained that this was done because to expand the
rights offering to include all PIERS would have resulted in the
Reorganized Debtor being a public company, requiring the Debtors
to update their filings with the SEC at the cost of millions.
24
(See Tr. 2/18/2011 at 80-81.}ls
Finally, the Modified Plan provides that the Equity
Committee will have a representative on the Liquidating Trust
board and that there will be a mechanism for removal of the
Liquidating Trustee. Compare 442 B.R. at 364-65 with 0 255 at
8.2 & 35.2. However, the Modified Plan provides only for removal
of the Liquidating Trustee for fraud, misconduct, or breach of
fiduciary duty. (0 255 at 8.2.) The Court believes that the
Liquidating Trustee must be removable at the discretion of a
majority of the Trust Advisory Board. In addition, the
composition of the Trust Advisory Board must reflect the
constituents who hold Liquidating Trust Interests. When
creditors are paid in full, their Liquidating Trust Interests
will be canceled and preferred shareholders will be issued
Liquidating Trust Interests. (Tr. 7/13/2011 at 98; 0 255 at
6.3, 7.3, 16.3, 18.3, 19.3, 20.3, 22.1, 22.2, 23.1 & 24.1.)
Consequently, the Trust must provide that when creditors lost
their Liquidating Trust Interests, the creditors' representatives
on the Board will be replaced by representatives selected by
equity.
IS It appears, nonetheless, that because stock is being
issued to creditors under the Modified Plan, the Reorganized
Debtor may be a public company. The Debtors have now changed
their position and contend that they will not be required to
update their filings with the SEC. See infra Part F.
25
B. Reasonableness of the GSA
In the January 7 Opinion, the Court concluded that the GSA
was reasonable. 442 B.R. at 345. After reviewing all of the
claims being resolved in the GSA, the Court was not convinced
that the Debtors had a probability of achieving a significantly
better result if they were to continue to litigate than they will
receive under the GSA considering the claims separately or
holistically. Id. at 344. The Court further concluded that it
is not possible to say that any judgment against JPMC or the FDIC
would not face difficulty in collection, especially if it is in
the billions of dollars as the Plan Objectors contend. Id. In
particular, the Court found that the significant counterclaims
raised by JPMC and the FDIC against the Debtors (in excess of $54
billion) added to the difficulties of collecting from them. Id.
The Court also concluded that the complexity of the various
litigation and its interrelatedness, favored a settlement. Id.
at 345.
The Plan Supporters contend that the January 7 Opinion is
the law of the case and may not be altered in the absence of an
intervening change in the law or new evidence. See, e.g., Hayman
Cash Register Co. v. Sarokin, 669 F.2d 162, 169 (3d Cir. 1982);
In re Ameriserve Food Distrib.( Inc., 315 B.R. 24, 36 (Bankr. D.
Del. 2004). They contend that no new evidence or intervening
change in the law has been presented which merits reconsidering
26
the Court's conclusion that the GSA is reasonable.
The TPS Consortium disagrees. It contends that the Court's
January 7 Opinion was not a final order on this issue because the
Court denied confirmation rather than granting it. See, e.g.,
Gander Mountain Co. v. Cabela's, Inc., 540 F.3d 827, 830 (8th
Cir. 2008) (holding that ~ [ a ] district court's comments during
oral argument do not constitute a final order subject to the law
of-the-case doctrine"); Cable v. Millennium Digital Media Sys.,
L.L.C. (In re Broadstripe, L.L.C.), 435 B.R. 245, 256 (Bankr. D.
Del. 2010) (holding that ruling by state court on motion to
expedite proceeding was not law of the case on the merits of the
claim) .
The Court finds the TPS Consortium's cases distinguishable
and agrees with the Plan Supporters that its ruling on the
reasonableness of the GSA rendered as part of the January 7
Opinion is law of the case because decided a disputed issue.
Cf. Drexel Burnham, 960 F.2d at 289 (finding that order approving
settlement agreement, which was contingent on later confirmation
of a plan, was final for purposes of appeal). The Equity
Committee agreed that the January 7 Opinion's ruling on
reasonableness of the GSA would not be retried. (Tr. 1/20/11 at
51-52.) The Equity Committee does argue, however, that
intervening events have occurred which require reconsideration of
this Court's decision that the GSA is reasonable.
27
1. Business tort claims
On February 16, 2009, certain holders of WMI common stock
and debt securities issued by WMI and WMB
16
filed the ANICO
Litigation against JPMC in state court in Galveston County,
Texas, alleging misconduct by JPMC in connection with the seizure
of WMB and the P&A Agreement. (0.1. 6083 at ~ 23.) On March 25,
2009, the ANICO Litigation was removed and transferred to the DC
Court on motion of JPMC and the FDIC Receiver as intervening
defendant. (Id. at ~ 24.) On April 13, 2010, the DC Court
dismissed the ANICO Litigation finding that under the Financial
Institutions Reform Recovery and Enforcement Act of 1989
("FIRREA"), the receivership was the exclusive claims process for
claims relating to the sale of WMB. Am. Nat. Ins. Co. v.
JPMorgan Chase & Co., 705 F. SUppa 2d 17, 21 (D.D.C. 2010).
That order was recently reversed on June 24, 2011, by the
Court of Appeals for the D.C. Circuit. Am. Nat'l Ins. Co. v.
FDIC, 642 F.3d 1137, 1142 (D.C. Cir. 2011) (holding that because
the "suit is against a third-party bank for its own wrongdoing,
not against the depository institution for which the FDIC is
receiver (i.e., Washington Mutual), their suit is not a claim
within the meaning of [FIRREA] and thus is not barred") (citing
16 Since the sui twas filed, all claims based on WMI stock
or debt have been voluntarily dismissed and the ANICO Plaintiffs
currently assert rights only as WMB bondholders. Am. Nat'l Ins.
Co. v. FDIC, 642 F.3d 1137, 1140 (D.C. Cir. 2011).
28
Rosa v. Resolution Trust Corp., 938 F.2d 383, 394 (3d Cir. 1991)
(holding that claims for damages against assuming bank for its
own acts did not fall within jurisdictional bar because they did
not seek payment from assets of the receiver. As a result, the
Plan Objectors contend that the business tort claims which the
Debtors have against JPMC are not barred and are potentially
valuable assets which are being released for no consideration
under the GSA.
The Court disagrees. Despite the recent ANICO decision, the
likelihood of success on the Debtors' business tort claims, the
delay and cost of pursuing them, their complexity, and the
possible difficulties of collecting all militate in favor of
approval of the GSA. See, e.g., TMT Trailer Ferry, 390 U.S. at
424; In re RFE Indus., Inc., 283 F.3d 159, 165 (3d Cir. 2002);
Martin, 91 F.3d at 393.
With respect to the first factor, even the D.C. Circuit
acknowledged that there were "knotty questions" left to be
decided in the case, including whether the claims belonged
exclusively to the FDIC as the receiver of WMB.17 Am. Nat'l
17 JPMC and the FDIC Receiver contend that any derivative
claim that WMI may have for alleged harm to WMB is now owned by
the FDIC. 12 U.S.C. 1821(d) (2) (A) (i) (providing that the FDIC
as receiver "succeeds to all rights, titles, powers, and
privileges of . . . any stockholder
H
of the bank). See also
Pareto v. F.D.I.C., 139 F.3d 696, 700 (9th Cir. 1998) (holding
that 1821(d) (2) (A) (i) vests in the FDIC all rights and powers
of a stockholder of a bank to bring a derivative action).
29
Ins., 642 F.3d at 1145. The FDIC Receiver further argues that
the Debtors did not file any claim in the Receivership action
based on the alleged business tort claims and those claims are,
therefore, time-barred. Cf. 12 U.S.C. 1464(d} (2) (B) (any
claims challenging the appointment of the FDIC as Receiver must
be brought against the OTS within 30 days of the appointment).
Even if the Debtors do have an independent business tort
claim against JPMC, however, they still face significant
obstacles in successfully prosecuting Any claim for damages
would require that the Debtors prove that they were solvent
18
at
the time of the s zure of WMB, a position diametrically opposed
to assertions they would need to prove in the preference and
fraudulent conveyance claims which are also waived as part of the
GSA. The Debtors would also have to establish the facts
necessary to win those claims, namely that JPMC fraudulently
caused the decline in value of WMB in order to buy it at a
discount price.
18 The TPS Consortium asks the Court to consider a summary
of and excerpts from the Senate Report issued after an
investigation into the WMB collapse, which it contends shows that
the Debtors have viable claims against their directors and
officers. That Report, however, also noted that the market value
of the Debtors was based on misinformation, suggesting that the
Debtors might have been insolvent. (D.I. 8312 at Ex. A p. 4.)
This would defeat any claim that the Debtors might have on the
business tort claims, because the Debtors would have suffered no
damages.
30
Further, the difficulties in collecting any judgment against
JPMC have not changed since the Court's January 7 Opinion. The
GSA resolves not only the Debtors' business tort claims but the
many disputed claims which involve a multiplicity of issues
raising complex arguments about the intersection of bankruptcy
law and the regulation of banks. The Supreme Court's recent
decision in Stern v. Marshall also makes it likely that, in the
absence of a global settlement, the various claims would have to
be litigated in numerous state and federal courts, which might
result in conflicting decisions. Continuing the litigation on
the disputed claims will cause at least a 3-4 year delay in any
distribution to creditors, increase post-pe tion interest and
professional fees (which are currently running at the monthly
rate of $30 million and $10 million, respectively), and involve
complex issues including sovereign immunity (affecting even
whether discovery could be taken of the government agents),
pre-emption, and jurisdiction.
Given all these factors, the fact that one part of the GSA
is now more unsettled than it was does not change the Court's
mind about the overall reasonableness of the GSA. In fact, it
reinforces the Court's belief that this is precisely the type of
multi-faceted, multi-district litigation that calls for a global
settlement. The Court, therefore, reaffirms its conclusion that
the GSA provides a reasonable resolution in light of the possible
31
results of the multiple complex litigation, the likely
difficulties in collection, the expense inherent in any further
delay, and the paramount interests of the stakeholders. 442 B.R.
at 345.
2. Other to reasonableness
Many of the individual shareholders who object to
confirmation of the Modified Plan do so based on the assertion
that the GSA should not be approved. Some of the objections are
based on alleged facts for which no evidence was presented at the
confirmation hearings.
19
Those objections must fail for lack of
support in the record.
Many of the individual objectors also repeat arguments
presented at the confirmation hearing in December which the Court
already addressed in its January 7 Opinion. Absent changed facts
or law, the Court will not reconsider that decision. See, e.g.,
Hayman, 669 F.2d at 169; Ameriserve, 315 B.R. at 36.
The individual objectors do, however, refer to some issues
that the Court can consider. Specifically, they reference some
recent decisional law that they say the Court should consider in
determining reasonableness.
19 These include allegations about the value that JPMC
received in acquiring WMB. (D.l. 8407, 8408.)
32
a. Colonial BancGroup decision
The first was a decision in the Colonial BancGroup case in
which the that the FDIC did not have the right to set
off claims it had against deposits that the debtor had in its
former subsidiary bank that had been seized and sold to another
bank. In re The Colonial BancGroup, Inc., Bankr. No. 09-32303,
2011 WL 239201, at *9 (Bankr. M.D. Ala. Jan. 24, 2011). This,
they argue, means that the Debtors would have won the fight over
who had title to the deposit accounts in WMI's name at WMB.
The Court does not find, however, that the Colonial
BancGroup decision alters its conclusion on the reasonableness of
the GSA for two reasons. First, that decision did not deal with
the claim by the acquiring bank to the deposit accounts but only
dealt with the FDIC claim. Id. Second, the Court already
concluded in the January 7 Opinion that the Debtors had a strong
likelihood of success on the merits on their claim of ownership
to the deposit accounts. 442 B.R. at 331. The Colonial
BancGroup decision merely reinforces that conclusion.
b. Team Financial decision
The individual objectors also refer the Court to the
decision in Team Financial in which the Bankruptcy Court held
that the debtor, not the FDIC, owned a tax refund received by the
debtor for its consolidated tax group which included a bank for
which the FDIC was the receiver. In re Team Fin., Inc., Bankr.
33
No. 09-10925, 2010 WL 1730681, at *10 (Bankr. D. Kan. Apr. 27,
2010). The Team Financial Court held that the FDIC was limited
to a pre-petition breach of contract claim under the group's tax
sharing agreement. Id. at *11.
Again, the Court finds that decision is insufficient to
change its mind about the reasonableness of the GSA. In the
January 7 Opinion the Court concluded that the Debtors had a fair
likelihood of prevailing on the issue of who owned the tax
refunds. 442 B.R. at 333. The Court noted, however, that the
FDIC asserted a claim under the Tax Sharing Agreement between WMI
and WMB to the portion of the tax refund which related to WMB's
operating losses. Id. Because the estate is solvent and
unsecured creditors are likely to get paid in full, the Court
found that the FDIC's claim would entitle it to a substantial
recovery and, therefore, the Debtors were not likely to obtain a
net recovery which is substantially better than the GSA by
litigating that issue.
c. Deutsche Bank National Trust Co. decision
The Court is also aware that the DC Court recently denied a
motion of the FDIC to dismiss a complaint against it which raised
business tort claims arguably similar to the ANICO claims.
Deutsche Bank Nat'l Trust Co. v. FDIC, 1:09-cv-01656 (D.D.C. Aug.
17, 2011). The Court does not consider this relevant to its
consideration of the merits of any claims that the estate may
34
have against the FDIC in this case, however, as the order was not
a decision on the merits.
For all the above reasons, the Court concludes that there is
not any intervening change in the law or facts to cause it to
reconsider its conclusion in the January 7 Opinion that the GSA
is reasonable.
C. Value Distributed Under the Modified Plan
Pursuant to t ~ e Modified Plan, stock in WMI will be canceled
and stock in reorganized WMI (the "Reorganized Debtor") will be
issued to creditors who elect to receive stock in lieu of cash
payments or interests in the Liquidating Trust, as well as to
PIERS for that portion of their claims that are not paid in cash
or Liquidating Trust Interests. (Tr. 7/13/2011 at 97-98; D 255
at 6.2,7.2,16.2,18.2,19.2,20.2 & 22.2.) The Reorganized
Debtor will be vested with miscellaneous assets, the most
valuable of which is the stock of a subsidiary of WMI, WM
Mortgage Reinsurance Company ("WMMRC"). (Tr. 7/13/2011 at 97-98,
248.) The value of the Reorganized Debtor also includes certain
tax attributes, namely net operating losses ("NOLs"). The
Debtors' NOLs (including WMB in its tax group) amount to an
estimated $17.7 billion in face value for pre-2011 losses,
assuming an Effective Date of the Plan of August 31, 2011. (D
Demo Ii Tr. 7/13/2011 at 102-03.) The use of the NOLs, however,
is subject to the limitations of section 382 of the Internal
35
Revenue Code (the "Tax Code") .
The Reorganized Debtor will not be vested with any claims
(including claims against directors and officers) of the Debtors.
Instead, those claims are vested in the Liquidating Trust,
interests in which are being distributed to certain creditor
classes. (0 255 at 6.1, 7.1, 16.1, 18.1, 19.1, 20.1, 21.1,
28.3 & 32.1 (b) . )
According to the stock election results, stock in the
Reorganized Debtor will be held as follows: 24 million shares by
Senior Noteholders, 13 million shares by Senior Subordinated
Noteholders, and 123 million shares by PIERS holders. (0.1. 8108
at 32; Tr. 7/13/2011 at 101.) The shares will be issued at a
rate of one share for each dollar of claim exchanged. (D 255 at
1.167.) Based on the Debtors' valuation of the Reorganized
Debtor, the stock, cash, and interests in the Liquidating Trust
to be distributed to creditors will result in all creditor
classes being paid in full, with the exception of the lowest
class, the PIERS. Therefore, the Modified Plan anticipates that
there will be no distribution to any shareholders and their
interests will be canceled. (D 255 at 23.2, 24.2, 25. 1 &
26.1.) In the event that all the creditors do get paid in full,
however, Liquidating Trust Interests will be redistributed to the
preferred shareholders. (Tr. 7/13/2011 at 98; D 255 at 6.3,
7.3, 16.3, 18.3, 19.3, 20.3, 22.1, 22.2, 23.1 & 24.1.)
36
The Plan Objectors contend, however, that the Reorganized
Debtor has substant 1 value in excess of the claims of the
creditors that are receiving its stock. The stock in the
Reorganized Debtor is not being distributed to anyone other than
the creditors. (Tr. 7/13/2011 at 101.) Therefore, the Plan
Objectors argue that those creditors are getting more than the
amount of their claims in violation of section 1129(b). See,
~ , In re Exide Techs., 303 B.R. 48, 61 (Bankr. D. Del. 2003)
(holding that section 1129(b) prohibits creditors from receiving
more than the full value of their claims before junior classes
receive a distribution). Instead, the Plan Objectors argue that
the excess value should be given to the other stakeholders,
notably the preferred and common shareholders.
The Plan Supporters and the Plan Objectors each presented
valuation experts in support of their positions.
1. Daubert Motion
The Debtors filed a motion to exclude the testimony of both
of the Equity Committee's experts: Peter Maxwell, the valuation
expert, and Kevin Anderson, the tax expert. The Debtors argue
that Maxwell's opinion is not based on accepted methodologies and
is based on hypothetical scenarios that have no relevance to this
case (namely, that the Reorganized Debtor will raise substantial
amounts of debt and equity to develop or acquire additional
business in order to utilize more of the NOLs). See, e.g., Neb.
37
Plastics, Inc. v. Holland Colors Ams., Inc., 408 F.3d 410, 416-17
(8th Cir. 2005) (although factual basis of expert opinion
generally goes to credibility, if the opinion is "so
fundamentally unsupported" because it fails to consider relevant
facts, then it can offer no assistance to the trier of fact and
must be excluded); Guillory v. Domtar Indus., Inc., 95 F.3d 1320,
1331 (5th Cir. 1996) (expert testimony was properly excluded
where it was not based upon facts in the record but on altered
facts and speculation designed to bolster a party's position);
Boucher v. U.S. Suzuki Motor Corp., 73 F.3d 18, 21 (2d Cir. 1996)
(expert testimony should be excluded "if it is speculative or
conjectural or if it is based on assumptions that are so
unrealistic and contradictory as to suggest bad faith"); McMillan
v. Weeks Marine, Inc., 474 F. Supp. 2d 651, 657-59 (D. Del. 2007)
(excluding expert testimony as speculative because it was based
on unrealistic assumptions); In re Nellson Nutraceutical, Inc.,
356 B.R. 364, 373 (Bankr. D. Del. 2006) ("[IJf the factual basis
of an expert's opinion is so fundamentally unsupported because
the expert fully relies on altered facts and speculation, or
fails to cons relevant facts in reaching a conclusion, the
expert's opinion can offer no assistance to the trier of fact,
and is not admissible on relevance grounds."); In re Gretz,
Bankr. No. 09-10069, 2011 WL 1048635, at *4 (Bankr. D. Del. Mar.
38
18, 2011) (rejecting a valuation hypothesizing that an un
renovated property with no rental income was a fully-renovated
income-producing property because it was too far removed
from the facts on the ground for the Court to be able to
confidently rely upon it.").
The Equity Committee responded that even the Debtor's own
expert, Steven Zelin, considered and valued the Reorganized
Debtor's opportunity" to acquire or develop new
business. It argues that this type of disagreement does not
warrant excluding one expert's opinion but merely goes to the
credibility of the witnesses. The Equity Committee contends that
the Court's gatekeeper function under Rule 702 of the Federal
Rules of Evidence and Daubert is a substitute for testing
the assumptions underlying the expert witness' testimony on
cross-examination." Lichtenstein v. Anderson (In re Eastern
Continuous Forms, Inc.), No. Civ. A. 04-629, 2004 WL 2418285, at
*4 (E.D. Pa. Oct. 28, 2004). party confronted with an adverse
expert witness who has sufficient, though perhaps not
overwhelming, facts and assumptions as the basis for his opinion
can highlight those weaknesses through effective cross
examination." Stecyk v. Bell Helicopter Textron, Inc., 295 F.3d
408, 414 (3d Cir. 2004). The Equity Committee argues that Rule
702 establishes a policy of admitting expert testimony
which will 'probably aid' the trier of fact." Knight v. Otis
39
Elevator Co., 596 F.2d 84, 87 (3d Cir. 1979) (quoting Universal
Athletic Sales Co. v. Am. Gym, Recreational & Athletic Eguip.
Co., 546 F.2d 530, 537 (3d Cir. 1976. Accordingly, the Equity
Committee asserts that ndoubts about whether an expert's
testimony will be useful should generally be resolved in favor of
admissibility.H In re Japanese Elec. Prods., 723 F.2d 238, 278
(3d Cir. 1983), rev'd on other grounds, 475 U.S. 574 (1986).
To admit an expert's testimony under Rule 702 of the Federal
Rules of Evidence, courts must focus on nthe trilogy of
restrictions on expert testimony: qualification, reliability and
fit.H Calhoun v. Yamaha Motor Corp., 350 F.3d 316, 321 (3d Cir.
2003). The first element considers the qualifications of the
proposed expert in the field in which he is to testify, i.e., his
nknowledge, skills, and training.
H
In re Paoli R.R. Yard PCB
Litig., 35 F.3d 717, 741 (3d Cir. 1994). The second element
considers several factors:
(1) whether a method consists of a testable hypothesis;
(2) whether the method has been subject to peer review;
(3) the known or potential rate of errori (4) the
existence and maintenance of standards controlling the
technique's operation; (5) whether the method is
generally accepted; (6) the relationship of the
technique to methods which have been established to be
reliablei (7) the qualifications of the expert witness
testifying based on the methodologYi and (8) the non
judicial uses to which the method has been put.
Id. at 742 n.8. The third element requires that the nevidence
must first be relevant to be admissible. Relevant evidence is
evidence that helps the trier of fact to understand the evidence
40
or to determine a fact in issue." Oddi v. Ford Motor Co., 234
F.3d 136, 145 n.12 (3d Cir. 2000).
The Court heard argument and reserved judgment on the
Daubert motion until the testimony was presented and cross
examination completed, in orde.r to have abetter idea of the
bases for the experts' qualifications and opinions. After
considering that testimony, the Court concludes that the
testimony of Maxwell should not be excluded because, although he
did not follow normal methodologies for valuing a business, his
report was not a valuation of the Reorganized Debtor but simply a
critique of the valuation done by the Debtors' expert. To that
extent it is helpful to the Court. With respect to the argument
that Maxwell's opinion is based on hypothetical scenarios that
have no basis in the record, the Court is able to evaluate and
consider the likelihood of the occurrence of the various
scenarios on which Maxwell relies in considering the credibility
of his testimony about the value of the Reorganized Debtor.
The Debtors also argue that Anderson is not an expert in the
field on which he is asked to opine, namely the likelihood that
the IRS will use section 269 of the Tax Code to disallow some or
all of the NOLs. The Debtors specifically note that Anderson had
no experience with cases in which section 269 was a major
consideration. (Tr. 7/13/2011 at 132-35.) In addition, the
Debtors seek to exclude Anderson's opinion as an impermissible
41
legal opinion. See, e.g., Berckeley Inv. Grp., Ltd. v. Colkitt,
455 F.3d 195, 217 (3d Cir. 2006) ("Although Federal Rule of
Evidence 704 permits an expert witness to give expert testimony
that 'embraces an ultimate issue to be decided by the trier of
fact,' an expert witness is prohibited from rendering a legal
opinion.") .
With respect to the first issue, the Court found Anderson to
be an expert in tax issues relevant to the acquisition and merger
of corporations, particularly troubled companies. (Tr. 7/13/2011
at 127-29, 135.) Although the Debtors contend that he is not an
expert on section 269 of the Tax Code, the Court finds that too
narrow of an area of expertise to expect. Anderson testified
that in rendering advice on mergers and acquisitions involving
NOLs, he considered section 269, as well as section 382, because
the two were both implicated. (Id. at 128-29, 132 5.) Thus,
although he never issued a "pure" section 269 opinion, he always
considered its effect. (Id.) Consequently, the Court finds that
Anderson had sufficient experience with the applicability of
section 269 of the Tax Code to render an opinion.
With respect to the second factor, the Court is not being
asked to render a decision on the legal issue of whether the use
of the NOLs by the Reorganized Debtor will be challenged (and if
challenged, will be disallowed). Instead, the issue before the
Court is what is the value of the NOLs to the Reorganized Debtor
42
and its stakeholders. This requires not simply a determination
of the legal effect of section 269 but also the possibility that
it would be invoked under various scenarios which may occur in
the future. The Court finds that Anderson's opinion on this
issue is helpful to its ultimate determination of those
possibilities and their effect on the value of the NOLs.
Therefore, the Court will not exclude Anderson's testimony.
2. Value of WMMRC
a. Value of existing business
WMMRC is a captive reinsurance company which wrote policies
on mortgage loans issued by WMB and other affiliates of the
Debtors. (Tr. 7/13/2011 at 97-98, 252.) Since the seizure of
WMB, WMMRC has been in run-off: it has not issued any new
policies and is simply collecting premiums and paying claims on
the existing policies. (Id. at 97-98, 251-52.) WMMRC has no
independent management, no independent sales force, and no
employees. (Id. at 251.)
The Debtors' valuation expert, Ze1in, testified that in his
opinion the value of WMMRC was between $115 and $140 million.
(Id. at 260; D 341 at 8.) This was based on the Debtors'
business and actuarial projections for the run-off of WMMRC's
current policies through 2019 (when they will expire). (Tr.
7/13/2011 at 251-59, 262, 277-82; D 340.) Zelin assumed that the
Reorganized Debtor would have no other business and that the
43
income generated from the run-off of WMMRC's business would be
paid in dividends to investors rather than used to make
acquisitions'or build new business. (Tr. 7/13/2011 at 308-09.)
The Equity Committee does not disagree with the Debtors'
valuation of the existing WMMRC run-off business. In fact, its
expert, Maxwell, opined that the value of WMMRC in run-off was in
the same range as Zelin's, $129 to $135 million. (Tr. 7/15/2011
at 68-70, 120.)
The only valuation of WMMRC which was done using accepted
valuation methodologies was that done by Zelin. The Court
recognizes, however, the inclinations of debtors to undervalue
themselves and plan objectors to overvalue the company to support
their arguments. See, e.g., Exide, 303 B.R. at 61
Creditors Committee argues that the Debtor's expert has
undervalued the company and that the Plan will result in paying
the Prepetition Lenders more than 100% of their claims to the
detriment of the unsecured creditors. The Debtor, on the other
hand, argues that the Creditors Committee's expert has overvalued
the company and that the Plan is fair and equitable in its
treatment of unsecured creditors."). In addition, the Court
agrees that there are some flaws in Ze1in's analysis.
20
The
20 Maxwell highlighted some internal inconsistencies and
problems with Zelin's analysis: Zelin used the weighted average
cost of capital figure from his December 2010 report,
although that number has fallen since then by 5 to 10 percentage
points, which would have increased the value (Tr. 7/13/2011 at
44
Court, therefore, finds that the value of the existing business
of WMMRC (assuming no new business is generated or acquis ons
are made) is at the high end of Zelin's range of value, or $140
million.
b. Value of the NOLs
Although the face amount of the Debtors' NOLs is estimated
to be $17.7 billion for pre-2011 losses, the value of the NOLs is
limited by several factors. (D Demo 1; Tr. 7/13/2011 at 102-03.)
First, section 382 of the Tax Code will limit the Reorganized
Debtor's ability to use the NOLs, because under the terms of the
Modified Plan there will be a change in ownership of WMI (from
the current shareholders to the creditors). (Tr. 7/13/2011 at
102-03, 141-42, 162; D 367 at 4-5.)
A large part of that NOLs will also be lost once WMB ceases
to be a member of the tax group, because the bulk of the losses
were attributable to WMB's operations. (Tr. 7/13/2011 at 102-03,
162-63.) WMB will cease being a member of the Debtors' tax group
upon conclusion of the FDIC's receivership. (Id. at 104-05.)
Therefore, the Debtors have filed a motion for authority to
abandon the stock of WMB before the Effective Date of the
314-17; Tr. 7/15/2011 at 58); he used a WACC of 13-15% although
historical returns on equity for similar businesses are 8 to
12.5% and current returns for insurance companies are 6 to 10%
(Tr. 7/13/2011 at 324-32); he gave little weight to the value of
precedent transactions (which yielded a value of $145 to $205
million) and accorded most weight to the discounted cash flow
analysis (id. at 310-11; D 341 at 13, 23).
45
Modified Plan, which will result a $6 billion NOL for 2011 if
the Modified Plan is confirmed.
21
(Id. at 106, 164-65; D 368 at
4-5.) The portion of the tax loss for 2011 which occurs before
the Effective Date is subject to the limitations of section 382
of the Tax Code; the portion after the Effective Date is not.
(Tr. 7/13/2011 at lOS, 108.) Assuming an Effective Date of
August 31, 2011, the Debtors projected a limited NOL of $4
billion and an unlimited NOL of approximately $2 billion for the
2011 10sses.
22
(Id. at 109-10, 163-64; D 368 at 4-5.) The
Equity Committee's expert, Anderson, agreed with the Debtors'
decision to take a worthless stock deduction for the WMB stock.
(Tr. 7/13/2011 at 164-65.)
i. NOLs used by run-off business
Zelin did attempt to determine the net present value of the
NOLs in two components. The first was the value of the NOLs to
21 The Debtors filed a certificate of no objection to the
motion, causing the Court to grant it by order dated July 8,
2011. (D.l. 8104.) At a status hearing held on August 12, 2011,
the Debtors advised that they had withdrawn the certi cate of no
objection late on the evening of July 5, 2011, when they were
advised by the Equity Committee that individual shareholders
objected to the motion. (Tr. 8/12/2011 at 15.) However, after
reviewing the docket the Debtors were unable to identify any
objection to the motion. At the status hearing the Equity
Committee advised that it had no objection to the motion, so long
as the Debtors did not abandon the stock until after a plan was
confirmed. The Debtors agreed and a form of order to that effect
was to be filed with the Court. (ld. at 21.)
22 The later in the year that the Effective Date occurs, the
smaller the amount of the unlimited NOL. (Tr. 7/13/2011 at 107
10, 161; D Demo 2.)
46
existing WMMRC if it simply remains in run-off. Based on his
valuation of the Reorganized Debtor, Zelin testified that under
section 382 the portion of the NOLs which could be used by WMMRC
during run-off was approximately $7 million per year. (0 Demo 1;
Tr. 7/13/2011 at 103-04.) According to Zelin, the present value
of the NOLs that could be used by WMMRC is $10 to $20 million.
(Tr. 7/13/2011 at 260-61, 275-78, 284 85; 0 341 at 8.)
The Plan Objectors do not really dispute this value; they
contend only that it is based on WMMRC's current operations and
does not take into account the possible future revenues that
could be generated. See, e.g., Consolo Rock Prods. CO. V. Du
Bois, 312 U.S. 510, 526 (1941) (in valuing company court must
consider ~ I facts relevant to future earning capacity and hence
to present worth") .
Because Maxwell did not do a valuation of the existing
business with its NOLs, the Court accepts that the value of the
NOLs to the existing WMMRC business is that determined by Zelin
or $20 million. (Tr. 7/15/2011 at 36-37.)
ii. NOLs used by future business
Zelin also attempted to value the NOLs that might be able to
be used in the event of a future acquisition of a profitable
business by WMMRC, which he valued at an additional $10 to $25
million. (Tr. 7/13/2011 at 260-61, 275-78, 284-85; 0 341 at 8.)
47
The Plan Objectors argue that the principal defect
23
in
Zelin's valuation is that he values the Reorganized Debtor as a
liquidating company (rather than as a going concern) and fails to
attribute sufficient value to the ability of the Reorganized
Debtor to generate new business itself or to use the NOLs through
the acquisition of profitable businesses. (Tr. 7/15/2011 at 38.)
The Equity Committee's expert, Maxwell, opined that, assuming an
initial capital infusion of $140 million, debt of $200 million,
and a subsequent second tranche of debt of $160 million, the
Reorganized Debtor could have a value (based on a net present
value calculation) of $275 million. (Id. at 3 50; EC 154 at 7
8, 11.) He also opined that the value could increase with
subsequent equity raises or other merger/acquisition
opportunities.
24
(Tr. 7/15/2011 at 50-51.)
23 The Equity Committee also had more technical criticisms
of this part of the Zelin report: Zelin used a WACC for the
future acquisition of 25 to 35%, because it was an unknown, but
then did an additional downward adjustment of 33% to reflect the
probability that the acquisition will not be effective on day one
but will take time to occur. (Tr. 7/13/2011 at 332-34; D 341 at
37.) Maxwell characterized this as double-discounting resulting
in an effective rate of 38 to 52% when the correct rate should be
15.8 to 20%. (Tr. 7/15/2011 at 55-56.)
Maxwell opined that it is possible that the Reorganized
Debtor could have additional value of $240 to $420 million but
that is premised on raising billions of dollars in additional
equity to generate hundreds of millions of dollars in additional
income to use the NOLs. (Tr. 7/15/2011 at 84-86; EC 154 at 8.)
The Court finds that assumption purely speculative and
unrealistic.
48
24
The Plan Supporters disagree with Maxwell's conclusion and
assert that there are many flaws in his analysis.
25
Their
primary criticism is that Maxwell did not use typical
methodologies to do a conventional valuation of the Reorganized
Debtor. (rd. at 71-73.) Maxwell admitted this but stated that
he was just showing what the possible values are that could be
achieved by the Reorganized Debtor if new money was invested or
borrowed. The Equity Committee argues that this is not just
speculation but was, in fact, what the Settlement Noteholders
were expecting to do as evidenced by numerous analyses they
performed. (EC 132 & 138.)
The Plan Supporters also contend that Maxwell's assumption
that WMMRC will operate as a going concern is faulty. It is not
based on the current Modified Plan, any existing business plan,
or the known intentions of the future shareholders. (Tr.
7/15/2011 at 74-75, 119.) The Plan Objectors argue that the
Debtors have intentionally not done a business plan for WMMRC so
that the true value of the Reorganized Debtor as a going concern
25 The Debtors' technical criticisms of the Maxwell report
included: Maxwell's comparables for the debt to equity ratios
were not reinsurance companies (Tr. 7/15/2011 at 91); Maxwell's
cost of debt was based on double B rated securities though none
of the reinsurance comparables have that good a rating (id.)i his
rate of return is based on going-concern reinsurance companies,
not startups or run-offs (id. at 92); Maxwell gave 40% weight to
precedent transactions, because he erroneously thought Zelin did,
although he normally would not give that much weight to them (id.
at 131-32).
49
could not be evaluated. The Plan Supporters respond that it
would be presumptuous of the Debtors to prepare a business plan
for the Reorganized Debtor and that it will be up to the new
owners to decide how will be run.
Maxwell admitted that to achieve his going concern value,
the Reorganized Debtor would have to get new management, hire
employees, develop a business plan, get customers and vendors,
and acquire hard assets, none of which it currently has. (Id. at
75-79, 118.) Maxwell could not give an opinion on whether the
Reorganized Debtor could raise the equity or debt needed to
realize the values he attributes to the Reorganized Debtor.
at 98.) He admitted he did not know of anyone willing to lend or
invest in the Reorganized Debtor and stated that his report was
just one of a number of possible future scenarios. (Id. at 82
84, 88-89; EC 135.) He was also aware that only one third of the
rights offering had been subscribed in the Sixth Amended Plan and
the Modified Plan does not even have a rights offering. (Tr.
7/15/2011 at 90.) Further, Maxwell does not account for any
costs or risks associated with the scenarios he posits. (Tr.
7/13/2011 at 297.) Although Maxwell stated that the cost of
equity and debt takes into account some of those risks, he
admitted that it did not include the costs and risks of
converting a liquidating company with no employees or business
into a going concern. (Tr. 7/15/2011 at 149-52.) In addition,
50
Maxwell assumed that the future acquis ion will be fully
implemented on day one (generating $37 million in income, net of
interest expense) but admitted that is not realistic and there
would necessarily be time delays before any additional revenue
could be generated. (Id. at 79-81, 100-01, 124, 126.)
The Court agrees with the Plan Supporters that these are all
serious flaws in Maxwell's analysis, which precludes the Court
from concluding (as Maxwell opines) that the Reorganized Debtor
could have a value in excess of $275 million. However, the Court
agrees with Maxwell's critique of Zelin's report that it gives
too little value to the possible future earning capacity of the
Reorganized Debtor that could be achieved simply by operating as
a going concern or merging with a viab company. See, e.g.,
Consolo Rock, 312 U.S. at 526.
(1) Risk of Loss
The parties so disagree about the effect of the Tax Code
on the ability of the Reorganized Debtor to use the NOLs. The
Plan Supporters contend that Maxwell does not account at all for
any tax risk. (Tr. 7/13/2011 at 297; Tr. 7/15/2011 at 52-53,
107, 119.) They argue that he ignores the possibility that the
IRS will disallow all NOLs under section 269 of the Tax Code.
The Plan Objectors, in contrast, contend that Zelin artificially
undervalued the Reorganized Debtor because of imaginary tax
restrictions.
51
In valuing NOLs, bankruptcy courts must take into account
the sk that the NOLs will be disallowed. See, e.g., In re
Jartran, Inc., 44 B.R. 331, 380 (Bankr. N.D. Ill. 1984) (holding
that ~ t h e realization of the tax savings [from use of NOLs] is
subject to a number of contingencies, including continuation in
effect of relevant tax provisions, potential challenge under
section 269 of the Internal Revenue Code, and possible recapture
of the benefits utilized. Accordingly. . . a substantial
discount would be required."). See generally, Chaim J. Fortgang
& Thomas M. Mayer, Valuation in Bankruptcy, 32 UCLA L. Rev. 1061,
1130 (1985) ("Uncertainties in preserving the NOL increase the
discount.") .
Section 269 of the Tax Code states in relevant part that:
"If any person or persons acquire . control of a corporation,
. and the principal purpose for which such acquisition was
made is evasion or avoidance of Federal income tax . then the
Secretary may dis low such deduction, credit, or other
allowance." 26 U.S.C. 269(a) (1). For the principal purpose of
a transaction to be tax avoidance, the purpose of tax evasion or
avoidance has to be more significant, more important, or more
prominent than any other purpose; it can be one of the purposes
but not the principal purpose. See, e.g., Scroll, Inc. v.
Comm'r, 447 F.2d 612, 618 (5th Cir. 1971) (noting that the
"burden of proof on the taxpayer is not an easy one, and when the
52
disputed tax benefits are so disproportionate to the value of the
other asserted advantages, that burden may be practically
impossible to sustain"}; U.S. Shelter Corp. v. United States, 13
Cl. Ct. 606, 620 (Cl. Ct. 1987) (in considering what is the
primary purpose, the court should aggregate 1 tax avoidance
purposes and compare them to the aggregate business purposes)
(citing Bobsee Corp. v. United States, 411 F.2d 231, 239 (5th
Cir.1969.
The Court in U.S. Shelter concluded that tax evasion was not
the primary purpose of the acquisition even though the acquiror
was aware of and interested in using the NOLs, because it found
persuasive the testimony that the principal motivations for doing
the deal were the business reasons of acquiring a public company
and the specific assets of the acquired company. 13 Cl. Ct. at
622-28. In contrast, the Court in Scroll found the principal
purpose was tax avoidance where the acquired company was not
integrated into the acquiror's business and the tax attributes
and value of the tangible assets were significantly more than the
price paid. 447 F.2d at 615 n.4, 618. A finding of tax
avoidance can be made even if the change in control was through a
foreclosure by a creditor. See, e.g., The Swiss Colony, Inc. v.
Comm'r, 428 F.2d 49, 54 (7th Cir. 1970) (upholding Tax Court
conclusion that primary purpose of acquisition was tax avoidance
even though taxpayer argued that acquisition was accomplished
53
through foreclosure on stock to protect its position as a
creditor) .
The Plan Supporters presented a tax expert, Richard
Reinhold, a tax partner at Wilkie Farr & Gallagher, who testified
that the transfer of stock under the Modified Plan to the
creditors was a change of control that could trigger section 269
disallowance of the NOLs. (Tr. 7/13/2011 at 113.) Reinhold
opined that in considering the issue of what the principal
purpose of the creditors' election to take stock in lieu of cash
under the Modified Plan was, the IRS and courts will consider
future events that may shed light on the intent of the creditors.
(Id. at 200; D 404 at 7 n.15.) Those future events would include
any additional acquisitions of other companies by the Reorganized
Debtor. (Tr. 7/13/2011 at 197.) Reinhold did not testify that
the IRS or courts would be more likely to find that tax avoidance
was the principal purpose if the amount of capital raised
exceeded the non-tax assets' value; he only said that he could
not give an opinion that they would not. (Id. at 200-01, 224; D
404 at 4-6.) Reinhold opined, however, that if the amount of
capital raised is not more than the value of the non-tax assets
of the Reorganized Debtor then "the company has quite a good
argument that Section 269 will not be brought into play because
the principal purpose for the acquisition of shares would not be
considered tax avoidance.
ff
(Tr. 7/13/2011 at 200; D 404 at 7-9.)
54
The Equity Committee's expert, Anderson, opined that it was
unlikely that section 269 of the Tax Code would apply (resulting
in loss of the NOLs) if the Reorganized Debtor acquired
additional businesses, because to disallow the NOLs that future
acquisition would have to be for the "primary purpose" of tax
avoidance. (Tr. 7/13/2011 at 138; D 367 at 15-20; D 370 at 2-5.)
He stated that section 269 is rarely used by the IRS because the
newer section 382 is more specific in describing instances where
NOLs should be disallowed. (Tr. 7/13/2011 at 184.)
Anderson specifically disagreed with Reinhold's opinion that
the Reorganized Debtor could not acquire a company whose value
was more than the value of Reorganized Debtor (excluding the
NOLs) without running afoul of section 269. (Id. at 146-47; D
369 at 3.) Instead, Anderson stated that as long as the acquired
business had legitimate substantial operations, its acquisition
would not result in a loss of the NOLs. (Tr. 7/13/2011 at 142
47; D 367 at 15-17; D 369 at 3-4.) In addition, Anderson opined
that there were specific ways in which the Reorganized Debtor
could acquire assets and/or stock in the future that would not
implicate section 269. (Tr. 7/13/2011 at 149; D 367 at 15-17; D
369 at 3-4.)
The Debtor's expert, Reinhold, did not disagree with
Anderson's conclusion that a subsequent acquisition by the
Reorganized Debtor was not likely to cause a problem under
55
section 269 or 382. (Tr. 7/13/2011 at 208-11.) However, he
noted that his opinion was not addressing the risk that the IRS
will challenge any future transfer of ownership under 269 (as
Anderson's was), but whether it will challenge the current
transfer of ownership to the creditors under the Modified Plan.
(Id. at 193, 202 03, 208-11; D 404 at 7-9, D 341 at 36.)
Anderson admitted that section 269 could apply to the
transfer of stock under the Modified Plan to the creditors and
that in determining "principal purpose" courts look at future
actions to discern present intention. (Tr. 7/13/2011 at 166-67.)
Anderson still felt, however, that was unlikely that the IRS
(or courts) would find that the principal purpose of the transfer
of stock in the Reorganized Debtor under the Modified Plan was
tax avoidance or evasion. (Id. at 147-48, 151-53.)
In evaluating the two conflicting opinions, the Court finds
the opinion of Anderson more convincing. The cases that apply
section 269 are fundamentally different from the case at bench.
Those cases deal with taxpayers who acquire a company which has a
significant NOL and then merge it with their own business in
order to shelter their income. See, e.g., Scroll, 447 F.2d at
615 (noting that "[o]ne of the most obvious advantages accruing
to [the acquiror] as a result of the merger was the possibility
.. of offsetting [the acquired company's] substantial pre
acquisition net operating loss carryover against [the acquiror's]
56
even more substantial post-acquisition profits"); The Swiss
Colony, 428 F.2d at 52 (tax court had found that
acquired control of [liquidating company] 'for the principal
purpose of evading or avoiding Federal income taxes by securing
the benefit of net operating loss deductions which it would not
otherwise have enjoyed'H); U.S. Shelter, 13 Cl. Ct. at 609-10
(noting that section 269 was passed to prevent recently
developed practice of corporations with large excess profits
. acquiring corporations with current past, or prospective losses
or deductions, ... for the purpose of reducing [the acquiror's]
income and excess profits taxes.") (citing S. Rep. No. 627, 78th
Cong., 1stSess. 58 (1943)).
In this case, the creditors are acquiring the Reorganized
Debtor under the Modified Plan not to shelter their own income or
to merge it with a company they own. Instead, they are receiving
stock in the Reorganized Debtor simply in repayment of debt owed
them. Even the situation in The Swiss Colony case is
distinguishable. In that case, although the Taxpayer had
acquired the loss company's stock through foreclosure, it then
attempted to use that company's NOL to shelter its own profits.
428 F.2d at 52. That is not being done by the acquiring
creditors in this case.
In addition, most of the new shareholders will receive their
stock in the Reorganized Debtor not by election but by default.
57
(Tr. 7/14/2011 at 96-97; D 255 at 20.1 & 20.2.) In fact, the
bulk of the stock is being distributed to the PIERS, not because
they elected to receive it but because they are the lowest
creditor class.
26
(D 255 at 20.1 & 20.2.) Thus, the Court
concludes that the IRS is unlikely to find that the principal
reason that the creditors in this case are receiving stock under
the Modified Plan is for tax evasion purposes.
The fact that the Settlement Noteholders (who as holders of
PIERS will receive the bulk of the stock under the Modified Plan)
performed analyses of the value of the NOLs does not alone
suggest that tax evasion was their reason for accepting stock
instead of a cash distribution. See, e.g., In re Federated Dep't
Stores, Inc., 135 B.R. 962, 970 (S.D. Ohio 1992)
by corporate officials of the tax ramifications of an acquisition
is not, by itself, indicative of tax avoidance but is 'simply
intelligent business planning.'") (citation omitted); VGS Corp.
v. Cornrn'r, 68 T.C. 563, 596 (1977) ("Complicated business
26 Under the Debtors' valuation of the Reorganized Debtor,
there is nothing available for equity shareholders, so the fact
that stock in the Reorganized Debtor is being given to the
creditors is in large part mandated by the absolute priority
rule. See, e.g., Case, 308 U.S. at 115-16 (stating that absolute
priority rule requires that shareholders not receive any
distribution under a plan until creditors are paid in full) .
While the Debtors could have simply liquidated WMMRC and
disbursed the proceeds to the creditors rather than the stock,
the Debtors stated that the offers they received for WMMRC were
too low and that they, therefore, concluded that the creditors
would get a higher recovery by allowing WMMRC to finish its run
off. (Tr. 7/14/2011 at 45-47; D 391.)
58
transactions do not take place in a vacuum and we find this
[consideration of loss carryovers or other tax benefits] to be
nothing more than prudent business planning."]i U.S. Shelter, 13
Cl. Ct. at 625 (holding that ~ t h e principal purpose of a
transaction does not become tax avoidance merely because the
parties were cognizant of and considered the tax consequences.").
Further, despite doing those analyzes, three of the Settlement
Noteholders testified that they did not elect to take extra stock
in lieu of cash distributions. (Tr. 7/18/2011 at 123i Tr.
7/19/2011 at 112-13; Tr. 7/20/2011 at 81.)
In this case given the conservative valuation done by Zelin
(which assumes that WMMRC will generate no new business), the
Court also finds that the electing creditors' decisions to take
stock was likely influenced by a belief that the Debtors
undervalued the Reorganized Debtor by viewing it as a liquidating
company rather than as a going concern. (Tr. 7/14/2011 at 39
40.) See, e.g., Exide Techs., 303 B.R. at 48, 61 (noting the
inclination of debtor to undervalue the reorganized entity) .
Given the various reasons for distribution of stock to
creditors under the Modified Plan, the Court concludes that the
principal purpose of the transfer of ownership of the Reorganized
Debtor under the Modified Plan is not the avoidance of taxes.
The Court is cognizant of the fact that its opinion on this point
is not binding on the IRS. 26 C.F.R. 1.269-3(e) ( ~ I n
59
determining for purposes of section 269 . . . whether an
acquisition pursuant to a plan of reorganization in a case under
[the Bankruptcy Code] was made for the principal purpose of
evasion or avoidance of Federal income tax, . . . any
determination by a court under 11 U.S.C. l129(d) that the
principal purpose of the plan is not avoidance of taxes is not
controlling."). See also In re Hartman Material Handling Sys.,
Inc., 141 B.R. 802, 811-12 (Bankr. S.D.N.Y. 1992) (holding that
"[a] confirmation ruling that the principal purpose of a plan is
not tax avoidance significantly different from a 269 ruling
because the two rulings are made pursuant to different 'factual
frames of reference'" and noting that the bankruptcy court can
only consider facts up to the time of its ruling on confirmation
while the IRS can consider facts after confirmation until the
deduction is taken). Nonetheless, the Court considers it
significant that the IRS has not objected to confirmation of the
Modified Plan on the basis that its principal purpose is tax
avoidance although it clearly could have. 11 U.S.C. 1129(d) .27
For purposes of estimating the value of the NOLs, therefore,
the Court cannot accept the Debtors' assertion that the
27 If a governmental unit objected and the Court found that
the principal purpose was to avoid taxes, the Modified Plan could
not be confirmed. 11 U.S.C. 1129(d) ("Notwithstanding any
other provision of this section, on request of a party in
interest that is a governmental unit, the court may not confirm a
plan if the principal purpose of the plan is the avoidance of
taxes . . . .").
60
Reorganized Debtor could not obtain future investments that are
more than the value of its non-tax assets without having the IRS
conclude that the acquisition of stock by creditors under the
Modified Plan runs afoul of section 269 of the Tax Code.
(2) Value adjusted for loss
In determining the value of the NOLs resulting from any
future acquisition, Zelin assumed that any capital raised would
be no more than the value of the current WMMRC non-tax assets
based on section 269. (Tr. 7/13/2011 at 260-61, 275-78, 284; D
341 at 8.) As a result, he concluded that the value of the NOLs
resulting from any additional acquisitions was no more than $10
to $25 million. (Tr. 7/13/2011 at 260-61, 275-78, 284.)
The Court finds that Zelin's valuation is too low, because
it was based on the erroneous assumption that the Reorganized
Debtor would be restricted by section 269 of the Tax Code in what
capital could raise in the future. However, as noted above,
the Court finds that Maxwell's determinations of value are
fraught with problems, including the assumption that the
Reorganized Debtor will be able to raise debt and equity
instantly, even though the Debtors have not obtained exit
financing or any new debt or equity commitments. Maxwell's
present value of the NOLs also assumes that the Reorganized
Debtor will be able to generate instant cash flow from the new
debt and equity that has not even been committed yet. As a
61
result, the Court cannot accept Maxwell's determination that the
value of the Reorganized Debtor is $275 million.
Based on the two expert opinions, one of which is too
conservative and the other of which is too aggressive, the Court
concludes that the present value of the NOLs to the Reorganized
Debtor is $50 million. This is based on the Court's conclusion
that the Reorganized Debtor should be able to raise additional
capital and debt over the next twerity years equal to twice the
value of its current assets which will be invested in restarting
the reinsurance business of WMMRC or acquiring other related
businesses. The Court accepts as credible Maxwell's opinion that
the reinsurance market is a prime area for new investment given
the recent turmoil in the real estate market.
28
Based on all of the above, the Court concludes that the
value of the Reorganized Debtor and its NOLs is $210 million.
3. Value of Liquidating Trust Interests
In addition to distributions of cash, certain creditors are
receiving interests in the Liquidating Trust. (D 255 at 6.1,
7.1, 16.1, 18.1, 19.1, 20.1, 21.1 & 32.l(b).) The Debtors are
transferring to the Liquidating Trust I of their interests in
any causes of action the estates have, including potential suits
28 Maxwell testified that there would be interest in
investing in WMMRC because of the current opportunities in the
home insurance industry; he cited as an example that Goldman
partners had recently raised $600 million to start a new
reinsurance business. (Tr. 7/15/2011 at 38, 67, 122.)
62
against the Debtors' directors and officers. (Id. at 28.3 &
43.5.)
The LTW Holders contend, however, that this major component
of value that is being distributed to the creditors has been
ignored by the Debtors and must be valued in order for the Court
to determine whether the Modified Plan meets the best interests
of creditors test under section 1129 (a) (7) .
The Plan Supporters contend that is not necessary to
value the Liquidating Trust Interests because under the Modified
Plan's waterfall provisions, once creditors have received payment
in full of their claims, with interest, their Liquidating Trust
Interests will be canceled and all further recoveries realized by
the Liquidating Trust will flow to the preferred shareholders.
(Id. at 6.3, 7.3, 16.3, 18.3, 19.3, 20.3, 22.1, 22.2, 23.1 &
24.1; Tr. 7/13/2011 at 98.)
The Court agrees with the Plan Supporters that it is not
necessary to determine the precise value of the Liquidating Trust
assets because whatever they are worth will be distributed to
creditors and then to shareholders in accordance with the
priorities of the Code.
29
29 The Court therefore finds it unnecessary to determine
what if any value the suits against the Debtors' directors and
officers have. (D.l. 8312 at Ex. A pp. 2-4; Tr. 7/21/2011 at
204-05.)
63
D. Good Faith
Several Plan Objectors, led by the Equity Committee,
complain that the Plan cannot be confirmed because it has not
been proposed in good faith as a result of the improper conduct
of the Settlement Noteholders. They argue that any prior finding
of good faith in the January 7 Opinion should be reconsidered by
the Court, based on the newly discovered evidence of the Debtors'
and Settlement Noteholders' misconduct. Fed. R. Bankr. P.
9024 (b) .
1. Conduct of the Settlement Noteholders
The conduct of the Settlement Noteholders was first raised
by a pro se PIERS holder, Mr. Thoma, at the confirmation hearings
held in December, 2010. Although Mr. Thoma sought to introduce
what he described as evidence of improper trades by the
Settlement Noteholders, the Court refused that request as it was
hearsay. In its January 7 Opinion denying confirmation, however,
the Court stated that it was to approve any releases
of the Settlement Noteholders" as required by the GSA and Sixth
Amended Plan in light of Mr. Thoma's allegations of insider
trading by the Settlement Noteholders. Wash. Mut., 442 B.R. at
349. Following denial of confirmation, both the Settlement
Noteholders and the Equity Committee engaged in discovery, which
the Court limited to what information the Settlement Noteholders
64
received from the Debtors.
3o
Evidence regarding the conduct of
the Settlement Noteholders during the bankruptcy case was
presented over the course of four days during the hearings on
confirmation of the Modified Plan. That testimony revealed the
following.
The Debtors and JPMC began negotiating a resolution of their
disputes about ownership of various assets in March 2009. (Tr.
7/18/2011 at 55; Tr. 7/21/2011 at 101.) Those negotiations
continued off and on until the announcement that the parties had
reached an agreement in principal on March 4, 2010, and the terms
were read into the record on March 12, 2010. (Tr. 7/19/2011 at
144; Tr. 7/20/2011 at 74-75.) The settlement negotiations
included the exchange of term sheets between the Debtors and JPMC
reflecting the parties' relative stances on settlement of issues
related to the ownership of disputed assets. (Tr. 7/18/2011 at
67-68; Tr. 7/19/2011 at 130-35.) Counsel for the Settlement
Noteholders, Fried Frank, participated in many of these
negotiations, though they were precluded from sharing information
with the Settlement Noteholders unless the latter were under
confidentiality agreements. (Tr. 7/18/2011 at 57-59, 116, 119;
Tr. 7/19/2011 at 144; Tr. 7/20/2011 at 75; Tr. 7/21/2011 at 136.)
30 The Court did not permit discovery of any analyses that
the Settlement Noteholders did in determining whether to trade in
the Debtors' securities. The Settlement Noteholders asserted
that analysis was privileged and not relevant.
65
At times during that period, the Settlement Noteholders also
participated directly in the negotiations. (Tr. 7/18/2011 at 55;
Tr. 7/21/2011 at 101.) As a condition to their participation,
the Settlement Noteholders entered into confidentiality
agreements with the Debtors. (Tr. 7/20/2011 at 198.) During the
two formal confidentiality periods, the Settlement Noteholders
were required to restrict trading of the Debtors' securities or
to establish an ethical wall (precluding any confidential
information from being used by their traders) . (Id.)
The First Confidentiality Period ran from March 9 to May 8,
2009. (EC 24.) Only Aurelius established an ethical wall during
the First Confidentiality Period; the others restricted their
trading. (Tr. 7/18/2011 at 55.) Immediately after the First
Confidentiality Period, the Settlement Noteholders shared all
confidential information they had received from the Debtors with
their traders and actively traded in the Debtors' securities.
(AOC 18; AOC 54; AOC 62; Au 8.) That information included the
amount of a tax refund the Debtors estimated they would receive
(in excess of $2 billion), which information the Debtors also
made public. (D.l. 970; D 427; Tr. 7/18/2011 at 65, 79, 144; Tr.
7/20/2011 at 232-33.) The Debtors did not, however, make pub c
any of the settlement term sheets or even the fact that
settlement negotiations were occurring.
66
After the conclusion of the First Confidentiality Period,
two of the Settlement Noteholders (Appaloosa and Centerbridge)
independently approached JPMC in July and August 2009 in an
effort to further negotiations. (Tr. 7/20/2011 at 54-55.) Term
sheets were exchanged. (EC 14; EC 115; Tr. 7/20/2011 at 57-58,
243; Tr. 7/21/2011 at 32-33.) Appaloosa restricted its trading
during these negotiations, while Centerbridge restricted trading
only upon receipt of a counter-proposal from JPMC on August 18,
2009. (Tr. 7/20/2011 at 58-59, 130, 244-45.) JPMC withdrew its
counter-proposal in early September 2009. (rd. at 58-59, 244
45. )
Negotiations did not resume again until the Second
Confidentiality Period, which ran from November 16 to December
31, 2009 (the "Second Confidentiality Period"). (EC 37; EC 117;
EC 148; Tr. 7/18/2011 at 105; Tr. 7/19/2011 at 139-40; Tr.
7/21/2011 at 128-29.) During the Second Confidentiality Period,
all the Settlement Noteholders restricted trading. (Tr.
7/18/2011 at 104-05; Tr. 7/19/2011 at 140; Tr. 7/20/2011 at 71
72, 246.) Near the end of the Second Confidentiality Period,
Aurelius asked the Debtors to terminate the confidentiality
period a day early. (Tr. 7/18/2011 at 111.) The Debtors agreed
and again released to the public the Debtors' estimate of an
additional tax refund (in excess of $2 billion) which the Debtors
anticipated receiving because of a recent change in the tax laws.
67
(D.I. 2077; D 428; Tr. 7/18/2011 at 105; Tr. 7/19/2011 at 141;
Tr. 7/21/2011 at 127-28.) Once again, immediately after the
Second Confidentiality Period, the Settlement Noteholders
actively traded in the Debtors' securities using information they
had received from the Debtors, including the status of settlement
negotiations. (AOC 18; AOC 54; AOC 62; Au 8.)
Following the Second Confidentiality Period, the Settlement
Noteholders' involvement in negotiations was limited to a meeting
with the Debtors in January and a meeting with the Debtors, JPMC,
the FDIC, and the WMB Noteholders in February 2010 to discuss a
proposed plan of reorganization, how the Debtors' assets would be
distributed under a plan (the "Waterfall"), and updates on
litigation. (Tr. 7/19/2011 at 62-63, 70; Tr. 7/21/2011 at 130.)
One of the Settlement Noteholders, Appaloosa, also participated
in a meeting with the Debtors and JPMC on March 1 and thereafter
restricted its trading until the terms of the GSA were announced
on March 12, 2010. (Tr. 7/20/2011 at 76-77, 96.) After the
announcement of the GSA, the Debtors sent the Settlement
Noteholders advance drafts of the plan of reorganization,
disclosure statement, and Waterfall analyses. (EC 42; EC 34; Tr.
7/20/2011 at 77, 220, 262.) Upon receipt of those drafts, the
Settlement Noteholders restricted trading until the documents
were publ ly led. (AOC 18; Tr. 7/19/2011 at 77-78; Tr.
7/20/2011 at 77, 262.)
68
2. Application of section 1129 (a) (3)
The Bankruptcy Code requires that, to be confirmed, a plan
of reorganization must be "proposed in good faith and not by any
means forbidden by law." 11 U.S.C. 1129(a) (3). To meet this
standard, the Third Circuit has stated that a plan must "fairly
achieve a result consistent with the objectives and purposes of
the Bankruptcy Code." In re PWS Holding Corp., 228 F.3d 224, 242
(3d Cir. 2000). See also In re Abbotts Dairies of Pa., Inc., 788
F.2d 143, 150 n.5 (3d Cir. 1986); In re Madison Hotel Assocs.,
749 F.2d 410, 424-25 (7th Cir. 1984). To meet this standard, the
plan proponent must establish that "(1) [the plan] fosters a
result consistent with the Code's objectives ... , (2) the plan
has been proposed with honesty and good intentions and with a
basis for expecting that reorganization can be effected . . . ,
and (3) there was fundamental fairness in dealing with the
creditors." In re Genesis Health Ventures, Inc., 266 B.R. 591,
609 (Bankr. D. Del. 2001). Accord In re Frascella Enters., Inc.,
360 B.R. 435, 446 (Bankr. E.D. Pa. 2007).
The Settlement Noteholders, and the Debtors contend that the
conduct of the Settlement Noteholders was in accordance with the
terms of the parties' written confidentiality agreements and did
not violate any law or duty that the Settlement Noteholders might
have had. They contend that the Modified Plan is proposed in
good faith and confirmable under section 1129(a) (3).
69
The Equity Committee objects to confirmation of the Modified
Plan
31
asserting that it has not been proposed in good faith
because the Settlement Noteholders "dominated" or "hijacked" the
settlement negotiations and engaged in inequitable conduct,
including trading in the Debtors' securities while in possession
of material nonpublic information. The Plan Objectors
specifically contend that the Settlement Noteholders used
material nonpublic information to acquire a blocking position in
the various creditor classes to get a seat at the negotiating
table and assure that their claims got paid while nothing was
given to the shareholders. See, e.g., In re ACandS, Inc., 311
B. R. 36, 43 (Bankr. D. Del. 2004) (finding a lack of good faith
where pre-petition creditors committee dominated the debtor's
affairs resulting in "obvious self-dealing"); In re Coram
Healthcare Corp., 271 B.R. 228, 234 (Bankr. D. Del. 2001)
(denying confirmation for lack of good faith where debtor's CEO
had an undisclosed million dollar consulting agreement with a
creditor); In re Unichem Corp., 72 B.R. 95, 100 (Bankr. N.D. Ill.
1987) (finding lack of good faith where plan proponent breached
31 The Equity Committee has also filed a motion seeking
authority to prosecute an action against the Settlement
Noteholders for equitable disallowance of their claims. Although
the Motion only sought disallowance of the claims of Aurelius and
Centerbridge, the Equity Committee's objection to confirmation
asserts that equitable disallowance of the claims of all the
Settlement Noteholders is warranted. At oral argument, the
Equity Committee clari ed that it seeks authority to bring such
a claim against all four Settlement Noteholders.
70
fiduciary duties to debtor because did not intend the
objectives and purposes of the Bankruptcy Code to include
rewarding an individual for breaching his fiduciary duty") .
Based on the record developed, the Court finds that the
conduct of the Settlement Noteholders does not mean that the Plan
was proposed in bad faith. Despite the allegations of insider
trading by the Settlement Noteholders, the Court is unconvinced
that their actions had a negative impact on the Plan or tainted
the GSA.
Rather, the actions of the Settlement Noteholders appear to
have helped increase the Debtors' estates. During the First
Confidentiality Period, the Settlement Noteholders, together with
other creditors, persuaded the Debtors to submit a term sheet to
JPMC that was more "aggressive" than the one the Debtors had
initially contemplated. (Tr. 7/20/2011 at 50.) In addition,
during the July negotiations that Appaloosa and Centerbridge had
alone with JPMC, they persuaded JPMC to submit a counter-proposal
that increased the share of the tax refunds that JPMC was willing
to allocate to the Debtors. (EC 115; Tr. 7/20/2011 at 243.)
The cases cited by the Plan Objectors are distinguishable
from the present facts. Both Coram and Unichern involved
inequitable conduct of an executive of the debtor that lead to
the conclusion that the debtor's plan was offered in bad faith.
Coram, 271 B.R. at 234-35; Unichem, 72 B.R. at 99-100.
71
While ACandS is closer, the Court finds distinguishable
in important respects. In that case, the Court found that the
pre-petition creditors' committee gained control of the debtor to
the point where the committee alone made all the important
decisions, including taking over the process of reviewing and
settling all asbestos claims. 311 B.R. at 40.
32
In addition, the
plan and settlement drafted by the committee and proposed by the
debtor placed creditors in different classes for no discernible
reason, other than the fact that creditors represented by the law
firms on the committee were treated as secured creditors entitled
to payment in full while other creditors (with the same illness
and manifestations) were treated as unsecured creditors entitled
to little or nothing. Id. at 43.
While the evidence in this case shows that the Settlement
Noteholders participated in the settlement negotiations and plan
drafting and review, the Court finds that it falls short of the
almost total control exercised by the committee in ACandS. The
Settlement Noteholders were only one of several groups of
creditors involved in this case, including the WMI Noteholders
and the WMB Noteholders. Nor does the Modified Plan have the
32 The Court in ACandS was particularly concerned to learn
that while counsel for the debtor was purportedly reviewing and
settling claims, in fact that task was subcontracted to a company
whose sole principal was a paralegal from the law firm that
served as chair of the pre-petition creditors' committee. 311
B.R. at 40. The settlement of claims by that firm appeared to
favor creditors represented by the members of the committee. Id.
72
fatal flaw of improper classification and treatment of claims
that the ACandS plan had. In this case, the creditor classes are
treated in accordance with the priorities of the Bankruptcy Code
and their contractual subordination rights. If the Settlement
Noteholders had improperly dominated the case as in ACandS, the
Modified Plan would have elevated the treatment of the PIERS
class (in which they hold the bulk of their claims); instead the
PIERS are receiving the treatment warranted by their subordinated
status.
While the Court is not suggesting that the Settlement
Noteholders be commended for their actions, the record shows
their actions do not support a conclusion that the Modified Plan
cannot be confirmed because it has been proposed in bad faith.
The harm caused by the Settlement Noteholders has or can be
remedied by other means.
33
See infra Part H.
E. Best Interests of Creditors
The Plan Objectors continue to press their arguments that
the Modified Plan violates the best interests of creditors test
articulated in section l129(a) (7). That section requires that a
plan of reorganization provide non-consenting impaired creditors
33 The Court in its January 7 Opinion held that the
Settlement Noteholders were not entitled to releases. 442 B.R.
at 349. In addition, the Court held that the Settlement
Noteholders' almost exclusive right to participate in the rights
offering discriminated against other creditors in the same class.
Id. at 361. The rights offering has subsequently been removed.
(Tr. 2/18/2011 at 80-81.)
73
(and shareholders) with at least as much as they would receive if
the debtor was liquidating in chapter 7. 11 U.S.C. 1129(a) (7).
See, e.g., In re U.S. Wireless Data, Inc., 547 F.3d 484, 495 (2d
Cir. 2008). The Plan Objectors raise many reasons why the
Modified Plan does not comply with that section.
1. Contract v. federal judgment rate
a. Plan Objectors
The Plan Objectors contend that the Modified Plan fails to
comply with the best interests of creditors test because it
provides for the payment of post-petition interest on creditors'
claims at their contract rate of interest rather than at the
federal judgment rate. This results, they argue, in the
creditors receiving more (and the shareholders accordingly
receiving less) than they would under a chapter 7 liquidation.
34
The general rule is that unsecured creditors are not
entitled to recover post-petition interest. United Sav. Ass'n v.
Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 372-73
(1988) (holding that only over-secured creditors are entitled to
receive post-petition interest under section 506(b)). There is
34 This could also conflict with the requirements of the
fair and equitable test under section 1129(b). Although that
section embodies the absolute priority rule, which forbids junior
classes of creditors or equity from receiving any distribution
until senior creditors are paid in full, it so mandates that
senior creditors not receive more than 100% of their claim before
junior classes receive a distribution. See, e.g., Exide Techs.,
303 B.R. at 61 (Bankr. D. Del. 2003).
74
an exception to the general rule, however, when the debtor is
solvent. Onink v. Cardelucci (In re Cardelucci), 285 F.3d
1231, 1234 (9th Cir. 2002) (finding that when a debtor is
solvent, unsecured creditors are entitled to post-petition
interest at the "legal rate"). This is so because under a
chapter 7 liquidation, where the debtor solvent, unsecured
creditors are entitled to post-petition interest on their claims
before shareholders receive any distribution. 11 U.S.C.
726(a) (5) & (6) (stating that in a chapter 7 case unsecured
creditors are entitled to interest at the legal rate from the
date of the filing of the petition before any payment can be made
to the debtor or equity). See, e.g., Kitrosser v. The CIT
Grp./Factoring, Inc., 177 B.R. 458, 469 (S.D.N.Y. 1995)
("Although the requirements of Chapter 7 are in general not
applicable to Chapter 11 proceedings . . . Section 726 does apply
through the requirements of Section 1129."); In re Premier Entm't
Biloxi LLC, 445 B.R. 582, 644 (Bankr. S.D. Miss. 2010) ("Section
726 applies indirectly to chapter 11 cases by virtue of the 'best
interests of creditors' test in 1129, under which distributions
proposed under a plan of reorganization under chapter 11 must at
least equal the amount that would have been paid in a liquidation
under chapter 7.").
The Plan Objectors contend that the majority of courts to
address this issue conclude that "the legal rate" due under
75
section 726(a) (5) is the federal judgment rate. See, e.g.,
Cardelucci, 285 F.3d at 1234 (concluding that federal judgment
rate, rather than state judgment rate or contract rate, was due
on unsecured claims under section 726(a) (5) for purposes of best
interests of creditors test); In re Garriock, 373 B.R. 814, 816
(E.D. Va. 2007) ("Having reviewed each line of cases, the Court
is persuaded that 'the legal rate' refers to the federal judgment
rate, and does not encompass any lawful pre-petition
contract rate."); In re Adelphia Commc'ns Corp., 368 B.R. 140,
257 (Bankr. S.D.N.Y. 2007) (concluding that "[i]t is by far the
better view, in my opinion, that 'legal rate' is the federal
judgment rate and not the same as that authorized under section
506(b), which is the contract rate."); In re Best, 365 B.R. 725,
727 (Bankr. W.D. Ky. 2007) ("The more recent cases hold that the
federal judgment rate is the proper rate of interest under 11
U.S.C. 726(a) (5)"); In re Dow Corning Corp., 237 B.R. 380, 412
(Bankr. E.D. Mich. 1999) (determining that the phrase "interest
at the legal rate" means the federal judgment rate); In re
Chiapetta, 159 B.R. 152, 161 (Bankr. E.D. Pa. 1993) ("[W]e
further conclude that, since a claim is like a judgment entered
at the time of the bankruptcy filing, the applicable rate should
be the federal judgment rate ...."); In re Melenyzer, 143
B.R. 829, 832-33 (Bankr. W.D. Tex. 1992) (concluding that the
appropriate rate of interest payable to unsecured creditors
76
pursuant to section 726(a) (5) is the federal judgment rate).
The Plan Supporters argue, however, that the Court has
already decided this issue in the January 7 Opinion and concluded
that the contract rate was the presumed rate under section
726(a) (5) unless the equities of the case mandate otherwise.
They contend that ruling is the law of the case and cannot be
reargued.
The Court disagrees with the Plan Supporters on this point.
In the January 7 Opinion, the Court did not conclude that the
contract rate was the presumed rate, it merely cited a line of
cases that so hold. 442 B.R. at 358. At the same time, however,
the Court noted that there is a line of cases that hold that the
federal judgment rate is the appropriate rate under section
726(a) (5). Id. at 357-58. The Court also noted that it had
previously "concluded that the federal judgment rate was the
minimum that must be paid to unsecured creditors in a solvent
debtor case under a plan to meet the best interest of creditors'
test, but that the Court had discretion to alter it." Id. at 358
(emphasis added) (citing Coram, 315 B.R. at 346). The Court,
however, did not decide the question in this case, because the
Court believed it needed to consider the equities of the case.
Now that all issues have been presented to the Court, the
Court concludes that the better view is that the federal judgment
rate is the appropriate rate to be applied under section
77
726 (a) (5), rather than the contract rate.
35
The Court's
conclusion is supported by many factors.
First, section 726(a) (5) states that interest on unsecured
claims shall be paid at "the legal rate" as opposed to "a" legal
rate or the contract rate. As the LTW Holders note, where
Congress intended that the contract rate of interest apply, it so
stated. See 11 U.S.C. 506(b) (stating that if a secured
creditor is over-secured, the creditor shall be entitled to
"interest on such claim . provided for under the agreement or
State statute under which such claim arose.") (emphasis added).
See also Adelphia Commc'ns, 368 B.R. at 257; DOw, 237 B.R. at
405-06 (holding that use of term "legal" as opposed to "contract"
rate mandated conclusion that Congress meant "a rate fixed by
statute") .
Second, the payment of post-judgment interest is procedural
by nature and dictated by federal law rather than state law,
further supporting use of the federal judgment rate. Cardelucci,
285 F.3d at 1235 (citing Hanna v. Plumer, 380 U.S. 460, 473-74
(1965 .
Third, the use of the federal judgment rate promotes two
important bankruptcy goals: "fairness among creditors and
" To the extent I suggested in Coram that the federal
judgment rate was not required by section 726(a) (5), I was wrong.
315 B.R. at 346 (applying federal judgment rate nonetheless
because of the equities of the case).
78
administrative efficiency." Cardelucci, 285 F.3d at 1236. See
also Best, 365 B.R. at 727 (federal judgment rate provides "an
efficient and inexpensive means of culating the amount of
interest to be paid to each creditor"); Dow, 237 B.R. at 407
(providing a uniform rate "keeps the bankruptcy estate from being
saddled with potentially difficult and time-consuming
administrative burdens" of determining what rate is applicable to
each creditor's claim); Melenyzer, 143 B.R. at 833 (federal
judgment rate provides court with an "easily ascertainable,
nationally uniform rate" and increases predictability in the
process) .
The Court finds that the line of cases holding there is a
presumption the contract rate applies are distinguishable and/or
unpersuasive. See, e.g., Dow, 456 F.3d at 676-79 (remanding to
bankruptcy court to determine if equities of case permitted
allowance of default interest to creditors rather than the
contract rate); In re Southland Corp., 160 F.3d 1054, 1059-60
(5th Cir. 1998) (determining rate of interest for an over-secured
creditor); In re Chi., Milwaukee, St. Paul & Pac. R.R. Co., 791
F.2d 524, 529-30 (7th Cir. 1986) (in case under railroad
reorganization chapter of Bankruptcy Act, court held that
creditors were entitled only to contract default rate, not higher
market rate, without discussing federal judgment rate).
79
The Indenture Trustee for the PIERS urges the Court not to
be swayed by arguments that equity will receive a recovery if the
federal judgment rate is used rather than the contract rate,
because that is not a factor which courts should consider. See,
~ , Urban Communicators PCS LP v. Gabriel Capital, L.P., 394
B.R. 325, 340 (S.D.N.Y. 2008) (holding that "it is not
inequitable to cut down the interest of Debtors' shareholders by
interest payments at a default rate to which the Debtors
contractually agreed
H
); In re Int'l Hydro-Elec. Sys., 101 F.
Supp. 222, 224 (D. Mass. 1951) (holding that "[t]he burden of
. payment [of post-petition interest on interest] will fall
entirely on the interest of the stockholders . . . [who] cannot
complain that they are treated inequitably when their interest is
cut down by the payment of a sum to which the debenture holders
are clearly entitled by the express provisions of the trust
indenture.
H
)
The cases cited by the Indenture Trustee are not on point.
The Urban Communicators Court was considering what was due to an
over-secured creditor under section 506(b) rather than what post
petition interest is due to unsecured creditors under section
726(a) (5). 394 B.R. at 333-34. The Int'l Hydro-Elec. Court was
dealing with the rearrangement of a public utility company under
title 15, not a reorganization under title 11. 101 F. Supp. at
223. Nonetheless, the Court agrees that the effect on equity is
80
not an appropriate factor to be considered, and the Court will
not consider that. In applying the plain language of the
statute, however, the Court concludes that the federal judgment
rate is the proper measure for post-petition interest due to the
unsecured creditors.
Even if a consideration of the equities was appropriate,
after considering the evidence in this case, the Court does not
find that the equities support the use of anything other than the
federal judgment rate. Cf. Cardelucci, 285 F.3d at 1236
(rejecting argument that in cases where all creditors could get
paid contract rate of interest, debtor would be getting a
windfall if creditors' interest claims are limited by the federal
judgment rate because n'interest at the legal rate' is a
statutory term with a definitive meaning that cannot shift
depending on the interests invoked by the specific factual
circumstances before the court.").
The Plan Supporters argue, however, that payment of the
various contract rates of interest as provided in the Modified
Plan is warranted because the distribution scheme is simply a
function of the subordination provisions in the various
creditors' contracts (the Senior Subordinated Indenture, the CCB
1 Guarantee Agreements, the CCB-2 Guarantee Agreements, the
Junior Subordinated Notes Indenture, and the PIERS Guarantee
Agreement) which they say mandate that the subordinated creditors
81
pay the senior creditors their claims in full, including contract
interest. (See WMI NG 1-7.)
The TPS Consortium disputes this contention. It argues that
the Debtors are only obligated to pay to each creditor class
their allowed claims and interest at the rate required by the
Code. To the extent that the creditors have agreements among
themselves - for one class to pay over its distribution to
another class - it does not impact the obligations of the
Debtors. Bank of Am. N.A. v. N. LaSalle St. Ltd.
P'ship (In re 203 N. LaSalle St. P'ship), 246 B.R. 325, 330
(Bankr. N.D. Ill. 2000) (holding that senior creditor could
assert its unsecured deficiency claim against subordinated
creditor even though it was a non-recourse obligation and could
not be collected from the debtor); First Fidelity Bank, N.A. v.
Midlantic Nat'l Bank (In re Ionosphere Clubs, Inc.), 134 B.R.
528, 532 (Bankr. S.D.N.Y. 1991) (concluding that because
creditors were under-secured, senior creditors were entitled to
interest only from the distributions due to subordinated
creditors); In re Smith, 77 B.R. 624, 627 (Bankr. N.D. Ohio 1987)
(holding that subordination agreements betweeh creditors may not u
impair the rights of the other creditors" and that Uthe amount of
claims against the Debtor, and the distribution to uninvolved
creditors, remain unaffected"). See also Patrick Darby,
Southeast and New England Mean New York: The Rule of Explicitness
82
and Post-Bankruptcy Interest on Senior Unsecured Indebtedness, 38
Cum. L. Rev. 467, 477 (where interest claim is not allowed under
Bankruptcy Code, the senior creditor must seek to collect that
interest from subordinated creditors) .
The Court agrees with the TPS Consortium's argument. The
fact that some of the creditors have contractually agreed to pay
their distribution to other creditors does not mean that the
Debtors are required to make payments to the senior creditors
that are more than the Bankruptcy Code allows, while preserving
the subordinated creditors' claims against the estate. While the
Debtors can, through a plan of reorganization, effectuate the
subordination agreements by diverting payments from subordinated
creditors to senior creditors, that cannot affect the total
claims against the estate, which do not include post-petition
interest on any unsecured claim at more than the federal judgment
rate. See, e.g., First Fidelity, 134 B.R. at 532; Smith, 77 B.R.
at 627.
b. WMI Senior Noteholders' Group
The WMI Senior Noteholders' Group argues that the best
interest of creditors test mandates that the Court award them the
higher of the federal judgment rate and the contract rate on
their floating interest rate bonds. During certain periods
throughout the case, the contract rate on the floating interest
bonds was actually less than the federal judgment rate.
83
Consequently, the WMI Senior Noteholders' Group argues that if
they are awarded only their contract rate of interest, it would
lead to the absurd result of junior creditors getting paid post
petition interest at a higher rate than senior creditors.
This argument is moot because the Court is not awarding
anyone post-petition interest at the contract rate. The WMI
Senior Noteholders are entitled under section 726(a) (5) only to
the federal judgment rate of interest from the Debtors, the same
as all other unsecured creditors. To the extent that this
results in them getting more or less than their contract rate of
interest, it may be a matter between them and the other creditors
who are parties to a subordination agreement, but it is
irrelevant to the Debtors' obligations under the Bankruptcy Code.
c. General unsecured creditors
The Creditors' Committee argues that application of the
federal judgment rate is inequitable in this case because the
only class that is adversely affected by doing so is the class of
general unsecured creditors. It cites the Debtors' updated
liquidation analysis which shows that, after application of the
subordination the general unsecured creditors are the
only ones who will receive less by application of the federal
judgment rate than by application of the contract rate. (D 375;
Tr. 7/14/2011 at 61-62, 82, 170.)
84
This is, of course, true in total dollars because none of
the general unsecured creditors will be getting a contract rate
of interest. (D 375.) However, they will be getting a higher
percentage of the post-petition interest to which they are
entitled under the federal judgment rate (76%) than under the
contract rate (29%), because of the limitation on payment of
interest to senior creditors. (Id.) Further, is irrelevant
that general unsecured creditors would get more in dollars if the
Court were to award contract rates of interest, because they are
simply not entitled to receive that rate under sections 726(a) (5)
and 1129 (a) (7) .
The Creditors' Committee also contends that further delay
will be caused by the Court denying confirmation of the Modified
Plan because of the need to make further revisions and perhaps
re-solicit, which will further erode recoveries for the lower
creditor classes. (0 254, 0 375; Tr. 7/14/2011 at 43-44, 71-72.)
This of course does not justify ignoring the requirements of
the Bankruptcy Code. As the LTW Holders note, further delay
might have been avoided by the Debtors if the Modified Plan had
simply provided that post-petition interest would be paid to
unsecured creditors at whatever rate the Court determined was
appropriate.
2. Date of computation of federal judgment rate
The Plan Objectors contend that if the federal judgment rate
85
of interest is paid on creditors' claims, it should not be the
rate as of the petition date. They propose calculating it as of
different dates largely because shortly after this case was
filed, the federal judgment rate fell precipitously from 1.95% to
as low as .18% as of June 16, 2011. (EC 301.)
The Equity Committee argues that the post-petition interest
rate should be either the rate as of the Effective Date of any
confirmed plan or a floating monthly rate. The Equity Committee
argues that this is appropriate because the purpose of post
petition interest is to compensate the creditors for the time
value of their money and should reflect the different rates
applicable during the pendency of the case. See, e.g.,
Melenyzer, 143 B.R. at 833.
The Court rejects this argument, however, because similar
arguments have been made to justi using market or contract
rates but were rejected. Id. at 832-33.
The TPS Consortium argues that the confirmation date is the
appropriate date to use because the federal judgment rate
derived from section 1961(a} of title 28 which states that
interest shall be paid "from the date of the entry of the
judgment." The TPS Consortium argues that none of the claims at
issue derive from any judgment and that the most analogous order
to a judgment is the confirmation order because it establishes
the parties' rights. See, e.g., In re Am. Preferred
86
Prescription, Inc., 255 F.3d 87, 92 (2d Cir. 2001) ("The
confirmation of a plan a Chapter 11 proceeding is an event
comparable to the entry of a final judgment in an ordinary civil
litigation."); Johnson v. Stemple (In re Stemple), 361 B.R. 778,
796 (Bankr. E.D. Va. 2007) (holding that "orders of confirmation,
like myriad orders entered by this Court, are considered final
judgments, thus triggering the doctrines of res judicata and/or
collateral estoppel.").
The Plan Supporters disagree arguing that, in the event the
Court finds that the federal judgment rate is the appropriate
rate to be paid for post-petition interest, it should be the rate
that was applicable as of the petition date, because it is from
that date that the creditors are measuring the loss of the use of
their money. See, e.g., In re Evans, Bankr. No. 10-80446C, 2010
WL 2976165, at *2 (Bankr. M.D.N.C. July 28, 2010) (holding that
the "date on which the applicable federal judgment rate is to be
determined for purposes of section 726(a) (5) is the federal
judgment rate in effect on the petition date"); In re Gulfport
Pilots Ass'n, Inc., 434 B.R. 380, 392-93 (Bankr. S.D. Miss. 2010)
(stating that if the debtor were solvent, creditor would be
entitled to post-petition interest at the federal judgment rate
in effect on the petition date); Best, 365 B.R. at 727 (holding
that the legal rate "mean[s] the federal judgment interest rate
at the date the petition is filed"); Chiapetta, 159 B.R. at 161
87
(holding that "since a claim is like a judgment entered at the
time of the bankruptcy filing, the applicable rate should be the
federal judgment rate in effect at the time of the bankruptcy
filing"); Melenyzer, 143 B.R. at 833 (holding that "for purposes
of [section] 726(a) (5), the federal judgment rate selected should
be that in effect as of the date of filing, as opposed to the
date of distribution .. Setting the legal rate of interest
as of the date of distribution makes little sense.").
The Court agrees with the Plan Supporters on this point.
The statute expressly provides that such interest shall be paid
"at the legal rate from the date of the filing of the petition"
suggesting that it is the interest rate effective on the petition
date that should be used. 11 U.S.C. 726(a) (5). The case law
is uniform in holding that it is the petition date at which the
federal judgment rate is determined for purposes of awarding
interest under section 726(a) (5). See, e.g., Evans, 2010 WL
2976165, at *2; Gulfport Pilots Ass'n, 434 B.R. at 393; Best, 365
B.R. at 727; Chiapetta, 159 B.R. at 161; Melenyzer, 143 B.R. at
833.
3. Compounding of interest
The Modified Plan provides that "interest shall continue to
accrue only on the then outstanding and unpaid obligation or
liability, including any Post-petition Interest Claim thereon,
that is the subject of an Allowed Claim." (0 255 at 1.151.)
88
The Equity Committee contends that this compounding of interest
is not permissible. See, e.g., Vanston Bondholders Protective
Comm. v. Green, 329 U.S. 156, 165-66 (1946) (holding that
interest on interest is not allowable on equitable principles);
Chi., Milwaukee, St. Paul & Pac. R.R., 791 F.2d at 532 (denying
compounding of interest because it would result in a windfall for
the debenture holders); In re Anderson, 69 B.R. 105, 109 (B.A.P.
9th Cir. 1986) (affirming bankruptcy court's denial of interest
on interest); In re The N.Y., New Haven and Hartford R.R. Co., 4
B.R. 758, 799 (D. Conn. 1980) (denying interest on interest under
the principles articulated in Vanston) .
The Debtors respond that compound interest is being paid
because that is exactly what the Debtors are obligated to pay
under the indentures. (See, e.g., WMI NG 1 at 5.3.)
The Court rejects the Debtors' argument. Once again, in
awarding post-petition interest to creditors in this case, the
Court is doing so not because of any contractual right they may
have to it. Their contractual right to compound interest has
been eliminated (as not "allowed") by section 502 (b) (2). Their
entitlement to post-petition interest is being granted only as
required by the terms of section 726(a) (5), which the Court
determines is the federal judgment rate. The latter permits only
annual compounding of interest. 28 U.S.C. 1961(b) (providing
that "[iJnterest shall be computed daily to the date of payment
89
. and shall be compounded annually. ") . See also Curry v. Am.
Int'l Grp., Inc., Plan No. 502, 579 F. Supp. 2d 424, 426 (noting
that the federal judgment rate is "compounded annually").
Because the Court concludes that creditors are only entitled
to the payment of interest from the Debtors at the federal
judgment interest rate in effect on the petition date, compounded
annually, the Court finds that the Modified Plan which provides
for payment of the contract rate violates the best interests of
creditors test. 11 U.S.C. 726(a) (5) & 1129(a) (7).
4. Payment of subordinated claims
The WMB Noteholders object to the Modified Plan because it
provides that senior unsecured creditors will receive post
petition interest on their claims before the WMB Noteholders'
subordinated claims are paid. They contend that this violates
the best interests of creditors test because they will not
receive at least as much as they would receive under chapter 7
according to the provisions of section 726.
The WMB Noteholders have stipulated that their claims are
subordinated to general unsecured claims because they hold claims
arising from rescission of a purchase or sale of a security of
WMB, an affiliate of the Debtors. 11 U.S.C. 510 (b) . Although
the distribution scheme in section 726 expressly provides that it
is subject to section 510, the WMB Noteholders contend that
section 510 (b) only subordinates them to "all claims or interests
90
that are senior to or equal the claim or interest represented by
such security." Id. They argue that because their securities
were bonds issued by WMB, i.e. debt, that their claims are only
subordinated to the general unsecured claims of the Debtors and
not to equity. Although case law is sparse on this issue, they
contend that it supports their theory. See, e.g., In re El Paso
Refinery, L.P., 244 B.R. 613, 624-25 (Bankr. W.D. Tex. 2000)
(holding that a subordinated claim is subordinated only to other
general unsecured claims of the same type but not to interest
unless the subordinated claim is itself a claim for interest) .
The Indenture Trustee for the PIERS responds that the
Modified Plan properly provides for post-petition interest on
unsecured claims before any distribution is due to subordinated
creditors such as the WMB Noteholders. The Indenture Trustee for
the PIERS notes that section 726 is expressly subject to section
510. 11 U.S.C. 726(a). See also, In re Virtual Network,
Servs. Corp., 902 F.2d 1246, 1249 (7th Cir. 1990); Wash. Mut.,
442 B.R. at 357; In re Rago, 149 B.R. 882, 889 (Bankr. N.D. Ill.
1992) .
At oral argument, the Indenture Trustee for the PIERS argued
that section 510(b) subordinates the WMB Noteholders' claims to
all "claims." 11 U.S.C. 510(b). (Tr. 8/24/2011 at 185-87.)
The definition of "claim" includes all "right to payment, whether
or not such right is reduced to judgment, liquidated,
91
unliquidated, fixed, contingent, matured, unmatured, disputed,
undisputed, legal, equitable, secured, or unsecured." Id. at
101 (5) (emphasis added). The Indenture Trustee for the PIERS
contends that this definition includes unmatured (i.e., post-
petition) interest. Although section 502{b) (2) provides that
"allowed" claims do not include unmatured interest, the
subordination in section 510(b) is to "claims" not "allowed
claims." Id. at 510(b). In contrast, section 510{c) provides
for equitable subordination to "allowed claims" only. Id. at
510 (c) (1) .
The Court agrees with the argument of the Indenture Trustee
for the PIERS. According to the plain language of sections 510
and 726, the WMB Noteholders are subordinated to all "claims,"
the definition of which includes unmatured interest on those
claims. Therefore, the Court concludes that unsecured creditors
are entitled to post-petition interest on their claims before any
distribution to the WMB Noteholders.
5. Effect on subordination rights
The PIERS Holders
36
argue that if the Court determines that
the Debtors are only obligated to pay creditors at the federal
judgment rate of interest, then that is all the senior creditors
are entitled to receive and the subordinated creditors are not
~ The PIERS Holders include Normandy Hill Capital L.P. (an
individual PIERS holder) and Wells Fargo Bank, NA, the Indenture
Trustee for the PIERS.
92
...----...- - - - - ~ ~ ~ ~ ~ - - - ~ ~ - - - - - - -
obligated to pay them the difference between what the Debtors pay
and their contract rate of interest.
The WMI Senior Noteholders' Group and WMI Senior
Noteholders' Indenture Trustee disagree. They contend that the
subordination provisions in the various creditors' contracts (the
Senior Subordinated Indenture, the CCB-1 Guarantee Agreements,
the CCB-2 Guarantee Agreements, the Junior Subordinated Notes
Indenture, and the PIERS Guarantee Agreement) mandate that the
subordinated creditors pay the senior creditors their claims in
full, including contract interest. (WMI NG 1 at 15.3; WMI NG 2
at 15.3; WMI NG 3 at 3(a) & (b); WMI NG 4 at 15.01; WMI NG
5 at 3(a) & (b); WMI NG 6 at 12.2; WMI NG 7 at 6.1.)
The PIERS Holders contend that the subordination provisions
do not require that they pay the senior creditors their full
contract rate of interest because it does not explicitly refer to
the rate of post-petition interest to which they are subordinate.
Therefore, the PIERS Holders contend that the interest they are
subordinated to is only the rate the Court determines is
appropriate. They rely on the Rule of Explicitness, which
provides that in order to subordinate junior creditors the
indenture must explicitly provide for that outcome. See, e.g.,
In re King Res. Co., 528 F.2d 789, 791 (10th Cir. 1976) (adopting
holdings in Kingsboro and Time Sales that "where the
subordinating provisions are unclear or ambiguous as to whether
93
post-petition interest is to be allowed a senior creditor, the
general rule that interest stops on the date of filing of the
petition in bankruptcy is to be followed"); In re Kingsboro Mort.
Corp., 514 F.2d 400, 401 (2d Cir. 1975) (holding that language of
subordination agreement requiring payment in full of "all
principal and interest on all Senior Debt" was insufficiently
express to apply to post-petition interest); In re Time Sales
Fin. Corp., 491 F.2d 841, 844 (3d Cir. 1974) (a rming denial of
enforcement of subordination agreement for payment of post
petition interest because the agreement "did not appropriately
apprise the debenture note holders that their claims against the
bankrupt would be subordinated to [the senior creditor's] demand
for post-petition interest").
The WMI Senior Noteholders' Group responds that the Rule of
Explicitness no longer appl s since passage of the Bankruptcy
Code and the enactment section 510. See, e.g., In re Bank of
New England Corp., 364 F.3d 355, 362, 365 (1st Cir. 2004)
(concluding that "the enactment of section 510(a) [of the
Bankruptcy Code] means that the enforcement of subordination
provisions is no longer a matter committed to the bankruptcy
courts' notions of "what may (or may not) be equitable" and
therefore the Rule of Explicitness is no longer applicable);
Chern. Bank v. First Trust of N.Y. (In re Southeast Banking
Corp.), 156 F.3d 1114, 1124 (11th . 1998) (stating that "we
94
conclude that Congress, by enacting section 5l0(a) of the
Bankruptcy Code, abrogated the pre-Code Rule of Explicitness. As
a necessary consequence of this change in bankruptcy law, the
Rule of Explicitness can no longer survive as the progeny of the
bankruptcy courts' equity powers or as a federal canon of
contract construction.").
The Court disagrees with the argument of the WMI Senior
Noteholders' Group that the Rule of Explicitness is no longer
applicable. While section 5l0(a) provides that subordination
agreements are enforceable, it states that they are only
enforceable "to the same extent that such agreement is
enforceable under applicable law." 11 U.S.C. 5l0(a). In the
Southeast Banking Corp. case, the Eleventh Circuit certified to
the New York Court of Appeals the question the applicability
of the Rule of Explicitness under New York law.
37
156 F.3d at
1126. The New York Court of Appeals answered the question in the
affirmative, stating that "[i]n accordance with the Rule of
Explicitness, New York law would require specific language in a
subordination agreement to alert a junior creditor to its
assumption of the risk and burden of allowing the payment of a
senior creditor's post-petition interest demand." Chern. Bank v.
n The Indentures are governed by New York law. (WMI NG 1
at 1.12; WMI NG 2 at 1.12; WMI NG 3 at 6(a); WMI NG 4 at
14.05; WMI NG 5 at 6(a); WMI NG 6 at 1.11; WMI NG 7 at
9.4 . )
95
First Trust of N.Y. (In re Southeast Banking Corp.), 93 N.Y. 2d
178, 186 (N.Y. 1999). As a result, the Eleventh Circuit held
that the language of the subordination provision was
insuf ciently precise on the issue of post-petition interest to
satisfy the Rule of Explicitness under New York law. Chem. Bank
v. First Trust of N.Y. (In re Southeast Banking Corp.), 179 F.3d
1307, 1310 (11th Cir. 1999). See also, First Fidelity Bank, N.A.
v. Midlantic Nat'l Bank (In re Ionosphere Clubs, Inc.), 134 B.R.
528, 534-35 (Bankr. S.D.N.Y. 1991) (concluding that the Rule of
Expli tness articulated in retains its vitality and
remains the controlling law in the Second Circuit" under the
Bankruptcy Code and refusing to enforce subordination agreement
that would pay post-peti on interest to senior creditors because
of lack of speci ty in the indenture) .
The WMI Senior Noteholders' Indenture Trustee further
argues, however, that Normandy Hill is relying on a prior version
of the Indenture Agreement and does not refer to critical
language from the subordination provision. The Indenture Trustee
contends that the correct version of the subordination provision
requires subordination to Senior Indebtedness, which is defined
as of, premium, if any, interest (including all
interest accruing subsequent to the commencement of any
bankruptcy or similar proceeding, whether or not a claim for
post-petition interest is allowable as a claim in any such
96
proceeding) ." (WMI NG 7 at 6.) 38
The Court concludes that the WMI Senior Noteholders' Group
and the Senior Noteholders' Indenture Trustee are correct. The
subordination provisions adequately apprised the subordinated
creditors that their payments were subordinate to all contractual
post-petition interest, even if the Court They
certainly, therefore, were on notice that they were subordinate
to contractual post-petition interest if the Court allowed some.
Therefore, the Court concludes that to the extent the Rule of
Explicitness is still applicable, the indentures at issue in this
case meet its requirements.
39
Therefore, the Plan provisions that
give effect to the subordination provisions in the indentures and
require subordinated creditors to pay senior creditors post-
petition interest at the contract rate even though the Debtors
are only required to pay interest at the federal judgment rate
38 The Indenture Trustee notes that it would have been
impossible to give notice to the subordinated creditors of
exactly what interest rate they were subordinated to, because the
PIERS were issued in 2001 and the Senior Notes were issued
between November 2003 and August 2006 with varying rates of
interest. (WMI NG 1-7.)
39 According to Normandy Hill, however, to hold as the WMI
Senior Noteholders' Group argues would penalize the subordinated
creditors for the bad acts of the senior creditors. It assumes
that the Court can apply the federal judgment interest rate only
if it finds that the Settlement Noteholders engaged in improper
conduct. Because the Court finds that the federal judgment
interest rate is the rate due under section 726(a) (5) without
considering the equities of the case, Normandy Hill's argument on
this point is moot. (See supra Part E1.)
97
are not violative of the Bankruptcy Code.
40
6. Releases for distributions
The Equity Committee also objects to confirmation of the
Modified Plan because it conditions distributions to creditors
and other stakeholders on granting a direct release to JPMC and
other non-debtors. (D 255 at 43.2 & 43.6.) The Equity
Committee contends that this violates the best interests of
creditors test under section 1129(a) (7). See, e.g., AOV Indus.,
792 F.2d at 1151 (holding that plan which required a creditor who
had a unique direct claim against plan funder to provide a
release of plan funder to get a distribution unfairly
discriminated against because majority of creditors had no
such claim); In re Conseco, 301 B.R. 525, 528 (Bankr. N.D. Ill.
2003) (holding that plan provision predicating receipt of
distribution on granting third party releases violated best
interest of creditors test because creditors could not be held to
have voluntarily agreed to a release simply by accepting a
distribution) .
The Equity Committee argues that under chapter 7, even
though preferred shareholders are not projected by the Debtors to
receive any distribution, they would still retain their claims
40 While the PIERS may receive payment in full of their
claims from the Debtors, they may be required to give a part of
their distribution to senior creditors. This, however, is simply
a result of the terms they accepted when investing in a
subordinated note.
98
against third parties including JPMC. Therefore, because the
preferred shareholders are not getting any consideration under
the Plan for their agreement to release JPMC and the others, they
should be able to receive a distribution without granting a
release to JPMC and the FDIC.
The Plan Supporters disagree. They contend that the
releases are a condition to the GSA imposed by JPMC and the FDIC.
They argue that the $7 billion in assets which are being used to
provide a recovery for creditors is only available because JPMC
and the FDIC have agreed to waive their claims of ownership of
certain assets and to waive in excess of $54 billion in claims
they hold against the estates. They argue that without the GSA,
creditors (and shareholders) would get no recovery.
The Court finds that the condition requiring a release in
order to receive a distribution does not violate the best
interest of creditors test. Any potential recovery which
shareholders may receive, even from the Liquidating Trust, is
largely due to the GSA which is funding the payments to creditors
who are senior in priority to the shareholders and who, in the
absence of the GSA, would have first priority to the proceeds of
the assets in the Liquidating Trust. In addition, granting a
release is purely voluntary. A preferred shareholder who does
not wish to give a release does not have to, but will be forgoing
any distribution. The cases cited by the Equity Committee do not
99
compel a different result because the release provision in this
case is voluntary and is applicable equally to all creditors and
shareholders, rather than applicable only to a creditor or
shareholder that has a unique direct claim against the released
parties. See, e.g., AOV Indus., 792 F.2d at 1151 (finding
unequal treatment because one creditor asserted it was being
required to release a direct, rather than an indirect, claim
against plan funder); Conseco, 301 B.R. at 528 (finding releases
which were consensual did not violate the Bankruptcy Code) .
7. Use of Liguidating Trust structure
The LTW Holders argue that the Modified Plan also violates
the best interests of creditors test because it provides for the
assignment of the estates' causes of action to a Liquidating
Trust and the issuance to creditors of interests in the Trust.
They contend that by using this mechanism, creditors will be
required to pay capital gains tax now on the value of the
interests in the Trust that are distributed to them, without any
concomitant payment to them of any value for many years until the
claims of the estate are litigated to judgment or settled. The
LTW Holders argue that in a chapter 7 case they would not have
any tax obligations until they actually received a distribution
from the estate.
Because the Court is denying confirmation for other reasons,
and directing the parties to mediation, the Court suggests that
100
the parties consider a means to avoid negative tax consequences
to creditors. See infra Part H.
8. Distribution to WMB Senior Noteholders
The Equity Committee objects to the distribution of $335
million of estate assets to WMB Senior Noteholders (Class 17A)
because it asserts that they are not creditors of this estate.
It contends that such a distribution provides no benefit to the
estate and merely diverts assets that could be used to provide a
distribution to legitimate creditors (or shareholders) of the
Debtors.
The WMB Noteholders have asserted that they have claims
against the Debtors for misrepresentations made by the Debtors in
connection with the sale of the WMB Senior Notes. While they
admit that such a claim would be subordinated under section
510(b), they contend that it is nonetheless a legitimate claim
against the Debtors. Rather than litigate this issue, the
Debtors have agreed (apparently with the urging of the FDIC) to
the payment of $335 million from the tax refunds for this class
of creditors.
The Court finds that this resolution is a reasonable
settlement of the dispute because it will avoid contentious and
expensive securities tigation which could result in a
significantly larger judgment against the Debtors. See, e.g.,
TMT Trailer Ferry, 390 u.S. at 424; In re RFE Indus., Inc., 283
101
F.3d at 165; Martin, 91 F.3d at 393.
F. Feasibility
The Equity Committee argues that if more than 300 creditors
elect to receive stock in the Reorganized Debtor,41 then the
Modified Plan will not be feasible. It contends that if the
Reorganized Debtor has more than 300 shareholders, it will be
required to comply with the reporting requirements of the
Securities Exchange Act of 1934. Because the Debtors have not
been complying with those requirements during the pendency of the
bankruptcy case, the Equity Committee asserts that the
Reorganized Debtor would be unable to file the delinquent reports
and audited financ 1 reports.
The Debtors do not dispute that it would be cost prohibitive
to file the missing financial statements. The Debtors argue,
however, that an entity that complies with SEC Staff Legal
Bulletin No.2 (Apr. 15, 1997, II.c.) is not required to file
any 10-Ks or 10-Qs while in chapter 11 nor to file any "missed"
10-Ks or 10-Qs upon emergence. They contend that they have
complied with the requirements in the Bulletin. The Debtors note
that the SEC has not initiated any enforcement inquiry or
41 The pebtors' claims agent could not testify as to the
exact number of creditors who will hold stock in the Reorganized
Debtor, either by election or default. (Tr. 7/13/2011 at 90-91.)
In addition, the Modified Plan provides the holders of Disputed
Claims, including the LTW Holders, the right to elect stock if
their claims are allowed, which may not be known for some time.
(0 255 at 27.3.)
102
suggested that the Debtors' financial reporting was deficient.
The Court finds that the Debtors have presented sufficient
evidence that the Modified Plan could be feasible even if the
Reorganized Debtor has more than 300 shareholders. Feasibility
does not require that success be guaranteed but rather only a
"reasonable assurance of compliance with plan terms." In re
Orlando Investors LP, 103 B.R. 593, 600 (Bankr. E.D. Pa. 1989).
See also In re Briscoe Enters., Ltd., II, 994 F.2d 1160, 1166
(5th Cir. 1993) ("[I]t is clear that there is a relatively low
threshold of proof necessary to satisfy the feasibility
requirement."). Based on the foregoing, the Court finds that the
Modified Plan meets the feasibility test under section
1129 (a) (11) .
G. Miscellaneous Other Objections
1. WMI Senior Noteholders' Group
The Modified Plan provides that WMI Senior Noteholders will
receive their pro rata share of Creditor Cash and Liquidating
Trust Interests totaling their aggregate claims plus post
petition interest. (D 255 at 6.1.) In addition, to the extent
that WMI Senior Noteholders do not get paid in full in cash on
the Effective Date, WMI Senior Noteholders were entitled to elect
to receive stock in the Reorganized Debtor in lieu of a
distribution of cash or Liquidating Trust Interests. (Id. at
6.2.) Approximately $24 million in WMI Senior Noteholders did
103
elect to receive stock in lieu of cash or Liquidating Trust
Interests. (0.1. 8108 at 32.)
The WMI Senior Noteholders' Group and the WMI Senior
Noteholders' Indenture Trustee object to the Modified Plan
contending it violates the absolute priority rule by providing
for a distribution (of cash, stock and interests in the
Liquidating Trust) to junior creditors before the Senior Notes
are paid in full in cash, as mandated by the subordination
provisions of the Indentures. (WMI NG 1 at 15.2; WMI NG 2 at
15.2; WMI NG 4 at 15.03; WMI NG 6 at 12.2(b); WMI NG 7 at
6.1(c).) See also In re Westpoint Stevens, Inc., 600 F.3d 231,
255-56 (2d Cir. 2010) (holding that under terms of subordination
agreement, senior creditors were entitled to be paid in full in
cash before subordinated creditors could receive distribution
under plan) .
The Court rejects the argument of the WMI Senior
Noteholders' Group and the WMI Senior Noteholders' Indenture
Trustee. First, the language of the Indentures do not support
their argument. For example, section 15.2 of the First
Supplemental Indenture for the Senior Debt Securi provides in
relevant part that "[i]n the event of ... bankruptcy ... such
Senior Debt shall be first paid and satisfied in full before any
payment or distribution of any kind or character, whether in
cash, property or securities . . . shall be made upon the
104
[Junior] Securities
"
(WMI NG 1 at 15.2. See also, WMI
NG 2 at 15.2; WMI NG 4 at 15.03; WMI NG 6 at 12.2(b).)
Those sections merely require that the WMI Senior Noteholders'
claims be "paid and satisfied in full" not that they be paid in
cash. (Id.) The WMI Senior Noteholders are, in fact, being
"paid and satisfied in full" under the Modified Plan by the
payment to them of a combination of cash and Liquidating Trust
Interests and/or, if they so elected, stock in the Reorganized
Debtor. They are entitled to no more under the provisions of the
Indentures.
Section 6.1(e) (1) of the First Supplemental Indenture
relating to the PIERS contains different language but the result
is the same. (WMI NG 7 at 6.1(e)(1).) It provides that "[iJn
the event of and during the continuance of any event specified in
Section 6.1 (a) [which includes a bankruptcy case] unless all
Senior Indebtedness is paid in full in cash, or provision shall
be made therefor" payments made by the Debtors to the PIERS shall
be segregated for the benefit of the Senior Noteholders. (Id. )
Under the Modified Plan, provision has been made for the payment
of the Senior Noteholders from the cash that the Debtors have on
hand or from cash distributions from the Liquidating Trust. To
the extent that the Senior Noteholders have elected to receive
stock in lieu of cash, they have consented to the "provision" for
the payment of their claims in that manner.
105
Second, the Senior Noteholders have accepted their treatment
under the Modified plan overwhelmingly, by more than 99% in
amount and in number. (0.1. 8113 at 9; Tr. 7/13/2011 at 65.)
Therefore, even if the Modified Plan did not comply with the
requirements of the subordination agreements, the Court finds
that the Senior Noteholders have waived that failure. See, e.g.,
Bartle v. Markson Bros., Inc., 314 F.2d 303, 305 (2d Cir. 1963)
(refusing to reverse bankruptcy referee's finding that plan was
in best interests of creditors although it violated subordination
agreement because senior creditors had knowingly voted to accept
plan that waived their rights). See also 4 Collier on Bankruptcy
<][ 510.03[3] (Alan N. Resnick & Henry Sommer eds., 16th ed. 2011)
("If subordination agreements were not waivable under a plan of
reorganization acceptable to the senior creditor, the section
would prevent just what Congress envisioned: that senior
creditors may compromise with junior creditors in order to
confirm a plan.") .
Third, the Bankruptcy Code does not require that the WMI
Senior Noteholders be paid in cash before junior creditors
receive a distribution. See, e.g., Case, 308 U.S. at 117 ("In
application of this rule of full or absolute priority this Court
recognized certain practical considerations and made it clear
that such rule did not 'require the impossible, and make it
necessary to pay an unsecured creditor in cash as a condition of
106
stockholders retaining an interest in the reorganized company.
His interest can be preserved by the issuance, on equi
terms, of income bonds or preferred stock.'") (quoting N. Pac.
Ry. Co. v. Boyd, 228 U.S. 482, 508 (1913)). The payment under
the Modi Plan of cash, Liquidating Trust Interests, or stock
of a value equal to their claims satis the absolute priority
rule and provides the Senior Noteholders with payment in full of
their claims.
2. LTW Holders
The LTW Holders object to confirmation of the Modified Plan
because they contend that the PIERS are improperly treated as
creditors rather than as equity. They argue that part of the
PIERS claims are based on the accretion of an original issue
discount that the claims had because of the value of warrants
that were issued in connection with the PIERS.
The Court rejects this argument. The same argument was
sed by the LTW Holders in connection with the Sixth Amended
Plan. In the January 7 Opinion, the Court found that the PIERS
hold preferred stock issued by WMCT 2001 and that WMCT 2001 holds
debt of the Debtors. 442 B.R. at 361. Therefore, the Court
concluded that unless WMCT 2001 had been merged into the Debtors
(as had several other affiliates), the PIERS claims were debt.
at 362.
107
At the confirmation hearings held in connection with the
Modified Plan, the Debtors presented evidence that WMCT 2001 did
not merge with the Debtors and remains a separate entity_ (Tr.
7/14/2011 at 20-33; D 401.) Consequently, it is clear that the
PIERS are debt, not equity.
H. Eguity Committee Standina Motion
The Equity Committee has recently filed a motion for
authority to prosecute an action to equitably subordinate or
sallow the Settlement Noteholders' claims. ( D . 1. 81 7 9 . ) The
parties agreed to present evidence, brief and argue those issues
in conjunction with confirmation of the Modified Plan.
In order for the Court to grant the Equity Committee's
motion, the Court must find that it has stated a "colorable"
claim which the Debtors have unjustifiably refused to prosecute.
See Official Comm. of Unsecured Creditors of Cybergenics Corp. v.
Chinery, 330 F.3d 548, 566-67 (3d Cir. 2003). The party seeking
standing bears the burden of proof. G-1 Holdinas, Inc. v. Those
Parties Listed on Exhibit A (In re G-1 Holdings, Inc.), 313 B.R.
612 , 62 9 (Ban kr. D . N . J. 2004).
The Court finds, through the Debtors' support of the
Settlement Noteholders' opposition to the Equity Committee's
motion, that the Debtors have refused to pursue the equitable
subordination or disallowance claim. Whether that was justified
depends on whether the claim is colorable and the costs of
108
pursuing that claim. See, e.g., In re STN Enters., 779 F.2d 901,
905 (2d Cir. 1985) (noting that in order to determine whether the
refusal to prosecute the claim was unjustified the court must
balance the probability of success against the financial burden
the suit would have on the estate) .
The threshold for stating a colorable claim is low and
mirrors the standard applicable to a motion to dismiss for
failure to state a claim.42 See, e.g., In re Centaur, LLC, No.
10-10799, 2010 WL 4624910, at *4 (Bankr. D. Del. Nov. 5, 2010)
deciding whether there is a colorable claim, the court
should undertake the same analysis as when a defendant moves to
dismiss a complaint for failure to state a claim."); In re
Adelphia Commc'n Corp., 330 B.R. 364, 376 (Bankr. S.D.N.Y. 2005)
(noting that the burden of showing a colorable claim is a
easy one") .
1. Claim for eguitable subordination
In its objection to confirmation, the Equity Committee
contends that there is a viable claim for equitable subordination
of the Settlement Noteholders' claims. An individual shareholder
raised the same objection. The Settlement Noteholders argued
42 While the Settlement Noteholders assert that the Court
should apply a summary judgment standard because it has
considered the extensive evidence presented at the confirmation
hearings, the Court declines to do so because it substantially
restricted the discovery which the Equity Committee could take on
this issue.
109
preliminarily that the objection is procedurally defective. See,
~ , Protarga v. Webb (In re Protarga), Adv. No. 04-53374, 2004
WL 1906145, at *3 (Bankr. D. Del. Aug. 25, 2004) ("Claims for
equitable subordination must be brought as a separate adversary
proceeding pursuant to Rule 7001(8) ."). The Equity
Committee's motion for authority to bring an adversary action
solves that procedural requirement.
The Settlement Noteho1ders and the Creditors' Committee
contend, however, that the Equity Committee and shareholders do
not have standing to bring an equitable subordination claim based
on the requirements of the Constitution because they have
suffered no damages which could be remedied by equitable
subordination. See Lujan v. Defenders of Wildlife, 504 U.S. 555,
560 (1992) (discussing the three elements needed for standing:
(1) an injury in fact, which is concrete, particularized and
actual or imminent; (2) a causal connection between the injury
and the conduct; and (3) a likelihood that the injury will be
redressed by a favorable decision). They argue that even if the
Settlement Noteholders' claims are subject to equitable
subordination,43 they would simply be subordinated to other
43 In order to show a valid claim for equitable
subordination three elements are required: (1) engagement in some
type of inequitable conduct; (2) the misconduct resulted in
injury to the creditors or created an unfair advantage to the
defendant; and (3) the equitable subordination of the claim must
be consistent with the provisions of the Bankruptcy Code. See,
~ , United States v. Noland, 517 U.S. 535, 538-39 (1996);
110
creditors' claims and still be paid ahead of equity. See, e.g.,
Adelphia Recovery Trust v. Bank of Am., N.A., 390 B.R. 80, 99
(S.D.N.Y. 2008) (granting motion to dismiss equitable
subordination claim by creditors of parent against lenders of
subsidiary because "lilt follows reasonably from the judicial and
legislative interpretations of the statute that the 'other
creditors' whose welfare is the primary focus of equitable
subordination law must be creditors of the same debtor, as a
given claim may not be subordinated to an equity interest, but
only to another claim.") .
The Court agrees with the Settlement Noteholders and the
Creditors' Committee that under the plain language of the statute
equitable subordination only permits a creditor's claim to be
subordinated to another claim and not to equity. See 11 U.S.C.
510(c) (providing for equitable subordination of "all or part of
an allowed claim to all or part of another allowed claim") .
Equitable subordination is not a remedy available to (or of much
help in redressing any injury to) the shareholders for the
Settlement Noteholders' actions. Therefore, the Court finds that
the Equity Committee has failed to state a colorable claim for
equitable subordination of the Settlement Noteholders' claims.
Citicorp Venture Cap. Ltd. v. Comm. of Creditors Holding
Unsecured Claims, 160 F.3d 982, 986-87 (3d Cir. 1998); In re
Mobile Steel Co., 563 F.2d 692, 699-700 (5th Cir. 1977).
111
2. Claim for equitable disallowance
a. Availability of Remedy
The Equ Committee contends alternatively that, because of
the improper conduct of the Settlement Noteholders in trading on
material non-public information, the equitable disallowance of
their claims is warranted so that any distribution to which they
would be entitled is redistributed to other creditors and
ultimately to the shareholders.
44
See, e.q., Citicorp, 160 F.3d
at 991 & n.7 (3d Cir. 1998) (affirming equitable subordination of
insider's claim to other creditors because of trading on insider
information, but not precluding additional remedies such as
table disallowance and an award of expenses, fees, and other
costs caused by insider's conduct); Adelphia Commc'ns Corp. v.
Bank of Am., N.A. (In re Adelphia Commc'ns Corp.), 365 B.R. 24,
71-73 (Bankr. S.D.N.Y. 2007) (denying motion to dismiss because
equitable disallowance of claims by bankruptcy court remains
viable cause of action and equitable subordination is not the
exclusive remedy for wrongdoing), aff'd in relevant part, 390
44 The Indenture Trustee for the PIERS contends that even if
the Court equitably disallows the claims of the Settlement
Noteholders, the Indenture Trustee as the holder of the claims is
s 11 entitled to payment of 100% of those claims. The Court
disagrees. To the extent the Court disallows those claims, they
are disallowed regardless of who holds them. Cf. Enron Corp. v.
Sprinqfield Assocs., L.L.C. (In re Enron Corp.), 379 B.R. 425,
439-45 (S.D.N.Y. 2007) (concluding that transferee of a claim
could be subject to equitable subordination and disallowance
under section 502(d) for conduct of transferor if claim was
assigned, though not if it was sold).
112
B.R. 64, 74-75 (S.D.N.Y. 2008).
The Equity Committee argues that equitable disallowance of
the Settlement Noteholders' claims is warranted in this case
because they traded on insider information obtained while they
participated in settlement negotiations with the Debtor and JPMC.
See Pepper v. Litton, 308 U.S. 295, 311 (1939) {holding that
claim of insider who traded on ide information was properly
subordinated on equitable principles} .
The Equity Committee contends that the instant case is the
"paradigm case of inequitable conduct by a fiduciary." Citicorp,
160 F.3d at 987. Like the creditor in Citicorp, the Equity
Committee contends that the Settlement Noteholders purchased (and
sold) the Debtors' securities with "the benefit of non-public
information acquired as a fiduciary" for the "dual purpose of
making a profit and influenc[ing] the reorganization in [their]
own self-interest." rd. See also Wolf v. Weinstein, 372 U.S.
633, 642 (1962) ("Access to inside information or strategic
position in a corporate reorganization renders the temptation to
profit by trading in the Debtor's stock particularly
pernicious.") .
The Settlement Noteholders contend initially that equitable
disallowance is not a valid remedy under the Bankruptcy Code,
because it is not one of the specific exceptions to allowance of
a claim articulated in section 502(b). See, e.g., Travelers
113
Casualty & Surety Co. of Am. v. Pac. Gas & Elec. Co., 549 U.S.
443, 449-50 (2007) (holding that Bankruptcy Code does not bar
contractual claim for attorneys' fees incurred during bankruptcy
case because it was not disallowable under one of the nine
exceptions to disallowance under section 502(b)). See also
Mobile Steel, 563 F.2d at 699 (concluding that "equitable
considerations can justify only the subordination of claims, not
their disallowance"). The Settlement Noteholders argue that the
legislative history of the Code supports this argument, citing a
version of the Senate bill that did not get included in the
Bankruptcy Code, which would have provided that "the court may
disallow, in part or in whole, any claim or interest in
accordance with the equit of the case." S. 2266, 95th Congo
510 (c) (3) (1977).
The Equity Committee responds that both arguments were
rejected in the Adelphia case. 365 B.R. at 71, aff'd in relevant
part, 390 B.R. at 74-75. The Bankruptcy Court in Adelphia noted
that there is other 1 slative history that expressly states
that section 510 "is intended to codify case law, such as Pepper
V. Litton. and is not intended to limit the court's power in
any way.'" 365 B.R. at 71 (citing Kenneth N. Klee, Legislative
History of the New Bankruptcy Law, 28 DePaul L. Rev. 941 (1979),
reprinted in Collier on Bankruptcy, App. Pt. 4-1495)). As a
result, the District Court in Adelphia concluded that "the Court
114
cannot give any weight to the omission of Section 510(c) (3) of S.
2266 from the Bankruptcy Code, Congress could have decided to do
away with equitable disallowance, or it could have thought
specific reference to it was superfluous." 390 B.R. at 76.
In addition, the strict Court in Adelphia held that the
Travelers decision did not overturn the Pepper v. Litton decision
which nfairly read, certainly endorses the practice (in
appropriate circumstances) of the equitable disallowance of
claims, not on the basis of any statutory language, but as within
the equitable powers of a bankruptcy court."
Here, the Court agrees with the well-reasoned decisions of
the Bankruptcy and District Courts in Adelphia and concludes that
it does have the authority to disallow a claim on equitable
grounds ~ i n those extreme instances - perhaps very rare - where
it is necessary as a remedy." Adelphia, 365 B.R. at 73. See
also, Citicorp, 160 F.3d at 991 n.7 (disagreeing with district
court's conclusion that equitable subordination was the exclusive
remedy available for inequitable conduct and noting that Pepper
v. Litton expressly upheld the bankruptcy court's power to
disallow or subordinate a claim based on equitable grounds).
The cases cited by the Settlement Noteholders do not
foreclose the equitable disallowance of claims albeit under a
different analysis. Travelers, 549 U.S. at 449-50 (holding
that nSection 502(b) (1) disallows any claim that is
115
'unenforceable against the debtor . . . under any agreement or
applicable law' [which is] most naturally understood to
provide that, with limited exceptions, any defense to a cl
that is available outside of the bankruptcy context is also
available in bankruptcy."); Mobile Steel, 563 F.2d at 699 n.10
(concluding that equitable disallowance of claims is not
available because "would add nothing to the protection against
unfairness already afforded the bankrupt and s creditors. .
If the misconduct directed against the bankrupt is so extreme
that disallowance might appear to be warranted, then surely the
claim is either invalid or the bankrupt possesses a clear defense
against it."). Because the Equity Committee seeks to disallow
the claims of the Settlement Noteholders under facts that suggest
they violated the securities laws, the Court believes that the
Debtors would have a defense to those claims outside of the
bankruptcy context as well. See, e.g., SEC v. Universal Express,
Inc., 646 F. Supp. 2d 552, (S.D.N.Y. 2009) ("In addition to its
discretion to order disgorgement, a court has the discretion to
award prejudgment interest on the amount of disgorgement and to
determine the rate at which such interest should be calculated.
Awarding prejudgment interest, 'like the remedy of disgorgement
itself, is meant to deprive wrongdoers of the fruits of their
ill-gotten gains from violating securities laws.''') (quoting SEC
v. Lorin, 877 F. Supp. 192, 201 (S.D.N.Y. 1995), aff'd in part
116
and vacated in part, 76 F.3d 458 (2d Cir. 1996; SEC v.
Halic-iannis, 470 F. Supp. 2d 373, 385-86 (S.D.N.Y. 2009) (holding
that civil monetary penalties can be awarded for securities
violations, which designed to punish the individual violator
and deter future violations of the secur ies laws," and awarding
civil monetary penalties of $15 million, roughly the amount of
the defendant's ill-gotten gains).
b. Merits of claim
In Pepper v. Litton, the Supreme Court upheld the equitable
disallowance of the claim of an insider who traded on material
inside information, concluding that:
He who is in . a fiduciary position . . . . cannot
utilize his inside information and his strategic
position for his own preferment. He cannot violate
rules of r play by doing indirectly through the
corporation what he could not do directly. He cannot
use his power for his personal advantage and to the
detriment of the stockholders and creditors no matter
how absolute in terms that power may be and no matter
how meticulous he is to satisfy technical requirements.
308 U.S. at 311.
The TPS Group contends that, although the Court need not
decide that the Settlement Noteholders have violated the
securities laws, reference to insider trading cases illustrates
the magnitude of the Settlement Noteholders' inequitable conduct.
Supreme Court has recognized two theories of insider
trading under section 10(b): the theory" and the
theory." See SEC v. Cuban, 620 F.3d 551, 553
117
(5th . 2010). Under the classical theory, section 10(b) and
Rule 10b-5 are violated when a corporate insider (i) trades in
the securities of his corporation (ii) on the basis of (iii)
mate nonpublic information (iv) in violation of the fiduciary
duty owed to his shareholders. See, e.g., U.S. v. 0' Haqan, 521
U.S. 642, 651-52 (1997) ("Trading on such information quali
as a 'deceptive device' under 10(b) . because 'a
relationship of trust and confidence [exists] between the
shareholders of a corporation and those insiders who have
obtained confidential information by reason of their position
with that corporation.''') (citation omitted). Under the
misappropriation theory, by contrast, a corporate "outsider"
violates section 10(b) and Rule 10b-5 "when he misappropriates
confidential information for securities trading purposes, in
breach of a duty owed to the source of the information" rather
than a duty owed to the persons with whom he trades. Id. at 652.
The Equity Committee and the TPS Group both assert that the
Settlement Noteholders' conduct violated the classical theory of
insider trading. In addition, the TPS Group asserts that
Centerbridge violated the misappropriation theory.
i. Classical theory
(1) Material nonpublic information
The Settlement Noteholders argue that they did not trade on
any material nonpublic information. Instead, they contend that
118
the only material nonpubl information which they received from
the Debtors during the confidential periods were the estimated
amounts of the Debtors' tax refunds, which were disclosed by the
Debtors to the public before the Settlement Noteholders began to
trade again.
The Equity Committee and the TPS Group assert that the
Settlement Noteholders received additional nonpublic information
including the knowledge that a settlement was being discussed and
the relative stances the part were taking in those
negotiations. In particular, the Equity Committee and the TPS
Group focus on the term sheets exchanged by the parties.
According to the Equity Committee, the parties were conceding
issues at a time when the public knew only that the Debtors,
JPMC, and the FDIC were engaged in contentious litigation.
Materiality of nonpublic information is determined by an
objective, "reasonable investor" test: "[T]he law defines
'material' information as information that would be important to
a reasonable investor in making his or her investment decision."
In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1425
(3d Cir. 1997). With regard to information on events like a
potential merger, courts determine materiality based on a
balancing of both the "indicated probability that the event will
occur and the anticipated magnitude of the event light of the
totality of the company activity." Basic, Inc. v. Levinson, 485
119
U.S. 224, 238 (1988) (emphasis added).
The parties largely do not dispute that the magnitude of a
global settlement with JPMC and the FDIC would be great in this
case.
45
See, e.g., SEC v. Geon Indus., Inc., 531 F.2d 39, 47-48
(2d Cir. 1976) (stating that "[s]ince a merger which [a
company] is bought out is the most important event that can occur
a small corporation's life, to wit, its death, we think that
inside information, as regards a merger of this sort, can become
material at an earlier stage than would be the case as regards
lesser transactions - and this even though the mortality rate of
mergers in such formative stages is doubtless high."). The issue
the parties in this case dispute is the probability that a
settlement would occur, specifically whether the negotiations
were too tentative and the parties were too far apart.
The Debtors and the Settlement Noteholders contend that
neither the knowledge of negotiations nor the parties' relative
stances during the negotiations were material non-pubI
information because of the extreme distance between the part s'
45 Owl Creek alone argues that the magnitude factor is not
met here because, unlike a merger, settlement proposals are a
common and necessary component of bankruptcy cases. The Court
agrees that settlement proposals are common, but also notes that
statements of interest and merger proposals are just as common
and yet may be material. Basic, 485 U.S. at 238-39. What the
magnitude factor measures is not the fact that a proposal was
made, but what the result of the proposal would be if accepted
(i.e. the actual merger or settlement were consummated).
Geon Indus., Inc., 531 F.2d 39, 47-48 (2d Cir. 1976).
120
stances and the ebbs and flows of the negotiation process. See,
~ , Taylor v. First Union Corp. of S.C., 857 F.2d 240, 244-45
(4th Cir. 1988) (holding that "preliminary, contingent, and
speculative" negotiations were immaterial because there was "no
agreement as to the price or structure of the deal"); Filing v.
Phipps, No. 5:07CV1712, 2010 WL 3789539, at *5-6 (N.D. Ohio Sept.
24, 2010) (finding that merger talks were not material where
parties had a "get acquainted" meeting and discussed executing a
confidentiality agreement); Levie v. Sears Roebuck & Co., 676 F.
Supp. 2d 680, 688 (N.D. Ill. 2009) (finding merger discussions
not material where they were preliminary in nature) .
According to the Settlement Noteholders, it would have been
sheer speculation that JPMC's position on one or more potential
settlement terms in March or November 2009 could have provided
assurance that JPMC would take that same position in future
complex, multi-party, multi-issue negotiations. In the context
of such a complex negotiation, the Settlement Noteholders argue
that the discussions could only be material once all the parties
reached an agreement in principal or at least came extremely
close to a deal. (D.I. 8429 at 10.)
The Court disagrees with this statement of materiality. The
Supreme Court has explicitly rejected the argument that there is
no materiality to discussions until an agreement-in-principle has
been reached. Basic, 485 U.S. at 237. In addition, the cases
121
cited by the Plan Supporters are distinguishable as they deal
only with preliminary discussions. Unlike the cases cited, here
the parties executed confidentiality agreements, exchanged a
significant amount of information, and engaged in multi-party
negotiations for over a year. The discussions went far beyond a
mere "get acquainted meeting." Filing, 2010 WL 3789539, at *5-6.
The Settlement Noteholders contend that whether a settlement
was likely to occur should be evaluated in light of the facts as
they existed at the time, not with the benefit of hindsight.
See, e.g., In re General Motors Class E Stock Buyout Sec. Litig.,
694 F. Supp. 1119, 1127 (D. Del. 1988) ("The probability of a
transaction occurring must be considered in light of the facts as
they then existed, not with the hindsight knowledge that the
transaction was or was not completed."). According to the
Settlement Noteholders, in this case at the conclusion of both
confidentiality periods, the parties felt that the negotiations
were dead and, therefore, they were not material.
The Court is not convinced, however, by this contention.
See, e.g., SEC v. Gaspar, 83 Civ. 3037, 1985 WL 521, at *14
(S.D.N.Y. Apr. 16, 1985) ("The ultimate success of the
negotiations is only one factor to consider" in determining
materiality). The first set of negotiations ended in March, with
the Settlement Noteholders claiming they were a "disaster," yet
the Debtors continued to negotiate with JPMC in April. (Tr.
122
7/20/2011 at 55-56.) In fact, Aurelius and Owl Creek berated the
Debtors for conducting settlement talks during that time without
them, indicating that the Settlement Noteho1ders themselves
viewed the negotiations as continuing and material. (Tr.
7/18/2011 at 73.)
The contention that settlement negotiations were dead (and
therefore not material) is also belied by the actions of
Centerbridge and Appaloosa. In July and August 2009 they engaged
in their own separate negotiations with JPMC, at which time they
both restricted their trading, even though they had not received
any other information from the Debtors.
46
The Equity Committee argues that the fact that there was
early agreement on several terms of the settlement negotiations
made them particularly material. The Settlement Noteholders
disagree, asserting that the market already understood the two
major components of any deal: that the Debtors were likely to
prevail in retaining ownership of the disputed bank deposits and
that, as a predicate for a plan, some agreement on the tax
46 Centerbridge stated that such restrictions were taken
only out of \\an abundance of caution" but admitted that an
acceptable counterproposal from JPMC might \\nudge the
negotiations towards the 'materiality' end the spectrum of the
settlement negotiations, in that an acceptable proposal could
lead to further fruitful negotiations." (0.1. 8430 at 17-18.)
The Court is unconvinced by this explanation. Centerbridge
admits that determined quickly that JPMC's counter-proposal
was inadequate, yet continued to restrict trading until six days
after JPMC withdrew its counter-proposal.
123
refunds would have to be reached between the Debtors and JPMC.
See Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 166 (2d Cir.
1980) (finding that the confirmation of facts that "were fairly
obvious to all who followed the stock . . cannot be deemed
'reasonably certain to have a substantial effect on the market
price of the security.'").
Again, the Court disagrees. There is no evidence in the
record that the market knew that the Debtors would prevail on the
disputed bank deposits or that there would be a settlement on the
tax refunds. All the public knew was that the Debtors, JPMC, and
the FDIC were litigating those issues. In fact, the Court was
prepared to issue a decision on the summary judgment motions
filed by the parties on the bank deposit issue when the GSA was
announced.
The Settlement Noteholders argue further that the
probability of a settlement cannot be evaluated based on
agreement on a few terms but must be viewed as a whole. Despite
the fact that some terms did not change, the Settlement
Noteholders note that many terms were constantly changing as
later term sheets were exchanged. (Tr. 7/21/2011 at 109.) At
one point, JPMC changed its stance in the negotiations so
drastically that the Debtors viewed it as essentially
"reset [ting] the bookends" of any potential deal. (EC 16; Tr.
7/18/2011 at 108.) The Settlement Noteholders warn that if
124
disclosure of the constantly changing settlement terms was
required, it result in endless bewildering guesses as to
the need for disclosure, operate as a deterrent to the legitimate
conduct of corporate operations, and threaten to 'bury the
shareholders in an avalanche of trivial information.'ff Taylor,
857 F.2d at 245.
This same argument was denounced by the Supreme Court when
it rejected the standard for evaluating
materiality of merger discussions and appl equally here.
Three rationales have been offered in support of the
test. The first derives from
the concern expressed in TSC Industries that an
investor not be overwhelmed by excessively detailed and
trivial information, and focuses on the substantial
risk that preliminary merger discussions may collapse:
because such discussions are inherently tentative,
disclosure of their existence itself could mislead
investors and foster false optimism. The first
rationale, and the only one connected to the concerns
expressed in TSC Industries, stands soundly rejected,
even by a Court of Appeals that otherwise has accepted
the wisdom of the agreement-in-principle test.
assumes that investors are nitwits, unable to
appreciate - even when told - that mergers are risky
propositions up until the closing." Disclosure, and
not paternalistic withholding of accurate information,
is the policy chosen and expres by Congress.
Basic, 485 U.S. at 237 (quoting Flamm v. Eberstadt, 814 F.2d
1169, 1175 (7th Cir. 1987).
The Plan Objectors disagree with the Settlement Noteholders'
contention that the settlement negotiations were too tentative to
be material. The TPS Group asserts that over the course of
negotiations it became clear that a settlement was more probable
125
(as issues were resolved) and that the funds available to the
estate were increasing. The Plan Objectors argue that the
materiality of the information is evident from the fact that as
soon as the Settlement Noteholders were free to trade on that
information they did: engaging in what the Equity Committee
characterizes as a "buying spree" concentrating on acquiring (at
a discount) junior claims because the Settlement Noteholders knew
(although the public did not) that the junior creditors were
likely to receive a recovery. (AOC 18; AOC 54; AOC 62; Au 8.)
The Equity Committee also asserts that a materiality
inference can be drawn from the fact that the Settlement
Noteholders requested (and the Debtors granted) a termination of
the Second Confidentiality Period a day early, on December 30,
2009, in order to permit them to trade before the end of the
year. (Tr. 7/18/2011 at 111.) See, e.g., Basic, 485 U.S. at 240
n.18 ("We recognize that trading (and profit making) by siders
can serve as an indication of materiality."); United States v.
Victor Teicher & Co., No. 88 CR. 796, 1990 WL 29697, at *2
(S.D.N.Y. Mar. 9, 1990) (citing the "very fact of [defendant's]
trading" as "evidence of the materiality of the information") .
The Settlement Noteholders respond that materiality cannot
be gleaned from the trades in question, however, because some of
the Settlement Noteholders were selling while others were buying
or not trading at all. (AOC 18; AOC 54; AOC 62; Au 8.) If the
126
settlement discussions had any materiality, the Settlement
Noteholders argue that they would have all traded in the same
fashion. They point to Appaloosa and Centerbridge as an example.
Both received a summary of the Debtors' April negotiations and
JPMC's August counter-offer during their own separate
negotiations, yet they engaged in opposite trades after receiving
that information. {AOC 54; AOC 62.} In another instance,
Aurelius sold PIERS on March 8, 2010, four days before the
announcement of the GSA, after which the price of the PIERS
skyrocketed. {Au 8.} According to the Settlement Noteholders,
if Aurelius possessed material nonpublic formation regarding
the settlement, it would not have made such an unwise trade.
The fact that the Settlement Noteholders made unwise or
contrary trades, however, does not provide a defense to an
insider trading action. See, e.g., SEC v. Thrasher, 152 F. SUpp.
2d 291, 301 (S.D.N.Y. 2001) (concluding that a tippee is
potentially liable for insider trading even if it loses money by
trading on false information) {citing Bateman Eichler, Hill
Richards, Inc. v. Berner, 472 U.S. 299, 318 (1985.
The Court does find difficult to draw any conclusions
from the Settlement Noteholders' trades. The Settlement
Noteholders actively traded in the Debtors' securities prior to,
and after, the confidentiality periods. It is possible that
their trades were based on the publically disclosed information
127
regarding the tax refunds, but because full discovery on
Settlement Noteholders' internal trading decisions has not been
permitted to date, the Court is unable to reach any conclusion
based on the trades alone.
Based on the evidence presented thus far, however, it
appears that the negotiations may have shifted towards the
material end of the spectrum and that the Settlement Noteholders
traded on that information which was not known to the public.
Consequently, the Court finds that the Equity Committee has
stated a colorable claim that the Settlement Noteholders received
material nonpublic information. Further discovery would help
shed light on how the Settlement Noteholders internally treated
the settlement discussions and if they considered them material
to their trading decisions.
(2) Insider status
(a) Temporary Insider
Insiders of a corporation are not limited to officers and
directors, but may include "temporary insiders" who have "entered
into a speci confidential relationship in the conduct of the
business of the enterprise and are given access to information
solely for corporate purposes." D i r ~ s v. SEC, 463 u.S. 646, 655
n.14 (1983). See also In re Krehl, 86 F.3d 737, 743 (7th Cir.
1996) (holding that" [aJ ccess to ins information can be
sufficient to confer insider status even where there is no legal
128
right or ability to exercise control over a corporate entity") .
The Equity Committee and the TPS Group contend that the
Settlement Noteholders became temporary insiders when they were
given material non-public information creating a fiduciary duty
on their part towards other creditors and shareholders.
The Settlement Noteholders assert that temporary insider
status under the securities law is inapplicable to situations
where the corporation and the outsider work together toward a
goal in which they each have diverse interests and only applies
if they are working towards a common goal. Dirks, 463 U.S. at
655 n.14. According to the Settlement Noteholders, the Supreme
Court's use of the phrase ~ s o l e l y for corporate purposes" in
Dirks was meant to exclude instances where a corporate purpose
may be one or even the "primary reason" among others. Id.
Further, the Settlement Noteholders assert that the Debtors have
always been aware that the Settlement Noteholders' purpose for
participating in the negotiations was to further their own
economic self interest. (Tr. 7/21/2011 at 185, 202.)
The Equity Committee responds that the Debtors y gave the
Settlement Noteholders access to the settlement term sheets to
further the Debtors' efforts to effectuate a consensual plan of
reorganization, which was the common goal of both the Debtors and
the Settlement Noteholders. This, it argues, satisfies the
common corporate goal required by Dirks. 463 U.S. at 655 n.14.
129
In addition, the Equity Committee argues that the Settlement
Noteholders only obtained the information because they had
acquired blocking positions in two subordinated classes of
creditors (the senior subordinated notes and the PIERS). It
contends that this is sufficient to create a fiduciary duty on
their part to those two classes of creditors. Rickel &
Assocs., Inc. v. Smith (In re Rickel & Assocs., Inc.), 272 B.R.
74, 100 (Bankr. S.D.N.Y. 2002) (holding that creditors' committee
member could not use his position on committee to advance his own
personal interest at the expense of the unsecured creditors) .
The Court finds that the Equity Committee has stated a
colorable claim that the Settlement Noteholders became temporary
insiders of the Debtors when the Debtors gave them confidential
information and allowed them to participate in negotiations with
JPMC for the shared goal of reaching a settlement that would form
the basis of a consensual plan of reorganization.
(b) Non-statutory insider
Alternatively! the Equity Committee and TPS Group assert
that the Settlement Noteholders owed duties as non-statutory
insiders under bankruptcy law. See, e.g., Luedke v. Delta Air
Lines, Inc., 159 B.R. 385 (S.D.N.Y. 1993) (holding that plaintiff
stated a claim that creditors! committee assumed a duty to all
parties by becoming a joint sponsor and proponent of plan); In re
Wash. Mut., Inc., 419 B.R. 271, 278 (Bankr. D. Del. 2009) (noting
130
that of a class of creditors may, in fact, owe fiduciary
duties to other members of the class" when they hold themselves
out as representing that class); Official Comm. of Eguity Sec.
Holders of Mirant Corp. v. The Wilson Law Firm, P.C. (In re
Mirant Corp.), 334 B.R. 787, 793 (Bankr. N.D. Tex. 2005) ("[W]hen
a party purports to act for the benefit of a class, the party
assumes a fiduciary role as to the class."); Rickel, 272 B.R. at
100 (noting that creditors' committee member may not use s
position to advance his personal interest at the expense of the
creditor class); In re Allegheny Int'l, Inc., 118 B.R. 282, 298
(Bankr. W.D. Pa. 1990) (party who received "a great volume of
information that was not available to other creditors,
shareholders, and the general public" was a temporary insider) .
See generally Mark J. Krudys, Insider Trading by Members of
Creditors' Committees - Actionable!, 44 DePaul L. Rev. 99, 142
(1994) (noting that of creditor steering committees,
like official creditors' committees, appear to come within the
temporary insider definition articulated in Dirks"); Donald C.
Langevoort, 18 Insider Trading Regulation, Enforcement and
Prevention 3: 8 (database updated April 2011) recently,
the view has been expressed that members of a creditors committee
overseeing a reorganization of the issuer would be treated as
[temporary] insiders"). See also In re Winstar Commc' ns, Inc.. ,
554 F. 3d 382, 396-97 (3d C . 2009) (holding that parties who do
131
not fit the Bankruptcy Code definition of an insider may
nonetheless be insiders if they have a sufficiently close
relationship with the debtor to suggest that their transactions
were not conducted at arm's length).
The Equity Committee has alleged and presented some evidence
that the Settlement Noteholders could be considered insiders of
the Debtors because of their status as holders of blocking
positions in two classes of the Debtors' debt structure. As
such, it could be found that they owed a duty to the other
members of those classes to act for their benefit. Therefore,
the Court finds that the Equity Committee has stated a colorable
claim that the Settlement Noteholders are temporary insiders of
the Debtors.
(3) Knowledge
The Settlement Noteholders assert that there is no evidence
that they knowingly or recklessly traded while in possession of
material nonpublic information, and, therefore, the required
scienter element of an insider trading claim is lacking. See(
~ , Burlincton Coat Factory Sec. Litig., 114 F.3d at 1422
(finding that scienter requires a nstrong inference" that when
trading the defendant nknew or recklessly disregarded" the fact
that information in his possession was material). Because the
Debtors explicitly agreed to disclose any material nonpublic
information at the end of each confidentiality period, the
132
Settlement Noteholders contend that they had no knowledge that
the public did not know all material information. The Settlement
Noteholders note that the burden was on the Debtors to assure
that the disclosures were appropriate. (Au 16; Au 27; EC 24; EC
37; EC 111; EC 117; EC 141; EC 148.) See also Richard H. Walker,
Div. of Enforcement, Sec. Exch. Comm'n, Regulation FD - An
Enforcement Perspective (Nov. 1, 2000), 2000 WL 1635668, at *2
(stating that the regulation "places the responsibility for
avoiding selective disclosure, and the sks of engaging in it,
squarely on the issuer" of the information).
The Equity Committee responds that good faith reliance on
assurances of a third party, such as the source of the
information, to disclose all material information to the public
cannot be a defense. Such a rule would vitiate the insider
trading laws if a third party's assurances, with no further duty
of inquiry, automatically insulated a party from insider trading
liability. Further, the Equity Committee asserts that there is
clear circumstantial evidence (the volume of trades immediately
after the confidentiality periods ended) which show that the
Settlement Noteholders knowingly traded on the basis of the
material, nonpublic information. See, e.g., SEC v. Heider, 90
Civ. 4636, 1990 WL 200673, at *4 (S.D.N.Y. Dec. 4, 1990)
{allegations that volume of call option purchases spiked prior to
merger and that defendants were responsible for a significant
133
portion of that volume supported a "strong inference" of
defendant's scienter).
The Settlement Noteholders disagree, asserting that the
evidence of their trading does not support an inference of
scienter. Burlington Coat Factory Sec. Litig., 114 F.3d at 1424
(declining to infer fraudulent intent from "trading in the normal
course of events"). They argue that the trading volume can be
attributed to other facts of public record such as the momentum
of the tax bill through Congress and the Debtors' estimates of
their tax refunds.
While trades may provide circumstantial evidence of intent
or recklessness, the statute only requires that the Settlement
Noteholders have knowledge that they were in possession of
material nonpublic information. Whether or not they profited
from such knowledge or actually applied such knowledge in trading
is not a required element. United States v. Teicher, 987 F.2d
112, 120 (2d Cir. 1993) (stating that "[u]nlike a loaded weapon
which may stand ready but unused, material information can not
lay idle in the human brain") .
In addition the Court does not agree with the Settlement
Noteholders' reliance exception to the scienter element of
insider trading. The Settlement Noteholders each had strict
internal policies prohibiting insider trading. (EC 3; EC 19; EC
103; AOC 16.) The Equity Committee contends that notwithstanding
134
those internal polic ,the Settlement Noteholders knowingly
traded with knowledge that the Debtors were engaged in global
settlement negotiations with JPMC of which the trading public was
unaware. The Settlement Noteholders cannot use the Debtor or
their own counsel as a shield if they violated those policies.
The Court finds that the Equity Committee has made
sufficient allegations and presented enough evidence to state a
colorable claim that the Settlement Noteholders acted recklessly
in their use of material nonpublic information. Goldman v.
McMahan, Brafman, Morgan & Co., 706 F. Supp. 256, 259 (S.D.N.Y.
1989) ("An egregious refusal to see the obvious, or to
investigate the doubtful, may in some cases . . . be the
functional equivalent of recklessness."); Rolf v. Blyth, Eastman
Dillon & Co., Inc., 570 F.2d 38, 47 (2d Cir. 1978) ("Reckless
conduct is . . . 'an extreme departure from the standards of
ordinary care . . . to the extent that the danger was either
known to the defendant or so obvious that the defendant must have
been aware of it.'") (citation omitted).
ii. Misappropriation theory
The TPS Group also alleges that Centerbridge is liable under
the misappropriation theory which provides that insider trading
can be found where "(1) . the defendant possessed material,
nonpublic information; (2) which he had a duty to keep
confidential; and (3) . . . the defendant breached his duty by
135
acting on or revealing the information in question." SEC v.
Lyon, 605 F. Supp. 2d 531, 541 (S.D.N.Y. 2009). Liability
attaches where ~ t h e tippee traded on the misappropriated
information when [it] knew or should have known it was
misappropriated." SEC v. Willis, 777 F. Supp. 1165, 1169
(S.D.N.Y. 1991).
According to the TPS Group, the Debtors shared information
about the April 2009 negotiations with Fried Frank which was
under a written confidentiality agreement barring it from sharing
information with its clients, unless they were subject to
confidentiality agreements of their own. (EC 10; D 408.)
Nonetheless, on July 1, 2009, Fried Frank shared summaries of the
April negotiations with both Centerbridge and Appaloosa, who were
not at the time subject to a confidentiality agreement with the
Debtors. (EC 215.) Centerbridge continued to trade, while
Appaloosa voluntarily rest cted its trading. The TPS Group
asserts that, as a result, Fried Frank breached its duty of
confidentiality to the Debtors and Centerbridge misappropriated
confidential information.
The TPS Group asserts that Centerbridge knew or should have
known that the information was restricted and subject to Fried
Frank's confidentiality obligations to the Debtors. (Tr.
7/21/2011 at 30-31.) SEC v. Musella, 578 F. Supp. 425, 442
(S.D.N.Y. 1984) (finding knowledge where the individual was a
136
. market professional" who should have
inquired about the circumstances of the tip
received") .
In addition, the Equity Committee contends that following
the Second Confidentiality Period, material information was
shared with the Settlement Noteholders by Fried Frank. The
Settlement Noteholders contend, however, that although they had
discussions and meetings with Fried Frank about the plan of
reorganization, they received no material information from Fried
Frank about the substance of the negotiations during this period.
(Tr. 7/18/2011 at 116, 119; Tr. 7/19/2011 at 144; Tr. 7/20/2011
at 75; Tr. 7/21/2011 at 136.) The Court has substantial doubts
about these assertions. Further discovery on this issue would
fy this point.
For all the above reasons, the Court finds that the Equity
Committee and the TPS Group have stated a colorable claim that
the Settlement Noteholders engaged in insider trading under the
classical and misappropriation theories.
The Settlement Noteholders warn that any finding of insider
trading will chill the participation of creditors in settlement
discussions in bankruptcy cases of public companies. The Court
disagrees. There is an easy solution: creditors who want to
participate in settlement discussions in which they receive
material nonpublic information about the debtor must ther
137
restrict their trading or establish an ethical wall between
traders and participants in the bankruptcy case. These types of
restrictions are common in bankruptcy cases. Members of
creditors' committees and equity committees are always subject to
these restrictions. See e.g., Adelphia, 368 B.R. at 152 n.11.
The Court does not believe that a requirement to restrict trading
or create an ethical wall in exchange for a seat at the
negotiating table places an undue burden on creditors who wish to
receive confidential information and give their input.
c. Burden on estate
The Court is required, however, to balance the probability
of success on the claim against the burden on the estate that
would result from its prosecution. Judging from the vigor with
which the Settlement Noteholders have opposed the Equity
Committee's standing motion, the Court is concerned that the case
will devolve into a litigation morass. In addition, the Court
notes that as the case continues, the potential recoveries for
all parties in the case dwindles. Regardless of which parties
prevail, they may be disappointed to find their recovery
significantly less than expected.
Therefore, before the Equity Committee proceeds with its
claim any further, the Court will direct that the parties go to
mediation on this issue, as well as the issues that remain an
impediment to confirmation of any plan of reorganization in this
138
case. A status hearing to discuss this will be held at the
omnibus hearing currently scheduled for October 7, 2011, 11:30
am.
IV. CONCLUSION
For the foregoing reasons, the Court will deny confirmation
of the Plan, grant but stay the Equity Committee's standing
motion, and direct the parties to proceed to mediation.
An appropriate Order is attached.
DATED: September 13, 2011 BY THE COURT:
Mary F. Walrath
United States Bankruptcy Judge
139
EXHIBITC
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
In re: ) Chapter 11
)
WASHINGTON MUTUAL, INC., et al., 1 ) Case No. 08-12229 (MFW)
)
Debtors. ) Jointly Administered
) Hearing date: July 28,20II at II :30 a.m. (Requested)
) Objection deadline: July 22,2011 at 5:00 p.m. (Requested)
MOTION FOR AN ORDER AUTHORIZING THE
OFFICIAL COMMITTEE OF EQUITY SECURITY HOLDERS TO COMMENCE
AND PROSECUTE CERTAIN CLAIMS OF DEBTORS' ESTATES
The Official Conunittee of Equity Security Holders (the "Equity Conunittee") of the
above-captioned debtors and debtors in possession (the "Debtors"), by and through its
undersigned counsel, hereby files this motion (the "Motion") for entry of an order pursuant to
Sections 105, 1103 and 1109 oftitle 11 of the United States Code (as amended, the "Bankruptcy
Code") authorizing the Equity Conunittee to conunence and prosecute certain claims and causes
of action (the "Claims") against Centerbridge Partners, L.P. and certain of its managed funds
("Centerbridge") and Aurelius Capital Management, LP and certain of its managed funds
("Aurelius") on behalf of the Debtors' Chapter 11 estates. In support of this Motion, the Equity
Conunittee respectfully states as follows:
PRELIMINARY STATEMENT
1. In this motion, the Equity Conunittee seeks standing to conunence and pursue an
action for equitable disallowance of the claims held by Aurelius and Center bridge, two hedge
funds that are major creditors of the WMI Estate. As two members of the ad hoc creditors group
I The Debtors in these chapter II cases, along with the last four digits of each Debtor's federal tax
identification number, are: Washington Mutual, Inc. (3725) and WMI Investment Corp. (5396). The Debtors'
principal offices are located at 1301 Second Avenue, Seattle, Washington 98101.
{00535688;vl}
known as the Settlement Note Holders,
2
Aurelius and Centerbridge engaged in a campaign to
obtain confidential infonnation about the Estate's most valuable assets, including its claims
against JPMorgan Chase Bank, N.A. ("JPMC',). and then used that infonnation to infonn the
management of their WMI securities portfolio. This conduct violates federal securities laws,
cheats other less-well-connected creditors, and undermines public confidence in the bankruptcy
system. The factual basis for these claims is set forth in the proposed Complaint, attached hereto
as Exhibit A.
2. Rather than take steps to protect other, smaller creditors and stakeholders from
these hedge funds' predatory trading, the Debtors actually enabled that trading by feeding the
Settlement Note Holders confidential infonnation, then enabling trading based on a flimsy
determination that all 'material" confidential infonnation had been disclosed. The Debtors have
taken steps to block the Equity Committee's investigation into this conduct and have publicly
stated that the allegations are merit1ess. As a result, the Equity Committee seeks standing to
pursue these claims on the Debtors' estates' behalf.
3. At the hearing on confinnation of the Debtors' Modified Sixth Amended Plan, the
Equity Committee will proffer evidence of Aurelius' and Centerbridge's inequitable and
unlawful trading activities. The Equity Committee asks the Court to consider that evidence in
determining whether the claims against Aurelius and Center bridge are colorable and should be
pursued.
The "Settlement Note Holders" as the term is used herein means Appaloosa Management L.P. and certain
of its funds ("Appaloosa"), Owl Creek Asset Management, L.P. and certain of its funds ("Owl Creek"),
Centerbridge and Aurelius.
{00535688;vl} 2
2
JURISDICTION
4. This Court has jurisdiction to consider this matter pursuant to 28 U.S.C. 157
and 1334. This is a core proceeding pursuant to 28 U.S.C. 157(b). Venue is proper before this
Court pursuant to 28 U.S.C. 1408 and 1409. The statutory predicates for this Motion are
Bankruptcy Code Sections 105, 11 03 and 11 09.
BACKGROUND
5. On September 26, 2008 (the "Petition Date"), each of the Debtors filed a
voluntary petition for relief under chapter 11 ofthe Bankruptcy Code.
6. The Debtors continue to operate their businesses and manage their properties as
debtors in possession pursuant to Sections 1107(a) and 1108 of the Bankruptcy Code.
7. On January 11, 2010, the United States Trustee for the District of Delaware
appointed the Equity Committee.
8. On February 11, 2011, the Court granted the Equity Committee's motion to take
limited discovery from the Settlement Note Holders under Fed. R. Bank. P. 2004 [Docket No.
6725]. The Equity Committee subsequently obtained some documents, including trading
records, from each of the four funds and took one deposition of a representative of each fund.
RELffiF REQUESTED
9. By this Motion, the Equity Committee seeks entry of an order authorizing the
Equity Committee to initiate an adversary proceeding against Aurelius and Centerbridge for the
purpose of prosecuting the Claims, and if appropriate, exclusive authority to propose one or more
settlements in respect of all or a portion ofthe Claims on behalf ofthe Debtors' estates.
{OOS3S688;vI} 3
BASIS FOR RELIEF
10. The Bankruptcy Code does not expressly confer power on an official committee
to pursue claims on behalf of a debtor's estate. Notwithstanding, courts have held that official
committees have an "implied, but qualified right . . . to initiate adversary proceedings in the
name of the debtor in possession under 11 U.S.C. 1l03(c)(5) and 1l09(b)." In re STN
Enters., 779 F.2d 901, 904 (2d Cir. 1985). In fact, the Third Circuit Court of Appeals has held
that a bankruptcy court may authorize a party-in-interest, such as an official committee, to pursue
litigation on behalf of the estate when the debtor fails or refuses to do so. See In re Cybergenics
Com., 330 F.3d 548, 566 (3d Cir. 2003) ("(W]e are satisfied that the most natural reading of the
Code is that Congress recognized and approved of derivative standing for creditors' committees.
Sections 1109(b) and 1 1 03(c)(5), taken together, evince a Congressional intent for committees to
playa robust and flexible role in representing the bankruptcy estate, even in adversarial
proceedings."); In re Yes! Entm't Corp., 316 B.R. 141, 145 (D. Del. 2003) ("[Bankruptcy Court
has] the power to authorize a creditors' committee to sue derivatively to recover property for the
benefit of the estate."); see also In re Adelphia Commnc'ns, 330 B.R. 364, 372-73 n.l6 (Bankr.
S.D.N.Y. 2005) ("[T]he provisions of the Bankruptcy Code imply a qualified right for creditors'
committees to sue on behalf of an estate with bankruptcy court approval."); In re Adelphia
Commnc'ns Corp., 285 B.R. 848, 855 (Bankr. S.D.N.Y.) ("[I]t is permissible, not uncommon,
and often desirable for official committees to seek and obtain the right to assert [a] claim on
behalf of the estate ... when there is doubt as to the debtor's ability or inclination to prosecute
the claim vigorously ...."). Even if the Bankruptcy Code did not confer standing on statutory
committee's directly, the Third Circuit opined that such standing could be conferred through the
bankruptcy court's equitable powers. In re Cybergenics Corp., 330 F.3d 548 at 568 ("[T]he
{OOS3S688;vl) 4
ability to confer derivative standing upon creditors' committees is a straightforward application
of bankruptcy courts' equitable powers").
11. Derivative standing should be conferred where: (1) a colorable estate claim exists
that (2) the debtor unjustifiably refused to pursue and (3) the bankruptcy court has permitted the
committee to initiate the action. See In re Yes! Entm't Corp., 316 B.R. at 145 (citing 0-1
Holdings, 313 B.R. 612, 628 (Bankr. D.N.J. 2004; In re Valley Media, Inc., 2003 WL
21956410, at *2 (Bankr. D. Del. 2003).
A. The Complaint Presents Colorable Claims.
12. The requirement that a claim be "colorable" presents a low bar. See Adelphia at
376 (stating that the required showing for colorable is "a relatively easy one to make"). It only
requires the Court to decide whether the movant has asserted "claims for relief that on
appropriate proof would support a recovery." In re STN Enters., 779 F.2d at 905. That is, it
must be merely ''plausible'' or "not without some merit." In re Colfor, Inc., 1998 WL 70718, at
*2 (Bankr. N.D. Ohio 1998).
13. The proposed Complaint attached as Exhibit A sets out the factual basis for the
Claims and demonstrates that they are colorable. In addition, the Equity Committee will submit
evidence relevant to the Claims at the hearing on confirmation of the Debtors' Modified Sixth
Amended Plan of Reorganization, which is scheduled to beginon July 13, 2011. The Equity
Committee asks that the Court consider this evidence in conjunction with this motion for
standing and that the Court determine whether the claims are colorable based on that evidence.
B. The Debtors Will Not Prosecute The Claims.
14. Where the debtor-in-possession unreasonably fails to pursue an estate claim or
cannot do so effectively because of conflicts-of-interest. an official committee may step into the
{OOS3S688;vl} 5
debtor's shoes and prosecute the claim as the representative of the estate. See In re Cybergenics
Corp., 330 F.3d at 577.
15. The Debtors have made it abundantly clear in multiple filings that they will not
pursue the Claims. They have stated that the allegations that form the basis for the Claims are
meritless and represent nothing more than a delay tactic by the Equity Committee. (See, e.g.,
Debtors' Supplemental Response to the Objection of the Official Committee of Equity Security
Holders to Confirmation of the Modified Sixth Amended Plan of Reorganization, July 11, 2011,
[Docket No. 8131] at pp. 14-27). The Debtors' own involvement in the unlawful trading
activities, including the blessing of the Settlement Note Holders' trading while the funds were in
possession of confidential information about settlement negotiations with JPMC, renders the
Debtors incapable of acting in the Estate's best interest with respect to the Claims.
16. If successful, the Claims will benefit the estate. Aurelius and Centerbridge have
undertaken an inequitable and unlawful scheme to garner enormous profits on WMI's debt
instruments. The hedge funds stand to gain tens or even hundreds of millions in ill-gotten gains
iftheir claims against the Estate are paid in full. Disallowance ofthese tainted claims will allow
the Estate instead to distribute the funds to innocent stakeholders.
17. Authorization of the Equity Committee to pursue this adversary proceeding
against Aurelius and Center bridge need not delay plan confirmation. If the Court determines that
the Debtors' Modified Sixth Amended Plan should be confirmed based on the evidence
submitted at the July 13, 2011 hearing, the Court can do so but order any distribution to Aurelius
or Center bridge be reserved pending resolution ofthis action.
{OO535688;vl} 6
C. The Equity Committee Seeks Prior Court Approval To Prosecute The Claims.
18. The final question regarding derivative standing is whether the movant has
obtained Court approval prior to asserting claims on behalf of the estate. This factor is easily
met as that is precisely the relief requested in the Motion. For the reasons stated above, the
Equity Committee respectfully submits that it should be granted.
RESERVATION OF RIGHTS
19. The Equity Committee reserves its rights to pursue additional claims against the
Settlement Note Holders and other defendants not currently named in the Complaint.
NOTICE
20. Notice of this Motion has been provided to (i) the Office of the United States
Trustee; (U) counsel to the Debtors; (iii) counsel to the Official Committee of Unsecured
Creditors; (iv) counsel to each of the Settlement Note Holders; and (v) those parties entitled to
notice pursuant to Bankruptcy Rule 2002, in accordance with Local Rule 2002-1(b). In light of
the nature of the relief requested herein, the Equity Committee submits that no other or further
notice is necessary.
NO PRIOR REOUEST
21. No prior request for the relief sought herein has been made to this Court or any
other courts.
CONCLUSION
WHEREFORE, the Equity Committee respectfully requests that this Court enter an
Order, substantially in the form annexed hereto as Exhibit B (a) granting the Equity Committee
leave, standing and authority to commence and prosecute the Claims on behalf of the Debtors'
estates; (b) granting the Equity Committee authority to propose settlements of the Claims,
{OO535688jvl} 7
subject to Court approval; and (iii) providing the Equity Committee such other and further relief
as the Court may deem just, proper and equitable.
Dated: July 12,2011
ASHBY & GEDDES, P.A.
Wilmington, Delaware
/s/ Gregory A. Taylor
William P. Bowden (DE Bar No. 2553)
Gregory A. Taylor (DE Bar No. 4008)
Stacy L. Newman (DE Bar No. 5044)
500 Delaware Avenue, 8th Floor
P.O. Box 1150
Wilmington, DE 19899
Telephone: (302) 654-1888
Facsimile: (302) 654-2067
wbowden@ashby-geddes.com
gtaylor@ashby-geddes.com
snewman@ashby-geddes.com
Delaware Counsel to the Official Committee of
Equity Security Holders ofWashington Mutual,
Inc., et al., and with respect to the Settlement Note
Holders, only as to Centerbridge Partners, L.P.,
Appaloosa Management L.P., and Owl Creek Asset
Management, L.P.
-and-
SUSMAN GODFREY, L.L.P.
Stephen D. Susman (NY Bar No. 3041712)
Seth D. Ard (NY Bar No. 4773982)
654 Madison Avenue, 5th Floor
New York, NY 10065
ssusman@susmangodfrey.com
dwalker@susmangodfrey.com
sard@susmangodfrey.com
{00535688;vl} 8
Parker C. Folse, III (W A Bar No. 24895)
Edgar Sargent (W A Bar No. 28283)
Justin A. Nelson (WA BarNo. 31864)
Daniel J. WaIker(WA BarNo. 38876)
1201 Third Ave., Suite 3800
Seattle, WA 98101
Telephone: (206) 516-3880
Facsimile: (206) 516-3883
pfolse@susmangodfrey.com
esargent@susmangodfrey.com
jnelson@susmangodfrey.com
dwalker@susmangodfrey.com
Co-Counsel to the Official Committee ojEquity
Security Holders oj Washington Mutual, Inc. et al.
-and-
SULLIVAN HAZELTINE ALLINSON LLC
/s/ William D. Sullivan
William D. Sullivan (DE Bar No. 2820)
901 N. Market St., Suite 1300
Wilmington, DE 19801
Telephone: (302) 428-8191
Facsimile: (302) 428-8195
bsuIlivan@Sha-llc.com
Conflicts Co-Counsel Jor the Official Committee oj
Equity Security Holders oJWashington Mutual,
Inc., et al., as to Aurelius Capital Management.
L.P.
{OOS3S68S;vI} 9
Exhibit A
(Complaint)
{00535688;vl}
---------------------------
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
Chapter 11
)
Inre: )
Case No. 08-12229 (MFW)
)
WASHINGTON MUTUAL, INC., et al., t
)
(Jointly Administered)
)
Debtors.
)
---------------------------)
OFFICIAL COMMITTEE OF EQUITY )
SECURITY HOLDERS ON BEHALF OF
)
THE ESTATE OF WASHINGTON
MUTUAL, INC.,
)
Adv. Pro. No. -___(MFW)
)
Plaintiff,
)
)
v.
)
)
)
CENTERBRIDGE PAR1NERS, L.P.,
CENTERBRIDGE CREDIT P AR1NERS,
)
L.P., CENTERBRIDGE CREDIT
)
PAR1NERS MASTER, L.P., AURELIUS
)
CAPITAL MANAGEMENT, LP,
)
AURELIUS CAPITAL MASTER, LTD.,
AURELIUS CONVERGENCE MASTER, )
LTD., AND ACP MASTER, LTD.,
)
)
Defendants,
)
)
and
)
)
WASHINGTON MUTUAL, INC.,
)
)
Nominal Defendant. )
COMPLAINT
The Debtors in these chapter 11 cases, along with the last four digits of each Debtor's federal tax
identification number, are: Washington Mutual, Inc. (3725) and WMI Investment Corp. (5396). The Debtors'
principal offices are located at 1301 Second Avenue, Seattle, Washington 98101.
Plaintiff, the Official Committee of Equity Security Holders (the "Equity Committee" or
"Plaintiff'), representing shareholders of Debtor, Washington Mutual, Inc. ("Debtor" or
"WMI"), for their complaint against Defendants pursuant to Sections 1 05 and 510 of the
Bankruptcy Code, and Rules 7001 and 3007 of the Federal Rules of Bankruptcy Procedure,
allege, upon infonnation and belief, as follows:
NATURE OF ACTION
1. This action seeks to redress the Defendants' abuse of the bankruptcy process by
inserting themselves into the Debtors' management of the Estate and then using confidential
infonnation that they learned as part of that process to unlawfully reap profits on their
investments in the Debtors' securities.
2. Both of the Defendants acquired material, infonnation about the
Debtors' assets and liabilities during the course of the bankruptcy. This non-public infonnation
included the tenns of settlement negotiations that the Debtors exchanged with JPMorgan Chase,
N.A. ("JPMC") in which JPMC offered the Estate billions ofdollars in exchange for a release of
claims. As far as the public was aware, at the time these negotiations were occurring, these
claims were still very much in dispute.
3. In addition to learning the terms of settlement negotiations, the Defendants were
given access to the Debtors' lawyers and advisors, including litigation counsel who provided
assessments of the Debtors' litigation claims. None of this infonnation was disclosed to the
public.
4. While in possession of this material, non-public infonnation about the value of
the Debtors' estate, both of the Defendants continued to trade in the Debtors' securities. Both
acquired tens of millions of dollars worth of the Debtors' bonds after learning about JPMC's
settlement offers and before the tenns of the final settlement with JPMC were announced to the
public. In addition, because both Defendants refused to restrict their ability to trade except
during limited periods, their management of the investment portfolio, including their decisions to
hold hundreds of millions in the Debtors distressed debt, is tainted by their knowledge of non
public information.
5. The Defendants stand to collect tens of millions of ill-gotten profits on their
investments in WMI securities. If the Debtors' Modified Sixth Amended Plan is approved, all of
the Debtors' senior and senior subordinated bonds will be paid in full, including post-petition
interest. The Defendants acquired most of these bonds at steep discounts, often at times when
the Defendants were aware of JPMC's offers to contribute billions of value to the Estate. This
profiteering from confidential information nominally obtained to further the interests of the
Estate caused injury to other creditors and claimants and also to the Estate itself. The
Defendants should not be pennitted to benefit from their inequitable conduct and their claims
should be disallowed.
JURISDICTION AND VENUE
6. This Court's jurisdiction is founded upon sections 157 and 1334 of title 28 of the
United States Code, in that this proceeding arises under title 11 of the United States Code (the
"Bankruptcy Code"), or arises in or is related to the above-captioned jointly administered chapter
11 cases under the Bankruptcy Code, which are pending in the United States Bankruptcy Court
for the District ofDelaware.
7. This civil proceeding is a core proceeding under sections 157(b)(2)(A), (B), (C),
(0), (H), (K) and (0) of title 28 of the United States Code.
8. Venue in this Court is appropriate under section 1409(a) of tide 28 of the United
States Code.
9. On ____,' 2011, the Court entered an Order [Docket No. --.J granting the
Equity Committee standing to commence this action.
THE PARTIES AND OTHER KEY PARTICIPANTS
10. The Equity Committee is the statutory committee of equity holders duly
appointed on January 11, 2010 in the Debtors' chapter 11 proceedings by the Office of the
United States Trustee for the District of Delaware.
11. Aurelius Capital Management, LP is a limited partnership engaged in the business
of, among other things, managing funds that acquire distressed debt and equity, with its principal
place ofbusiness in New York, New York. Aurelius Capital Master, Ltd., Aurelius Convergence
Master, Ltd., and ACP Master, Ltd are funds managed by Aurelius Capital Management, LP.
This Complaint refers to the funds and the management entity collectively as "Aurelius."
12. Center bridge Partners, L.P. is a limited partnership engaged in the business of,
among other things, managing funds that acquire distressed debt and equity, with its principal
place of business in New York, New York. Centerbridge Credit Partners, L.P. and Centerbridge
Credit Partners Master, L.P. are funds managed by Center bridge Partners, L.P. This Complaint
refers to the funds and the management entity collectively as "Centerbridge."
13. Upon information and belief, Owl Creek Asset Management, L.P. ("Owl Creek")
is a limited partnership engaged in the business of, among other things, managing funds that
acquire distressed debt and equity, with its principal place ofbusiness in New York.
14. Upon infonnation and belief, Appaloosa Management, L.P. ("Appaloosa") is a
limited partnership engaged in the business of, among other things, managing funds that acquire
distressed debt and equity, with its principal place ofbusiness in New Jersey.
15. The "Settlement Note Holders" comprise four hedge fund management entities,
Aurelius, Centerbridge, Appaloosa, and Owl Creek, and their affiliates and the funds that they
manage. Funds managed by each of these entities hold significant claims against the Estate in
various classes.
FACTS
History ofthe Settlement Note Holders Group.
16. The Settlement Note Holders started as two groups. The first group, Appaloosa
and Centerbridge, retained the same counsel to represent their joint interests in this bankruptcy
on or about September 2008. These two entities filed a single notice of appearance, a single
Rule 2019 statement and have always acted in concert in these proceedings.
17. The second group, Owl Creek and Aurelius, also began as one: they originally
belonged to a different ad hoc group, which has been referred to as the "WMI Note Holders,"
and which collectively held the other largest portion of the Debtors' estate and also acted in
concert to try to influence these proceedings.
18. In or around October 2009 Owl Creek and Aurelius left the WMI Note Holder
Group because of conflicts with senior noteholders. Shortly thereafter, Owl Creek and Aurelius
joined Appaloosa and Centerbridge to fonn the Settlement Note Holders. From that time until
very recently, these four entities have acted through the same counsel as a single group to jointly
advocate for their interests in this bankruptcy.
19. Beginning no later than January 2009, the Defendants and the other Settlement
Note Holders, in conjunction with other significant investors in the Debtors' securities, entered
into talks with counsel for the Debtors in efforts to obtain infonnation and exert influence over
the management of the Estate.
The Estate's Largest Assets Are Claims Against JPMorgan Chase.
20. From the beginning, the Settlement Note Holders' discussions with the Debtors
were focused in large part on the resolution of claims by the Estate against JPMC, which had
acquired the assets of WMI's subsidiary Washington Mutual Bank ("WMB'') the day before
WMI filed for bankruptcy protection.
21. The Estate's claims against JPMC represented by far the largest source of
potential recovery for WMI's creditors. Assets in dispute included a number of individual items
worth billions of dollars each: (1) over $4 billion that the Estate claimed WMI had on deposit at
WMB but over which JPMC maintained control and asserted a competing claim to ownership on
various grounds; (2) over $10 billion in collateral for certain WMI securities known as the Trust
Preferred Securities (''TPS''), the ownership of which was claimed by JPMC, WMI, and the
holders ofthe securities; (3) $2.6 billion in tax refunds due from the IRS, an amount that grew to
over $5 billion in November 2009 when the United States Congress extended the carry-back
period for tax losses.
22. The face amount of WMI's debt securities outstanding at the time of the
bankruptcy was approximately $6.65 billion. Each of the multi-billion dollar assets in dispute
with J P M C ~ t h e deposits, the TPS collateral, and the tax refunds-is individually material in the
context of the Estate as a whole, as were.a number of other assets in dispute between JPMC and
WMI.
23. In late January 2009, a group of WMI investors including Aurelius and Owl
Creek jointly drafted a proposal for a global settlement of all claims between JPMC and the
Estate. The hedge funds provided a copy of the proposal in the form of a term sheet to the
Debtors. Under this proposal, the full amount of the $4 billion deposit claim would be turned
over to the Estate and all of the TPS collateral would be retained by JPMC. As a settlement
proposal that would satisfy a substantial share of the Estate's creditors, this term sheet
constituted material information for investors in WMI securities at all times at least until March
12, 2010 when the terms of a global settlement between JPMC and the Debtors was publicly
announced.
The Settlement Note Holders' March 2009 Settlement Meeting With JPMC.
24. In March 2009, the Settlement Note Holders became directly involved in
negotiations with JPMC. On March 10,2009, the Debtors and JPMC held their first face-to-face
meeting to discuss global resolution of their claims and counter-claims. At the invitation of the
Debtors, the Settlement Note Holders attended and participated in this meeting.
25. At the March 10, 2009 meeting, attorneys from the firm White & Case, which
represented Aurelius and Owl Creek, presented a global settlement proposal to JPMC on behalf
of the Estate. The Debtors did not present their own proposal at the meeting, nor did JPMC
respond with a counter-proposal. The terms of the White & Case proposal included the release
of the full $4 billion in deposits to the Debtors and the retention by JPMC of the TPS collateral,
as well as proposed resolutions of all other significant disputes between the parties.
26. The terms of the White & Case proposal constituted material, non-public
information at all times at least through March 12, 2010 when the terms of a global settlement
between JPMC and the Debtors were publicly announced.
27. On or around March 18,2009, JPMC responded to the White & Case settlement
offer with an offer of its own. JPMC's counter-offer reflected agreement that the $4 billion in
deposits would be turned over to the Debtors, less an amount representing a portion of the tax
refund claim, and that JPMC would receive the TPS collateral. It also reflected agreement on the
majority ofthe other items in dispute.
28. The terms of JPMC's counter-offer constituted material, non-public information
at all times at least through March 12,2010 when the terms of a global settlement between JPMC
and the Debtors were publicly announced .
.!fqri[ Exchange ofSettlement Proqosals Between JPMC and the Debtors.
29. In mid-April, 2009, the Debtors and JPMC again exchanged settlement offers.
The terms ofthe April proposals were based on the parties' March terms. Proposed resolution of
the deposits, the TPS collateral, and many other items remained essentially unchanged from the
proposals made in March. Each party agreed to compromises with regard to other terms and
JPMC offered the Estate a portion of the tax refund claim, which JPMC had claimed entirely for
itself in its March offer.
30. The April term sheets from the Debtors and from JPMC were shared with
attorneys for the Settlement Note Holders who told their clients that additional term sheets had
been exchanged.
Mav 6. 2009 Meeting Between the Settlement Note Holders and the Debtors.
31. On learning that additional negotiations had taken place without its involvement,
Aurelius informed the Debtors that settlement proposals must not be made without the prior
approval of the Settlement Note Holders. In response, the Debtors agreed to hold a meeting with
the Settlement Note Holders on May 6, 2009 at which the Debtors would discuss the current
state of negotiations with JPMC and at which the Debtors' litigation counsel would make a
presentation on the Debtors' litigation claims. This meeting was held at the offices of Weil
Gotshal and Manges, counsel for the Debtors.
32. The contents of the April tenn sheets from the Debtors and from JPMC, and the
information about the JPMC negotiations and the presentation by the Debtors' litigation counsel
at the May 6, 2009 meeting constituted material, non-public information at all times at least until
March 12, 2010 when the terms of a global settlement between JPMC and the Debtors was
publicly announced.
March 2009 Confidentiality Apeement and Trading Restrictions.
33. Before March 2009, none of the Settlement Note Holders had restricted their
ability to trade in WMI securities. Nor had any of them established internal ethical screens
between employees who were involved with the work on the Estate and employees who were
analyzing WMI securities or making trading decisions with respect to those securities.
34. The Debtors and the Settlement Note Holders understood that participation in
settlement discussions with JPMC would expose the Settlement Note Holders to material, non
public information related to WMl's securities. The Debtors required the Settlement Note
Holders to enter into confidentiality agreements that would protect this information from
disclosure (temporarily, as explained below) and would also supposedly guard against trading
based on the information.
35. In order to avoid trading based on material, non-public information, the
confidentiality agreements required the Settlement Note Holders either to refrain entirely from
trading in the Debtors' securities during the pendency ofthe agreement or to establish an internal
ethical wall between individuals who were exposed to the confidential information and others at
the finn who might be making or influencing trading decisions. Centerbridge claims to have
refrained from trading during the pendency of the March 9, 2009 confidentiality agreement.
Aurelius claims to have established an internal ethical wall.
36. The term of the confidentiality agreements was sixty days, though it could be
shortened by agreement of the parties or in certain other circumstances. The confidentiality
agreements were entered into effective March 9, 2009 and ran for their entire sixty day term,
expiring on May 8,2009.
37. At the insistence of Aurelius and other Settlement Note Holders, the
confidentiality agreements contained a clause requiring the Debtors to publicly disclose any
confidential infonnation that was shared with the Settlement Note Holders during the pendency
of the agreement. The purpose of this clause was to permit the Settlement Note Holders, after
the expiration of the agreement, to freely trade in WMI securities based on all infonnation they
learned during the pendency ofthe agreement.
Aurelius and Centerbridge Traded Despite Knowing Material Information That Was Not
Disclosed to the Public.
38. On April 30, 2009, the Debtors disclosed certain financial infonnation about
WMI, including the estimated size of the tax refund that would be available to the estate under
the then-applicable tax laws. The Debtors did not disclose the terms ofthe March or April offers
made by White & Case, the Debtors, or JPMC. Nor did they ever disclose the infonnation
shared with the Settlement Note Holders on May 6, 2009 about the state of negotiations with
JPMC or about the Debtors' litigation claims.
39. Both Aurelius and Centerbridge traded in the Debtors' securities in the three
weeks following the May 8, 2009 expiration of the confidentiality agreement. Aurelius acquired
$12 million in subordinated debt within the first three trading days after the agreement expired.
Centerbridge increased its holdings of WMI bonds by a net amount in excess of $20 million
within two weeks of the expiration of the confidentiality agreement.
Centerbridge andAppaloosa Exchanged Settlement otrers With JPMC In July and August.
40. In late June, 2009, Fried Frank, counsel for Centerbridge and Appaloosa,
provided its clients with a copy of the terms of the April offers that had been exchanged by the
Debtors and JPMC. Centerbridge and Appaloosa drafted a term sheet for another offer for global
settlement by modifying the Debtors' April term sheet. In July, Appaloosa and Centerbridge
provided their revised term sheet to JPMC, without the knowledge or involvement of the
Debtors. In August, JPMC provided another counter-offer. The majority of the items in dispute
remained unchanged from the April offers, including the agreements on the $4 billion deposit
claim and the TPS collateral. Both parties made additional concessions to the other with respect
to the claims for the tax refunds and the parties moved closer to reaching a global settlement.
41. The terms of the July and August offers exchanged by Centerbridge, Appaloosa,
and JPMC were material, non-pubHc information with respect to WMI's securities at all times at
least until the terms of a global settlement between JPMC and the Debtors was publicly
announced on March 12,2010.
42. Appaloosa voluntarily restricted itself from trading in WMI's securities while it
was engaged in the July and August negotiations with JPMC. Centerbridge did not restrict itself
and acquired a substantial number of the Debtors' securities during this period, increasing the
face amount of its net holdings of WMI securities by $85 million in the two week period
between August 4th and August 17th and an additional $50 million in between August 17th and
September 16th.
The Settlement Note Holders Again Entered Confidential Negotiations With JPMC and the
Debtors In November 2009.
43. In November 2009, the Debtors and the Settlement Note Holders again
collaborated on a global settlement offer to JPMC. The Debtors had obtained a copy of the
August AppaloosaiCenterbridge and JPMC tenn sheets. The November offer was drafted by the
Debtors and the Settlement Note Holders based on the August offers. Many provisions in the
offer remained unchanged from the March, April, and August tenn sheets, including the
agreement on the ownership ofthe deposits and the TPS collateral.
44. The Debtors provided the revised tenn sheet to JPMC on November 23,2009. On
November 30, 2009, JPMC responded with another counter-offer. This JPMC counter-offer
again expressed agreement on a majority oftenns, including the deposits and TPS collateral, and
offered the Debtors the full amount of the tax refund created by newly passed legislation that
extended the tax loss carry-back period. This refund attributable to the new law was estimated
by the Debtors to be worth at least $2.6 billion.
45. The tenns of the Debtors' November 23, 2009 settlement offer to JPMC and of
JPMC's November 30, 2009 settlement offer to the Debtors were material, non-public
information with respect to WMI's securities at all times at least until the tenns of a global
settlement between the Debtors and JPMC were publicly announced on March 12, 2010.
46. In order to participate in the November negotiations with JPMC, the Settlement
Note Holders again entered into confidentiality agreements with the Debtors. These agreements
were substantially the same as the agreements entered into in March 2009, including provisions
requiring the Settlement Note Holders to refrain from trading or to establish an ethical wall and
the provision requiring the Debtors, on the expiration of the agreement, to disclose all material,
confidential information that had been shared with the Settlement Note Holders.
47. The Settlement Note Holders entered into these confidentiality agreements on
November 16,2009 and they were tenninated early at the request of the Settlement Note Holders
on December 30, 2009.
48. The only confidential infonnation that the Debtors disclosed pursuant to their
obligations under the November 16, 2009 confidentiality agreements was an estimate of the size
of the tax refund attributable to the extended carry-back created by the new legislation. The
Debtors did not disclose any of the terms of their November 23, 2009 offer to JPMC or any of
the tenns of JPMC's November 30, 2009 Nor did they disclose any infonnation
about any subsequent negotiations with JPMC or discussions between the Debtors and any of the
Settlement Note Holders about further settlement offers.
Aurelius and Centerbridge Traded Based on Information Learned During the November
Negotiations.
49. All four Settlement Note Holders claim to have restricted themselves from trading
during the pendency ofthe November 16, 2009 confidentiality agreements.
50. Defendants Aurelius and Center bridge engaged in significant trading activity
immediately after the expiration of the November 16, 2009 confidentiality agreements. On
December 31, 2009, the day after the confidentiality agreement expired, Aurelius acquired over
five-hundred thousand PIERS, the debt security that is last to recover under WMI's priority
scheme. Centerbridge also acquired a substantial volume of PIERS in the period
following the expiration of the confidentiality agreem,ent.
51. Negotiations between the Debtors and JPMC continued in January and February
2010. A final settlement was reached in early March and the tenns of that settlement were
announced in open court on March 12, 2010. Under that settlement agreement, the Debtors
received the $4 billion in deposits, JPMC received the TPS collateral free of any claim by the
Debtors, and the tax refunds were divided approximately $2.160 billion to JPMC, $2.196 billion
to the Debtors, $850 million to the FDIC, and $335 million to bondholders ofWMB.
FIRST CLAIM FOR RELIEF
(Equitable Disallowance of Defendants' Claims or, Alternatively, Equitable
Subordination Under 11 U.S.C. SlO(c) Against All Defendants)
52. Plaintiff realleges the paragraphs above as if fully set forth herein.
53. As alleged herein, Aurelius and Centerbridge engaged in wrongful conduct that
injured the Debtors, other creditors, and the Debtors' equity owners.
54. As alleged above, with respect to the wrongful conduct directed at the Debtors
and equity, each of the named Settlement Note Holders acted as a single unit. Indeed, these
entities held themselves out to the Debtors and this Court as one unit on many occasions and all
acted under the same counsel.
55. Aurelius' and Centerbridge's conduct was inequitable because both funds
breached fiduciary duties for their own gain. Aurelius and Centerbridge assumed fiduciary
obligations to the Debtors, to other creditors and to equity in several ways: (1) by buying up
large quantities of WMI debt securities in order to obtain a blocking position and asserting
control over key decisions in the bankruptcy; (2) by undertaking settlement negotiations with
JPMC on behalf of the entire Estate; (3) by becoming temporary insiders who were made privy
to confidential information concerning the Debtors.
56. The Defendants violated these fiduciary duties by, inter alia, purchasing the
Debtors' securities both for their own profit and to wield further control over the course of
settlement negotiations. They used their control to benefit themselves at the expense of other
claimants, including equity and certain impaired creditors. For example, they used their control
to negotiate a settlement that paid them out nearly in full - and far above the post-petition prices
they paid for the securities - without attempting to pursue a recovery for equity or certain
impaired creditors.
57. Aurelius' and Centerbridge's conduct was also inequitable because it violated
federal securities laws. Both funds traded in the Debtors' securities while in possession of
material, non-public information. As discussed more fully above, material non-public
information in the possession of Aurelius and Center bridge at the time they engaged in trades of
WMI securities included: (1) the terms ofthe January 22,2009 settlement term sheet that a group
of creditors including the Settlement Note Holders provided to the Debtors; (2) the terms of the
March 2009 settlement proposals by the clients of White & Case on behalf ofthe Estate and by
JPMC; (3) the terms ofthe April settlement proposals by the Debtors and JPMC; (4) information
presented by the Debtors and the Debtors' litigation counsel at a meeting on May 6,2009; (5) the
terms of settlement proposals made by Appaloosa and Centerbridge and by JPMC in July and
August 2009; (6) the terms of settlement proposals made by the Debtors in conjunction with the
Settlement Note Holders and by JPMC in November 2009.
58. Aurelius and Centerbridge obtained this material, non-pUblic information while
serving as temporary insiders of the Debtors and Aurelius' and Centerbridge's use of this
information for their individual profit violates their duties as temporary insiders.
59. Aurelius and Centerbridge also obtained the material, non-public information
identified in categories (2), (3), (4), and (6) set forth in paragraph 57 above while bound by
confidentiality agreements that required Aurelius and Center bridge to use the information only
for the Debtors' corporate purpose of advancing settlement negotiations with JPMC. Aurelius'
and Centerbridge's use ofthis information to inform trading for their individual profit constitutes
misappropriation ofthe information.
60. Aurelius and Centerbridge engaged numerous trades of the Debtors' securities
while in possession of this infonnation and their decisions to execute those trades were based, in
whole or in part, on this infonnation.
WHEREFORE, Plaintiff respectfully requests that the Court enter judgment in favor of
Plaintiff equitably disallowing Defendants' claims in whole or in part and providing any other
equitable or legal relief that the Court deems appropriate.
Dated: July 12, 2011
ASHBY & GEDDES, P.A.
Wilmington, Delaware
/s/ Gregory A. Taylor
William P. Bowden (DE Bar No. 2553)
Gregory A. Taylor (DE Bar No. 4008)
Stacy L. Newman (DE Bar No. 5044)
500 Delaware A venue, 8th Floor
P.O. Box 1150
Wilmington, DE 19899
Telephone: (302) 654-1888
Facsimile: (302) 654-2067
wbowden@ashby-geddes.com
gtaylor@ashby-geddes.com
snewman@ashby-geddes.com
Delaware Counsel to the Official Committee of
Equity Security Holders ofWashington Mutual,
Inc., et al., and with respect to the Settlement Note
Holders, only as to Centerbridge Partners, L.P.,
Appaloosa Management L.P., and Owl Creek Asset
Management, L.P.
-and-
SUSMAN GODFREY, L.L.P.
Stephen D. Susman (NY BarNo. 3041712)
Seth D. Ard (NY Bar No. 4773982)
654 Madison A venue, 5th Floor
New York, NY 10065
ssusman@susmangodfrey.com
dwalker@susmangod:&ey.com
sard@susmangod:&ey.com
Parker C. Folse, HI (WA Bar No. 24895)
Edgar Sargent (WA Bar No. 28283)
Justin A. Nelson (WA Bar No. 31864)
Daniel J. Walker (WA Bar No. 38876)
1201 Third Ave., Suite 3800
Seattle, WA 98101
Telephone: (206) 516-3880
Facsimile: (206) 516-3883
pfolse@susmangodfrey.com
esargent@susmangodfrey.com
jnelson@susmangodfrey.com
dwalker@susmangodfrey.com
Co-Counsel to the Official Committee ofEquity
Security Holders of Washington Mutual, Inc. et al.
-and-
SULLIVAN HAZELTINE ALLINSON LLC
William D. Sullivan (DE Bar No. 2820)
4 East 8th Street, Suite 400
Wilmington, DE 19801
Telephone: (302) 428-8191
Facsimile: (302) 428-8195
bsullivan@Sha-llc.com
Conflicts Co-Counsel for the Official Committee of
Equity Security Holders ofWashington Mutual,
Inc., et al., as to Aurelius Capital Management,
L.P.
ExhibitB
(Proposed Order)
{OOS3S688;vl}
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE
In re: ) Chapter 11
)
WASHINGTON MUTUAL, INC., et ai., ) Case No. 08-12229 (MFW)
)
Debtors. ) Jointly Administered
)
) Related Docket No. ___
ORDER GRANTING THE OFFICIAL COMMITTEE OF EQUITY
SECURITY HOLDERS STANDING TO COMMENCE AND
PROSECUTE CERTAIN CLAIMS OF DEBTORS' ESTATES
Upon the motion (the "Motion") of the Official Committee of Equity Security Holders
(the "Equity Committee") of the above-captioned debtors and debtors in possession (the
"Debtors") for entry of an order pursuant to Sections 105, 1103 and 1109 of title 11 ofthe United
States Code (as amended, the "Bankruptcy Code") authorizing the Equity Committee to
commence and prosecute certain claims and causes of action (the "Claims") against Centerbridge
Partners, L.P. and certain of its managed funds ("Center bridge") and Aurelius Capital
Management, LP and certain of its management funds ("Aurelius") on behalf of the Debtors'
Chapter 11 estates; and the Court having considered the Motion and the Complaint; and the
Court having jurisdiction to considering the Motion and the relief requested therein pursuant to
28 U.S.C. 1334; and this being a core proceeding pursuant to 28 U.S.C. 157(b); and venue
being proper before this Curt pursuant to 28 U .S.C. 1408 and 1409; and due and proper notice
of the Motion having been provided, and it appearing that no other or further notice need be
provided; and the Court having determined that the legal and factual bases set forth in the Motion
establish just cause for the relief granted herein; and upon all of the proceedings had before the
Court, and after due deliberation and sufficient cause appearing therefore, IT IS HEREBY
ORDERED as follows:
{OOS3S688;vl}
1. The Motion is granted.
2. The Equity Committee is authorized to file a complaint. substantially in the fonn
attached to the Motion as Exhibit A, and pursue the causes of action stated therein against
Centerbridge and Aurelius.
3. The Equity Committee is granted sole authority to propose settlements of the
Claims, subject to Court approval.
4. This Court shall retain jurisdiction with respect to all matters and disputes arising
out of or relating to this Order.
Dated: Wilmington, Delaware
______-7.
2011
THE HONORABLE MARY F. WALRATH
UNITED STATES BANKRUPTCY COURT
{00535688;vl} 2
EXHIBITD
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Page 1
UNITED STATES BANKRUPTCY COURT
DISTRICT OF DELAWARE
- - - - x
In the Matter of:
WASHINGTON MUTUAL, INC., et al., Case No. 08-12229 (MFW)
Debtors. (Jointly Administered)
x
- x
NANTAHALA CAPITAL PARTNERS, LP,
BLACKWELL CAPITAL PARTNERS, LLC,
AXICON PARTNERS, LLC,
BRENNUS FUND LIMITED,
COSTA BRAVA PARTNERSHIP III, LLP,
SONTERRA CAPITAL MASTER FUND, LTD.
Plaintiffs, Adv. Proc. 10-50911 (MFW)
v.
WASHINGTON MUTUAL, INC.,
MICHAEL MURPHY,
WILLIAM REED, JR.
THOMAS LEPPERT,
STEPHEN CHAZEN,
STEPHEN FRANK,
REGINA MONTOYA,
PHILLIP MATTEWS,
ORIN SMITH,
MARGARET OSMER MCQUADE,
JAMES STEVER,
FRANCIS BAIER,
DAVID BONDERMAN,
CHARLES LILLIS
Defendants.
- - - - - - - - - - - - - - - - x
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
5
10
15
20
25
Page 2
1 - - - - - - - - - - - - - - - - -x
MICHAEL WILLINGHAM and ESOPUS
2 CREEK VALUE LP,
3 Plaintiffs,
v. Adv. Proc. 10-51297 (MFW)
4
WASHINGTON MUTUAL, INC.,
Defendant.
6 - - - - - - - - - - - - - - - - -x
-x
7 WASHINGTON MUTUAL, INC. and
WMI INVESTMENT CORP.
8
Plaintiff,
9
v. Adv. Proc. 10-53420 (MFW)
PETER J. AND CANDANCE R. ZAK
11 LIVING TRUST OF 2001 U/D/O
AUGUST 31, 2001, ET AL.
12
Defendant.
13 - - - - - - - - - - - - - - - - -x
- - - - - - - - - - - - - - - - -x
14 OFFICIAL COMMITTEE OF UNSECURED
CREDITORS OF WASHINGTON MUTUAL,
INC., ET AL., ON BEHALF OF CHAPTER
11 ESTATES OF WASHINGTON MUTUAL,
16 INC., ET AL.
Plaintiff,
17 v. Adv. Proc. 10-53149 (MFW)
18 ALEXANDER SASHA KIPKALOV,
- - - -x
19
AMY DRIVER ANDERSON, Adv. Proc. 10-53135 (MFW)
- -x
ANTHONY BOZZUTI, Adv. Proc. 10-53131 (MFW)
21 - - -x
CHANDAN SHARMA, Adv. Proc. 10-53147 (MFW)
22 - -x
DAVID M. SCHWARTZ, Adv. Proc. 10-53144 (MFW)
23 - -x
EDWARD F. BACH, Adv. Proc. 10-53132 (MFW)
24 - - - - - - -
-
- - - - - -x
GREGORY H. WOOD, Adv. Proc. 10-53137 (MFW)
i
- - - - - - - - - - - - - -x
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5 5
6
7
8
9
10 10
11
12
13
14
15 15
16
17
18
19
20 20
21
22
23
25 24
1
2
3
4
6
7
8
9
11
12
13
14
16
17
18
19
21
22
23
24
- - - - - - - - - - - - -
-x
HENRY J. BERENS,
- - - - - - - - - - - - - -x
HOWARD MATTHEWS,
- - - - - - - - - - - - - -x
JAMES CORCORAN,
- - - - - - - - - - - - - - - - -x
JIANGUO ZHONG,
- - - - - - - - - - - - - - - - -x
JOHN M. BROWNING,
- - - - - - - - - - - -x
JON I WYCKOFF,
- - - - - - - - - - - - - -x
KEITH O. FUKUI,
-
- - - - - - - - - - - - - - - -x
MARC MALONE,
- - - - - - - - - - - - - - - - -x
MATTHEW WAJNER,
- - - - - - - - - - - - - - - - -x
MICHAEL R. ZARRO,
- - - - - - - - - - - - - - -x
NIRMAL BAlD,
- -
- - - - - - - - - - - -x
PETER GERRALD,
- - - - - - - - - - - - - -x
PETER HELLER,
- - - - - - - - - - - - - -x
RACHEL M. MILEUR a/k/a
RACHELLE M. MILEUR,
- - - - - - - - - - - - - - - - -x
RICHARD BLUNCK,
- - - - - - - - - - - - - -x
ROBERT C. HILL,
- - - - - - - - - - - - -
-x
STEPHEN E. WHITTAKER,
- - - - - - - - - - - - - -x
STEVEN HERUTY,
- - - - - - - - - - - - - -x
THOMAS E. MORGAN,
- - - - - - - - - - - - - - - - -x
WILLIAM K. GLASBY,
Defendants.
- - - - - - - - - - - - - - - -
-x
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Adv.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Proc.
Page 3
10-53134 (MFW)
10-53134 (MFW)
10-53134 (MFW)
10-53148 (MFW)
10-53156 (MFW)
10-53151 (MFW)
10-53139 (MFW)
10-53152 (MFW)
10-53136 (MFW)
10-53143 (MFW)
10-53145 (MFW)
10-53138 (MFW)
10-53146 (MFW)
10-53133 (MFW)
10-53157 (MFW)
10-53153 (MFW)
10-53150 (MFW)
10-53141 (MFW)
10-53154 (MFW)
10-53142 (MFW)
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
5
10
15
20
25
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
1
2
3
4
6
7
8
9
11
12
13
14
16
17
18
19
21
22
23
24
Page 4
4
United States Bankruptcy Court
824 North Market Street
Wilmington, Delaware
July 18,
1:00 AM
2011
B E FOR E:
HON. MARY F. WALRATH
U.S. BANKRUPTCY JUDGE
ECR OPERATOR: BRANDON MCCARTHY
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 47
debtors. This was prepared in connection with responding to
the discovery requests of the equity committee, and it lays out
all of our trades from the inception of the position through
October the 6th. You'll see the last trade here is on the
30th. That's the last trade inside that window, the 30th of
September, 2010.
BY MR. ECKSTEIN:
Q. And for purposes of just following along this exhibit,
because we're going to come back to it a couple of times, am I
correct, Mr. Gropper, that the last trade is on the first page
at the top and the first trade is on the last page at the
bottom?
A. Correct. It's in reverse chronological order.
Q. Thank you. Did you assist with the creation of this
document?
A. Yes.
Q. Now, I'd like to walk you through some of -
MR. ECKSTEIN: Your Honor, I guess consistent with
what I had said originally, I'd like to move Aurelius Exhibit 8
into evidence.
MR. FOLSE: No objection, Your Honor.
THE COURT: All right. It's admitted.
(Aurelius Exhibit 8, Chronological Trade History, was hereby
received into evidence.)
Q. Now, Mr. Gropper, I'd like to walk you through some of the
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 48
key events in this case, and I'm going to break them down into
several time periods. The first period I want to walk you
through is between your first purchase of Washington Mutual
securities in October 2008 and the beginning of -- and March
2009. Is that okay?
A. Yes.
Q. Okay. Prior to March 2009, did Aurelius have any
involvement in settlement negotiations in this case?
A. We did not.
Q. Prior to March 2009, did Aurelius have any contact with
the debtors?
A. Yes.
Q. Can you explain?
A. Yes. At the beginning of the case we thought that it was
very important for the debtors to commence litigation in order
to recover -- turn over litigation in order to recover the
deposit from JPMorgan. I mentioned earlier that we thought the
deposit rightfully belonged to the holding company. And we
thought that it created not the right incentives to settle the
case if, in fact, JPMorgan was sitting on the deposit and
lending it out and earnings its interest spread and paying the
estate, you know, somewhere between three and twenty basis
points depending on which month you go by. So we thought it
was very important for the debtors to assiduously pursue that
litigation as and against JPMorgan. We had no relationship
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 49
with anyone at the debtors or with Mr. Kostoros, so we reached
out to Wei1 Gotsha1 and the f01ks who were named on the papers
that had been filed earlier on in the case.
Q. During this period did Aurelius become a member of an
unofficial or an ad hoc group of creditors?
A. We did. Late in January 2009 we joined a group that was
represented by White & Case. I think at the time that we
joined there were thirty-five-something members of that group
and about seven people on a steering committee.
Q. And do you recall who the members of the steering
committee were?
A. I believe at the time they were Silver Point, Elliott,
Davidson Kempner, Owl Creek, Deutsche Bank and Taconic.
Q. And did Aurelius become a member of the steering
committee?
A. We eventually did after joining that group.
Q. And did the members of the White & Case group hold a
particular security within the Washington Mutual capital
structure?
A. I'd say that most of the members of that group owned the
senior bonds, but ourselves, Owl Creek, and E1liott a1so owned
subordinated bonds and junior subordinated bonds.
Q. Was there a forma1 agreement binding the members of the
White & Case group?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 50
Q. So you had no agreement governing trading in the
Washington Mutual securities?
A. No, we never discussed trading.
Q. And was there an agreement governing how the members of
the group would vote securities in connection with a plan?
A. No.
Q. Can you explain what was the reason for Aurelius deciding
to join the White & Case group in January 2009?
A. Well, by that time the position had grown in size, and as
is typical for us in cases, we wanted to become involved in the
restructuring process. Oftentimes, we do that by joining with
other creditors who are already represented by counsel in order
to save cost and economize and so the court won't have, you
know, a whole bunch of creditors showing up filing different
pleadings. So we joined that ad hoc group of creditors
represented by White & Case.
Q. Okay. Now, prior to March 2009 did you or anyone at
Aurelius participate in any meetings with the debtor or
JPMorgan Chase?
A. No.
Q. And prior to March of 2009 did you or anyone from Aurelius
receive material nonpublic information about the debtors?
A. We did not.
Q. And let me turn your attention to the second period, which
is beginning in March 2009. Did there come a time when
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 51
Aurelius became more actively involved in settlement
negotiations in this case?
A. Yes. In March 2009 the debtors reached out to White &
Case and asked that some members of that group get restricted
for the limited purpose of attempting to negotiate a settlement
with JPMorgan and potentially the FDIC. Debtors reached out
and made the same request to the folks in the Fried Frank
group.
Q. Now, in connection with that request did you come to enter
into a confidentiality agreement in this case?
A. We did. We have often in cases entered into
confidentiality agreements that would restrict us for a limited
period of time, after which any information that we learn would
be disclosed by the debtors. It actually represents kind of
the best practice way to enter into settlement negotiations in
Chapter 11s, rather than just doing them on an ad hoc basis and
saying gee, let's have a meeting. This was actually a way
where we formalized our agreement, we formalized the period
during which we would be restricted, and we formalized the
requirement by which the debtors had to disclose any
information that we had obtained during the confidentiality
period. So it really laid out the metes and bounds of how the
negotiations would work with precision.
Q. Mr. Gropper, let me turn your attention to what is marked
Aurelius Exhibit 16 and ask you if you can identify that
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Paqe 63
MR. ECKSTEIN: Thank you.
Q. Mr. Gropper, similarly, Aurelius Exhibit 38, I'll ask you
to identify that document.
A. It's the confidentiality aqreement that Weil Gotshal used
just a month aqo to help facilitate a consensual neqotiated
resolution of the Lehman Brothers cases.
Q. Did Aurelius siqn this confidentiality aqreement?
A. Yes, we did.
Q. And did you siqn it on behalf of Aurelius?
A. Yes.
Q. And did you neqotiate this document on Aurelius's behalf?
A. Yes.
Q. And are you familiar with its terms?
A. I am.
Q. And did this also contain a provision that obliqated
Lehman to disclose material nonpublic information provided to
the siqnatories at the expiration of the aqreement?
A. Yes.
MR. ECKSTEIN: Your Honor, I'd like to move Exhibit 38
into evidence.
MR. FOLSE: Same objections, Your Honor.
THE COURT: Well
MR. ECKSTEIN: And finally
THE COURT: Overruled, and then the exhibit is
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 64
(Aurelius Exhibit 38, Lehman Brothers Confidentiality
Agreement, was hereby received into evidence.)
MR. ECKSTEIN: Thank you, Your Honor.
Q. And finally, Mr. Gropper, I'd like to -- you to do the
same thing with Exhibit 39.
A. It's the confidentiality agreement we entered into in
Capmark. It's an agreement that I negotiated and signed, and
it contained a similar cleansing provision.
MR. ECKSTEIN: Your Honor, if I may, I'd like to move
that exhibit into evidence as well.
MR. FOLSE: Objection, hearsay and relevance, Your
Honor.
THE COURT: Overruled. It's admitted.
(Aurelius Exhibit 39, Capmark Confidentiality Agreement, was
hereby received into evidence.)
Q. Thank you, Mr. Gropper. Let me turn back to the March
confidentiality agreement in this case that was entered into
with the debtors. Can you explain to the Court what happened
after Aurelius signed the confidentiality agreement on
March 9th, 2009?
A. Yes. Again, there were five members of the White & Case
group and two members of the Fried Frank group that signed this
agreement, and all seven of us were invited to a meeting at
Sullivan and Cromwell's midtown office. They were
Q. Who is Sullivan and Cromwell in this case?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 65
A. They were counsel to JPMorgan. And the creditors were put
in one room. JPMorgan was in one room. The FDIC was in
another. And the -- but the debtors helped to organize this
meeting to help facilitate a negotiated resolution.
Q. And what was discussed at this meeting?
A. Well, when we first arrived at the meeting Mike Walsh from
Weil Gotshal and Brian Rosen came in to the creditor room and
laid out for us a -- what their suggestion of what the debtor's
proposal should be to JPMorgan as an opening proposal to
attempt to resolve these cases. In order to understand this
proposal we asked Mr. Rosen and Mr. Walsh actually,
Mr. Kostoros was there as well -- we asked mainly Mr. Kostoros
a number of questions about the assets of the debtors.
He provided to us a very important piece of information,
which was that the tax refunds that Washington Mutual could
expect were in the range of 2.6 to three billion dollars. That
was not something that was known to us prior that meeting. It
was obviously a very material input for us, because we could
only go off the GAAP financials. There were some other
questions we asked Mr. Kostoros about the estate, some of which
he answered but frankly, most of which he said he would not
answer because he didn't want to be -- he, Mr. Kostoros, didn't
want to be in a position where he had to disclose the answer to
those questions at the end of the confidentiality period. So
he was quite careful about what he did and did not say to us at
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 66
that meeting.
And then after we obtained the information we could from
Mr. Kostoros, a bunch of us did a bunch of analysis mainly on
legal pads attempting to come up with consensus inside the
at least the creditors' side of the house, an appropriate
proposal to make to JPMorgan, because we thought the debtors
had not asked for enough. So we spent a couple hours going
back and forth within and among just the creditor group, and
then we had a later meeting with Weil Gotshal and Alvarez, and
eventually the parties coalesced around a proposal that would
be delivered to JPMorgan at that meeting.
Q. Now, I'm assuming this NOL information that Mr. Kostoros
provided to you at that meeting was material nonpublic
information at that point in time, was it not?
A. Yes.
Q. NOw, after you deliberated was a proposal ultimately made
to JPMorgan Chase at that meeting?
A. I believe that Mr. Uzzi from White & Case, Mr. Scheler
from Fried Frank accompanied Mr. Kostoros, Mr. Rosen and
Mr. Walsh into the JPMorgan room. I never actually spoke to
the JPMorgan folks at this meeting. And they went into that
room and delivered the proposal orally.
Q. And do you know whether JPMorgan responded to that
proposal at that meeting?
A. JPMorgan said they weren't prepared to respond to that
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 67
proposal at that meeting, so the meeting ended shortly
thereafter. It was sometime in the middle of the day.
Q. Now, let me turn your attention to Aurelius Exhibit 18 and
ask you if you can identify the document.
A. This is an e-mail from Mike Walsh of Weil Gotshal laying
out the terms that were provided to JPMorgan orally at that
meeting. It actually was, I learned thereafter, reduced to
writing and then submitted by Mr. Walsh to JPMorgan,
simultaneously copying the creditors. So we received the
written form at the same time JPMorgan did.
Q. NOw, can you summarize what you understood to be the main
elements, the main business elements of this proposal?
A. Yes. I think one element was, of course, that the deposit
was liberated to WHI. I spent some time earlier explaining why
we thought that was the right result in the case. And then
but the real, I would say, meat of this proposal was really
under the box -- I see it's highlighted -- called tax issues.
And this was a splitting, if you will, of the tax refund
between the estate and JPMorgan, which served to resolve both
the ownership issue associated with the tax refund as well as
the fraudulent conveyance claims I referred to earlier and the
preference claims. So there was a lot being resolved in this
one heading.
And the way this proposal worked is that the first 500
million dollars of taxes received went to WHI, and then the
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 68
remainder was split sixty-forty, excuse me, in favor of WMI.
And then there was a bill that had been pending in Congress
earlier that year that had subsequently dropped out of
consideration, but it provided that companies could extend the
look back for net operating losses to receive a tax refund from
three years to five years. And so that additional amount due
to 2008 extended five-year carry back, that refers to that,
which is really the tax refunds allocable to years four and
year five. And that was to be split eighty percent to WMI,
with the remainder going to JPMorgan.
And then there were a number of other terms, a number of
other assets, and I certainly don't want to minimize them by
not going into them because frankly, they're significant from a
dollar perspective. But they're later on in the term sheet.
MR. ECKSTEIN: Your Honor, I'd like to move Aurelius
Exhibit 18 into evidence.
MR. FOLSE: No objection.
THE COURT: It's admitted.
(Aurelius Exhibit 18, E-mail from Weil Gotshal, was hereby
received into evidence.)
MR. ECKSTEIN: Thank you.
Q. NOw, Mr. Gropper, do you know whether JPMorgan Chase
responded to this proposal?
A. Well, I think at the time I referred to their response as
the non-response response. What they actually did was they put
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 69
together a chart, which laid out their position on the various
assets. And I kind of viewed it more of a position statement
than a counterproposal, but I would say that they did respond.
Q. Can I ask you to turn to Aurelius Exhibit 19 and identify
that document?
A. That's the aforementioned non-response response.
Q. This is the term sheet or the document which has the
Sullivan and Cromwell draft March 18th, 2009 heading on it?
A. Correct.
Q. And was this document ever provided to you?
A. It was. It was provided first to White & Case and then it
went to us under the terms of the confidentiality agreement.
Q. And this was about ten days into the confidentiality
period that we were dealing with; is that correct?
A. That's right.
Q. NOW, can you -- as you described the debtor's proposal,
can you describe the principal terms of the JPM proposal or
response and explain how it compared to the debtor's proposal?
A. Well, it was light-years apart. I mean, basically
JPMorgan's response was, you guys get the deposit. And keep in
mind that JPMorgan and the debtors were actually negotiating a
stipulation at the beginning of these cases where JPMorgan was
going to just give back the deposit to the debtors. And this
was obviously all publicly reported, all occurred in this
courtroom. So you know, the fact that JPMorgan was willing to
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 70
give over the deposit was, you know, not news, because they had
already talked about doing it kind of in exchange for nothing
else very early on in the case.
But other than that, JPMorgan effectively said, we win on
every other legal dispute, which I frankly found to be not at
all commensurate with the legal rights of the parties. I mean,
take the ownership issue of the tax refund. The purchase and
sale agreement provided -- it said nothing about whether or not
the tax assets were transferred to JPMorgan, and it was a
pretty big asset so, you know, one would think that there may
be a mention of it.
But the only claim the subsidiary had to the tax assets of
the holding company were pursuant to a tax sharing agreement.
That's the tax sharing agreement that we had reviewed. It was
publicly filed as an exhibit to the 10-K. And so the only way
the subSidiary could get at the tax asset was to exercise its
right under the tax sharing agreement. Well, that's an
intercompany claim, and the purchase and sale agreement
specifically carved out intercompany claims. So from our
perspective, speaking just from Aurelius's, our approach to
analyzing that dispute, we said well, gee, it's pretty clear
that in our view JPMorgan didn't, in fact, buy the tax asset.
Additionally, there were six-and-a-half billion dollars of
downstream transfers that were made within one year of the
filing, two-and-a-half billion of which were made within ninety
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 77
Q. And can you describe what took place at that meeting?
A. Yes.
Q. I guess first, who attended the meeting, do you recall?
A. Sure. I attended with counsel from Kramer Levin. Elliott
attended with their counsel at Stuttman Treister. Owl Creek
attended. Mr. Uzzi was there as well. And then folks from
Weil Gotshal, Quinn Emanuel and Mr. Kostoros -
Q. Okay.
A. were there as well. The first part of the meeting we
cleared the air from a process perspective. Again, we had
known that the debtors had made another proposal to JPMorgan.
I don't actually recall whether we learned the terms of that
proposal or not. We know that JPMorgan had responded to that
proposal. I do know that we did not receive that response from
JPMorgan.
So frankly, we spent a very short amount of time at the
beginning of the meeting kind of clearing the air from a
process perspective, as we thought that it would not be
constructive to spend more time on it. And then, frankly, we
spent a lot of time explaining our view of the case, really to
Quinn Emanuel. I mean, they were new to the case. They
were -- you know, had been in the case for all of two weeks.
And they're great lawyers, but they were getting up to speed in
a very, very complex case where there were actually litigation
deadlines that needed to be responded to. We'd been working on
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
J?age 78
the case now for seven months and had spent a tremendous amount
of money and time understanding the various claims of WMI. So
the debtors were really in a listening mode at this meeting and
allowing us to transmit to them our view of the various causes
of action and how to maximize value on behalf of the estate.
Again, we had -- we at Aurelius had pushed the debtors to
assiduously pursue litigation against JJ?Morgan from very early
on in the case. The debtors had not heeded that advice. The
debtors chose to take a different tack. It's their case. And
so we at Aurelius had expressed a view that had not been
followed, but we wanted to continue to express our opinion, as
did the other creditors who were present there.
Q. Did the debtor communicate to you any material nonpublic
information at the May 6 meeting?
MR. FOLSE: Objection, Your Honor. This phrasing of
the question calls for a legal conclusion. He can ask
factually what information they received or didn't receive, but
to stick a label on it doesn't help.
THE COURT: All right.
MR. ECKSTEIN: I'm happy to rephrase, Your Honor.
THE COURT: All right.
Q. Can you explain what information, if any, the debtor
communicated to you at the May 6 meeting?
A. Well, I will say that the May 6 meeting started by
Mr. Rosen saying that he wasn't going to provide any material
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Paqe 79
nonpublic information to us at the meetinq. Mr. Rosen also
said at that meetinq that based on disclosures that had been
made in the monthly operatinq report or that had been filed
prior to that meetinq that everyone at the meetinq was free to
trade. Those were the words that he used. It turned out we
actually had another day or so on the confidentiality
aqreement, so we didn't. But it was made very clear that the
debtor wasn't qoinq to provide us material nonpublic
information. We confirmed that we did not want any material
nonpublic information.
Q. Okay. At this meetinq did the debtors commit to include
Aurelius in all future plan neqotiations?
A. They actually affirmatively did not commit.
Q. NOW, did there come a time when the confidentiality period
that beqan on March 9th expired?
A. Yes. It expired on May the 8th.
Q. And in connection with the expiration of the
confidentiality period, did the debtors take any action
consistent with the confidentiality aqreement, and in
particular paraqraph thirteen that you spoke about earlier?
A. Yes. The debtors made disclosure in the March monthly
operatinq report that was filed on April 30th, 2009, in which
they disclosed the material nonpublic information that we had
received durinq the pendency of the confidentiality aqreement.
Q. Can I ask you to turn your attention to Aurelius Exhibit
VERITEXT REPORTING COMPANY
212-267 -6868 www. veritext.eom 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 80
24 and ask you to identify the document?
A. That's the monthly operating report to which I just
referred.
Q. This is the monthly operating report filed by the debtors
for the month ending March 2009; is that correct?
A. That's correct.
Q. And did this document, in fact, contain the disclosures
that you just referred to?
A. Yes.
Q. Can you point the Court to where those disclosures were
made?
A. Yes. There were some minor disclosures in some of the
other notes, but the main disclosure was in note 5, which is on
the screen.
Q. That's the note titled "taxes"?
A. "Taxes", right. And it says in the second-to-Iast
sentence of the first paragraph, the "current estimate for the
total expected refunds, net of potential payments, is in the
range of approximately 2.6 to 3.0 billion dollars." That
sentence was not present in the monthly operating report filed
in the prior month.
Q. And was there any other information that the debtors
disclosed in this monthly operating report?
A. Yeah. There were some other pieces of information that
were described in some of the other notes, I just don't recall
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 81
what it was.
Q. Now, following the release -- excuse me.
MR. ECKSTEIN: Your Honor, I'd like to move Aurelius
Exhibit 24 into evidence.
MR. FOLSE: No objection.
THE COURT: It's admitted.
(Aurelius' Exhibit 24, Monthly Operating Report, was hereby
received into evidence.)
MR. ECKSTEIN: Thank you.
BY MR. ECKSTEIN:
Q. Now, following the release of the March monthly operating
report in termination of the confidentiality agreement, did
Aurelius believe that it was free to resume unrestricted
trading of the debtor's securities?
A. Yes.
Q. And what was that decision based on?
A. Well, first of all, we had a confidentiality
that provided that the debtors will disclose all material
nonpublic information provided to us about the company, which
they did. And I just pointed to the monthly operating report
where they did so.
Additionally, we had met with the company two days before,
and Mr. Rosen had said, you guys are free to trade, those were
the words, based on the disclosures that were made in the
monthly operating report.
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 82
Additionally, we did our own analysis to determine that we
were not in possession of material nonpublic information. We
are absolutely compulsive about this stuff, the consequence of
getting it wrong is quite severe, so we spent a lot of time
making sure that we fully comply with the federal securities
laws.
So, in this instance, the only information that we had
that wasn't disclosed in the monthly operating report was the
back and forth with JPMorgan, in which the parties were very,
very far apart. So it was inconceivable, in our view, that
that represented material nonpublic information, and we
concluded that we were free to trade.
Q. Mr. Gropper, without revealing the content of any
discussions or advice, did Aurelius consult with its securities
counsel in connection with making this determination?
MR. FOLSE: Your Honor, I'm going to object to
testimony about this. You can't raise as a basis for
attempting to claim good faith -- I'm sorry, Your Honor.
Parker Folse on behalf of the equity committee. I do
object to this testimony. It seems improper to raise advice of
counsel, in effect, as the basis for a claim of good faith, and
yet at the same time, assert a privilege which Aurelius has
done to prevent the disclosure of the analysis that their
securities counsel did and gave them and the discussions they
had about the offers that had been disclosed to Aurelius during
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 104
BY MR. ECKSTEIN:
Q. Mr. Gropper, does this confidentiality agreement contain
provisions similar to the agreement that you entered into in
March 2009?
A. Yes.
Q. And, in particular, does this agreement also contain the
disclosure provision in Section 13 that you described earlier
in your testimony?
A. Yes.
Q. And is it the same basic provision as you agreed to in the
March 2009 agreement?
A. Yes, it is.
Q. And what was the term of this confidentiality agreement?
A. Forty-five days.
Q. And did this agreement require Aurelius to either restrict
trading or erect an ethical wall?
A. Yes, it did.
Q. And did Aurelius either restrict trading or erect an
ethical wall?
A. We chose in this instance to restrict our trading.
Q. And do you know why Aurelius chose to restrict trading in
this case?
A. By this time in the case, we had a much fuller position,
and we just thought that we wanted to bring to bear on the
negotiations all of the analytical horsepower that existed.
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 105
inside the firm, so all, Mr. Brodsky and Ms. Chan, and myself
participated in those discussions.
Q. And did Aurelius engage in any trading in the debtor's
securities during the duration of this confidentiality period?
A. We did not.
Q. And do you know whether any other parties involved in this
case entered into similar confidentiality agreements at this
time?
A. Appaloosa, Centerbridge and Owl Creek signed the same
form.
Q. Now, can you explain what took place in the case after you
entered into this confidentiality period?
A. We attended a meeting, we meaning the four Fried Frank
clients attended a meeting along with Fried Frank at Wei1
Gotsha1 the day this was signed with Brian Rosen and Bill
Kostoros.
At that meeting, the debtors told us the additional NOL
that would be available by virtue of the passage of the
Homeowner's Act, and we learned that that was an amount of 2.6
billion dollars. That was a big surprise to us.
Our analysis previous to that had only indicated that we
thought the NOLs were worth, you know, probably more than a
billion less than that. So that was a very, very material
input learning the amount of that tax disclosure.
Q. That was nonpub1ic at the time; am I correct?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 106
A. Yes, it was. And then we resolved to basically process
that information and come back and meet at a later point in
time to attempt to formulate a proposal to give to JPMorgan.
Q. And so what happened after the initial meeting?
A. We came back to Weil about a week later, just before
Thanksgiving on the 23rd, and the debtors passed out a proposal
and said, okay, this is what we'd like to propose to JPMorgan,
you know, what do you think.
Q. And I'm going to ask you to turn your attention to
Aurelius Exhibit 28, and ask you to identify the document.
A. That's the -- that's what was passed out at that meeting
on the 23rd.
Q. And were you in attendance at that meeting?
A. I was.
MR. ECKSTEIN: And, Your Honor, can we -- we would
like to move Aurelius Exhibit 28 into evidence.
THE COURT: Any objection?
MR. FOLSE: No objection.
THE COURT: It's admitted.
(Aurelius Exhibit 28, Debtor's Proposal to JPMorgan Chase, was
hereby received into evidence.)
MR. ECKSTEIN: Thank you.
BY MR. ECKSTEIN:
Q. Can you walk the Court through the business highlights of
this proposal?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 112
A. Yes. The debtors in their monthly operating report for
November, which was filed on December 30th, 2009 disclosed that
the amount of the additional NOL tax refund was going to be in
the amount of 2.6 billion dollars. Therefore, disclosing all
of the material and nonpublic information that we had been
exposed to during that confidentiality period.
Q. And can I turn your attention to Aurelius 32, and ask you
to identify the document.
A. That's the monthly operating report to which I just
referred, and if I can direct the Court to note 5. In the
second paragraph, the last sentence, it says, "WMI estimates
such an election could result into" -- sorry "in additional
refunds of up to approximately 2.6 billion dollars, as to which
they are competing claims of ownership."
Q. And was that the information that the debtor had provided
to you after you signed the confidentiality agreement on
November 16th?
A. That's correct, and that was not present in the prior
monthly operating report.
Q. And had Aurelius learned any other material nonpublic
information during this time?
A. We had not.
MR. ECKSTEIN: Your Honor, we'd like to move Aurelius
Exhibit 32 into evidence.
MR. FOLSE: No objection.
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 113
THE COURT: It's admitted.
(Aurelius Exhibit 32, November Monthly Operating Report, was
hereby received into evidence.)
BY MR. ECKSTEIN:
Q. So, Mr. Gropper, did you conclude that the publication of
the November monthly operating report put into the public
domain the material nonpublic information that you had received
during the confidentiality period?
A. Yes.
Q. And what did you believe was your rights with respect to
resuming trading in the debtor's securities?
A. Well, we really based it on a number of different factors.
First of all again, just as in the prior period, the debtors
had an obligation under the confidentiality period to -- under
the confidentiality agreement to disclose all material
nonpublic information that had been provided to us.
During the period of the confi the debtors were obviously
in the best position to make the determination as to what
information was material nonpublic information.
Additionally, we requested and received an e-mail from Mr.
Rosen at Weil Gotshal confirming that once the debtors had
disclosed the information in the monthly operating report, the
debtor's disclosure obligations under the confidentiality
agreement would be satisfied.
And lastly, we did our own analysis. I mean, again, the
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
i
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 114
only we had was a failed back and forth with
JPMorgan in which the parties were extremely far apart. There
was no semblance of a deal. JPMorgan had quote, reset the
bookends in the words of Mr. Kostoros, and in the words of Don
McCree were very far apart. No one thought that a deal was
eminent, so we concluded independently that we were not in
possession of material nonpublic information.
Q. Mr. Gropper, let me turn your attention to Aurelius
Exhibit 31, and ask you if you can identify that document.
A. That's the e-mail that Mr. Rosen sent to Matt Roose at
Fried Frank at our request.
Q. And was that e-mail provided to you?
A. It was. In the banner up above, you can see the two lines
says, "WAMU-Aurelius" which meant it went to all of the
Aurelius folks working on Washington Mutual, and I'll note also
that Karl Groskaufmanis who is a Fried Frank securities law
senior partner in Washington, D.C. was also copied on this.
Q. And who is Matthew Roose?
A. He's an associate of Fried Frank.
Q. And what did the -- what did Exhibit 31 provide?
A. We11, it said that after the monthly operating report was
filed, WMI wi11 consider all necessary disclosures
disclosure obligations to have been satisfied, and the
confidentiality agreement may be deemed terminated.
MR. ECKSTEIN: Your Honor, I'd like to move
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 115
Exhibit 31 into evidence.
THE COURT: Any objection?
MR. FOLSE: No objection.
THE COURT: It's admitted.
(Aurelius Exhibit 31, E-mail from Rosen to Roose, was hereby
received into evidence.)
MR. ECKSTEIN: Thank you.
BY MR. ECKSTEIN:
Q. So, Mr. Gropper, at the end of the confidentiality period,
did Aurelius resume trading of the debtor's securities?
A. We did.
Q. Okay. And can you turn your attention back to Aurelius
Exhibit 8, which is the trading records, and identify what
transactions the debtor entered -- Aurelius entered into, what
trades the debtor entered into following the termination of the
confidentiality period?
A. We sold about thirty-five million dollars worth of
subordinated bonds, thirteen million dollars worth or sorry,
fifteen million dollars worth of senior bonds, and we purchased
about ten million dollars worth of peers. I'll note, though,
that the purchase of peers that we transacted on December 31st
was at a price of two and a half times that of our last peers'
purchase before the restricted period went into effect.
So our prior purchase had been at eight dollars, but we
continued our purchase -- purchasing efforts, but as
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 116
you can see from the records, they were over twenty dollars a
share.
Q. And prior to those transactions, had the debtor disclosed
any new material information into the public record?
A. Well, the debtors had disclosed the tax information that 1
referenced in the monthly operating report we just looked at.
Q. That's the tax, the additional NOL look-back?
A. Yes.
Q. NOw, let me ask you to focus your attention on the period
following the termination of the second confidentiality period.
This is the period between December 31, 2009 and March 12,
2010.
You understand the period?
A. 1 do.
Q. Now, can you explain what role, if any, Aurelius played in
settlement negotiations during that period?
A. We did not have a role.
Q. And during this period, what views did Aurelius have about
the most effective way for the case to proceed?
A. Well, and 1 don't want to seem like a broken record, but
we said what we have said many times before, that we thought
the most efficacious way to push these cases to a resolution,
was for the debtor to pursue its litigation against JPMorgan
Chase. That was advice the debtors had chosen not to follow
earlier, and again, it was their case. But having gone t h r o u g ~
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 117
now a second failed attempt at negotiating a consensual
resolution, we thought the key to resolving these cases was for
litigation against JPMorgan to be assiduously pursued, and we
communicated that view.
Q. What other issues were you and the other settlement
noteholders focused on during this time period?
A. We started to examine whether or not it would be possible
to use the NOL carry forward and whether or not any value could
be created by utilizing that NOL carry forward. That's
actually a question we'd asked, what's the amount of it, during
the restricted period, and Mr. Kostoros declined to answer that
question. So we didn't know how big it was, but you could tell
again from looking at the GAAP financials, that it was a big
number.
So we started doing some work to determine whether or not
that could be utilized in an efficient manner with the folks
inside the tax group at Fried Frank. We also started to noodle
on structures of a plan. We didn't want to be in a position
where in the event a deal was cut with JPMorgan, whatever that
deal might be, there would then be a two month period where
people figured out how to actually get the money out. So we
started noodling over hypothetical manners to distribute
proceeds under a plan, and part of what was really taking up a
lot of effort at that time, was okay, what would happen if you
had a deal with JPMorgan but not the FDIC. How could you
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 118
distribute money to the creditors of WMI when the FDIC was
putting in a twenty billion dollar unsecured claim. So we just
started thinking through some of those structural issues.
Q. What steps, if any, did you take during this time period
to ensure that you did not receive material nonpublic
information?
A. Well, we gave strict instructions to our counsel at Fried
Frank not to communicate any such information to us, whenever
we met with the debtors we were compulsive to make clear that
we did not want to discuss any material nonpublic information,
and frankly, the debtors were very careful in this regard.
They knew that we were unrestricted, they knew we were trading
in the securities, and we went out of our way to make sure that
nothing got tripped up and we didn't inadvertently or
intentionally get any material nonpublic information.
Q. And did you believe during this time period that you
received any material nonpublic information?
A. We did not.
Q. And did you know during this time period whether or not
settlement negotiations were ongoing?
A. I think it was widely known in the marketplace that
settlement negotiations were going on. There was a research
report that came out in the beginning of January 2010 that
quoted that, you know, intense settlement negotiations are
going on or some such like that. So it was widely known in
the
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 119
marketplace that there were settlement negotiations going on.
We certainly did not know the content of those negotiations.
Q. And during this time period, did Aurelius participate in
any settlement negotiations?
A. No.
Q. And did Aurelius learn the substance of any negotiations
that were taking place during this time period?
A. We did not.
Q. And did you ultimately learn that a settlement had been
reached in the case?
A. We learned -- well, first we heard in the beginning of
March because Mr. Rosen announced it on the record in this
court that the parties were close to an agreement. After that
happened, I actually reached out to Fried Frank to see if we
could become involved in settlement negotiations. I never
heard back on that inquiry, and that was actually at a time
when I was working literally around the clock to settle one of
our holdings in the Lyondell case. I then worked till, you
know, I went away on vacation that Thursday morning, and then a
deal was announced when I was on vacation that Friday morning,
and I learned about it the same time the rest of the market
did.
Q. So did you learn the terms of a potential deal on March
4th?
A. No.
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 120
Q. Did the debtor -- did Aurelius continue to trade in the
debtor's securities during this time period?
A. We did. And, in fact, our trading, I think is
illustrative in this period, because we actually sold quite a
lot of peers on March 8th, 2010, which was a mere two or three
days before the deal was announced. That trade was unwise in
hindsight, because after the deal was announced, the peers
traded up several dollars. So I think it clearly shows we
certainly didn't know what was going on. We sold peers that
went up several dollars two days later.
Additionally, I'll just say about the deal that was
announced itself that had I been involved in the negotiations
at that time, and realized because, of course, the ultimate
deal included the FDIC, but had I realized that JPMorgan was
willing to part with, you know, that massive part of the tax
refund as was announced in the deal that was announced on the
record on March the 11th, I would've objected to that. I mean,
I don't think the FDIC or the bank bondholders had good claims
in this case at all. So the fact that JPMorgan was willing to
give up that value frankly I would've pushed to see that value
come into the estate.
Q. Was Aurelius or the other settlement noteholders a party
to the agreement that was announced in court on March 12th,
2010?
A. No.
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 163
THE COURT: All right.
MR. FOLSE: I used the wrong date.
THE COURT: Re-ask your question.
MR. FOLSE: Yes.
Q. It's correct, isn't it, that once Gerry Uzzi found out
about this back and forth that he was on the phone with Mr.
Roseni is that correct? And the next day, you were on the
phone to Bill Kostoros to protest what the debtor had done.
A. I don't know that that's correct at all. I don't know
whether Mr. Uzzi called Mr. Rosen. I did call Mr. Kostoros in
the end of April after I learned the debtors had made a
proposal. But again, I don't know whether I learned I just
don't recall whether I learned the sUbstance of that proposal.
And my objection to Mr. Kostoros was one of process in that I
had just agreed to put up a wall and become engaged in
settlement negotiations to attempt to resolve the c a s ~ , and
therefore I thought as a matter of process it was not right for
the debtors to negotiate without including us or informing us,
which they had done.
Q. Well, let's look at your e-mail of April 29, 2009. It's
EC Exhibit 12. It's already been admitted as AU Exhibit 22.
This is your e-mail to Bill Kostoros on April 29th, correct?
A. Yes.
Q. And you had found out that the debtor had made a further
proposal to JPMC. Your testimony is that you didn'.t have any
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 164
idea about the substance of that proposal?
A. No. My testimony is I just don't recall whether I learned
the substance of that proposal.
Q. The first thing you do in this e-mail is to show Mr.
Kostoros that Aurelius and Owl Creek had nearly a blocking
position in the subordinated bonds and the junior subordinated
bonds, correct?
A. That's incorrect.
Q. Well, let's see. It says please note -- it sets out a
list of holdings. It says, "please note that the above
holdings represent nearly a blocking position in both the
subordinated bonds and junior subordinated bonds." Do you see
that?
A. I do. But just to be clear, you referred to Aurelius and
Owl Creek, and this e-mail was sent on behalf of Aurelius, Owl
Creek and Elliott.
Q. Elliott, all right. So what is a blocking position?
A. It is a holdings of more than a third of a particular
class of a security within a debtor.
Q. And what does it allow the holder to block?
A. Well, sometimes nothing because if a plan is crammed down
it doesn't allow you to block anything.
Q. Well, what did you mean when you said blocking position
here?
A. I meant that we owned nearly thirty-three percent. It's
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 165
just a term of art used in bankruptcies to indicate that a
creditor group owns more than a third of a particular pOSition,
recognizing that an affirmative vote of a class under a
bankruptcy plan would require two-thirds.
Q. In the next paragraph you wrote:
"We understand from Brian Rosen's conversation of
Monday evening with Gerry Uzzi that without any prior
consultation with White & Case the debtor revised the
prior proposal to Morgan authorized by the White &
Case Group."
Do you see that?
A. I do.
Q. So you had become aware of a conversation that your
counsel had had with Brian Rosen on Monday, April 27th,
correct?
A. Yes.
Q. Because he told you about it, your lawyer.
A. Correct.
Q. And you say, "We do not agree with that course of action
and would have strongly objected to it if we had been consulted
prior to the offer being made."
You wrote that?
A. I did write that. This was one of a number of times when
we had suggested to the debtor a particular course of action or
I guess we had not been given the opportunity to suggest to the
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL INC., ET AL.
Page 166
debtor a course of action when they had gone off and done it
because it's the debtor's case and the debtors ran the case.
There were a number of times we made suggestions in fact when
the debtors didn't take them. There were a number of times
when the debtors did things without seeking any advice or
input, and this was one of those instances.
Q. I only asked whether this is what you wrote, and then you
and your answer is yes, correct?
A. This is what I wrote.
Q. And you had made it clear to the debtors early in the
negotiating process that you wanted to be involved in the
negotiation of material terms, and instead they went off and
negotiating and negotiated without doing that. And you
thought that was wrong, correct?
A. I thought it was wrong in the context where we had signed
a confidentiality agreement for purposes of being involved in
negotiations, and the debtors hadn't involved us in
negotiations during that period.
Q. And if you had been consulted in advance about the offer
the debtors intended to make you would have objected to it;
isn't that what this says?
A. That is what it says and that is correct.
Q. How did you know the debtor hadn't increased the value of
its settlement demand in this offer?
A. I just don't recall the terms.
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
EXHIBITE
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Page 1
UNITED STATES BANKRUPTCY COURT
DISTRICT OF D E ~ A W A R E
Case No. 08-12229(MFW)
- - - - - - - - - - - -x
In the Matter of:
WASHINGTON MUTUAL, INC. I et al.,
Debtors.
- - - - - - - - - - - - - - - - - - - - -x
U.S. Bankruptcy Court
824 North Market Street
Wilmington, Delaware
July 19, 2011
9:33 AM
B E FOR E:
HON. MARY F. WALRATH
U.S. BANKRUPTCY JUDGE
ECR OPERATOR: BRANDON MCCARTHY
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 51
free to resume trading, correct?
A. Yes.
Q. And so the very first day they could do that, which
happened to be the last day of the year, this indicates that
Aurelius sold roughly fifteen million dollars worth of senior
notes, correct?
A. Well, the funds managed by Aurelius did, correct.
Q. Say that again, please?
A. The funds managed by Aurelius sold the notes.
Q. Yes. And it looks like they were sold at 97.25 percent of
face value?
A. Correct.
Q. So those -- those notes were -- I dontt know whether this
is the right term of art, close to par?
A. They were.
Q. Not much upside left in them?
A. Well, there was post-petition interest that those notes
could receive. So I don't recall what the full pre-petition
plus post-petition claim was for those notes. It was certainly
north of par.
Q. And there were -- this began, verify that Itm reading this
correctly, there were additional sales of senior notes, fifteen
million dollars on January the 5th, youtll have to go over to
the preceding page to follow me, I think. And then another
five million dollars on January 7th, is that correct?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 52
A. Yes.
Q. Also on December 31st, Aurelius sold senior subordinated
notes with a face amount of about thirty-four million dollars
at ninety-three percent of par?
A. Correct.
Q. Did the sale by the way, did Aurelius report its
financial results on a calendar year basis?
A. Yes.
Q. Did the sales on December 31 establish a price that
Aurelius used to mark its portfolio to market for financial
reporting purposes?
A. I'm not sure. The marking of our portfolio is independent
of trades that can occur in the middle of the day.
Q. Well they occurred before the last day of the year, right?
A. Yes.
Q. And in fact the reason that Aurelius and the other
settlement noteholders asked the debtors to terminate the
agreement early was so you could do trades before the calendar
year ended, isn't that true?
A. That's incorrect.
Q. Why didn't you just let it expire on December 31st?
A. We wanted to make sure that for purposes of marking the
portfolio, that the information in the monthly operating report
was out and that the market prices would reflect it. We didn't
want to be in a situation where after the market closed on the
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 53
31st, the monthly operating report came out, which would be a
positive piece of information, and then when the auditors went
to determine what should be the year-end mark they'd say, okay,
we know there was a bond that traded at X but then this big
piece of information came out after market hours, we're not
sure how to mark the portfolio. And we wanted to avoid that
ambiguity.
Q. Also on December 31st, am I reading this correctly, that
Aurelius began buying PIERS, about 590,000 shares for a total
of 12.625 million?
A. Well, I'm not sure what you mean by began buying because
we've sold PIERS after that date, but we bought PIERS on
December 31st and I don't know if the quantity that you quoted
is correct but I'm happy to figure it out.
Q. You mean in terms of the dollar amount?
A. Correct.
Q. The 590,000 shares is correct, right?
A. Yes.
Q. And to get the price you would multiply, on each of those
two lines, the quantity times the price?
A. Yes.
Q. All right. Also in January -- by the way, the acquisition
of PIERS on behalf of the Aurelius funds, that continued
further into January, did it not?
A. Well, we bought a very, very small amount of PIERS on
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 54
January 4th. We bought another very, very small amount of
PIERS, I mean these are tiny trades in the context of the
position and the fund, you're talking about 50,000 dollar
trades in the context of a multi-billion dollar fund. We
purchased, again, in other instances in January.
Q. Are the trades shown beginning January 7th where it says
WMPFD all the way up to the end of January, are those PIERS
acquisitions?
A. they're very small PIERS acquisitions, yes.
Q. Something like 70, 80,000 shares? I'm just guessing.
A. That sounds high. I mean, I can -- again, I can figure it
out if we
Q. If you want to add them up, that's what we would do?
A. Yes.
Q. You multiply them by the line items, the prices shown on
the lines next to them?
A. Correct.
Q. And in January Aurelius also began buying significant
amounts of trust preferred securities, correct?
A. Well, we bought trust preferred securities and we sold
trust preferred securities.
Q. Well on January 4 and January 5, collectively, Aurelius
bought almost fifty million dollars worth of trust preferred
securities, didn't it?
A. Not fifty million dollars worth.
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
5
10
15
20
25
WASHINGTON MUTUAL, INC., ET AL.
1
2
3
4
6
7
S
9
11
12
13
14
16
17
lS
19
21
22
23
24
Paqe
A. Yes.
Q. Do you believe that this was also executed on behalf of
Washinqton Mutual, Inc. and WMI Investment Corp.?
A. Yes, it was.
Q. And do you believe that this aqreement was executed on or
about March 9th of 2009, the date on the first paqe?
A. Yes.
Q. Did Owl Creek put WMI on its restricted list when it
entered into this confidentiality aqreement?
A. Yes, we did.
Q. Did you understand this aqreement to have a termination
point?
A. Yes.
Q. What was your understandinq of what that termination point
was?
A. Paraqraph 13 of this aqreement talks about the outside
date, the latest date at which this aqreement would exist, as
beinq sixty days followinq the date of execution of this
aqreement. So we knew it would expire on that date, if not
earlier.
Q. And is it consistent with your understandinq that this
aqreement in fact terminated on or about May S, 2009?
A. Sometime around then, yes.
Q. Okay. Did Owl Creek trade in WMI securities durinq the
term of this aqreement?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 129
A. No.
Q. Did you understand the debtors to have any obligation
under this agreement?
A. Yes, they did. There in paragraph 13, there's a provision
that describes how upon termination of this agreement, that the
debtors must disclose any information that they deem material
and nonpublic.
MR. GLICKMAN: Your Honor, I would ask that EC-141 be
admitted into evidence.
THE COURT: Any objection?
MR. WALKER: No objection, Your Honor.
THE COURT: It's admitted.
(Confidentiality agreement with Owl Creek was hereby received
in evidence as Equity Committee's Exhibit 141, as of this
date.)
MR. GLICKMAN: Thank you.
Q. Let's go back to the March meeting that you mentioned.
Tell us what you recall about the events at that meeting?
A. It was a large meeting. There were a lot of people there,
I recall. There were a number of different bondholders. At
that point in time, we were being represented -- Owl Creek was
being represented by White & Case along with, you know, twenty
or so other noteholders. A number of us were there, maybe four
or five White & Case members. Fried Frank was there with their
two clients at the time. The day -- the way the day eVOlved, I
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
I
WASHINGTON MUTUAL, INC., ET AL.
Page 130
remember, the debtor and debtor's counsel were kind of
shuttling between different rooms.
The bondholders, as I said, were all in this large
conference room. The debtors would periodically come in and
talk to us about the issues at hand and then leave. And my
understanding was that they were talking to other parties. My
understanding was that JPMorgan was there with their counsel.
believe the FDIC, the creditors' committee, were there with
their counsel as well. But I never sat in with any of those
other parties. But that's my understanding.
Q. Did Owl Creek receive a proposed term sheet at the
meeting?
A. Yes, we did.
Q. Would you take a look at tab 5, please, which is another
document that Owl Creek produced in connection with these
proceedings, and it's been marked EC-140. Is this the term
sheet that Owl Creek received at the meeting?
A. Yes.
Q. Did Owl Creek prepare this?
A. No.
Q. What was your understanding as to who prepared this?
A. Well, my understanding at the time, and looking at this
header, I believe Weil prepared it.
Q. Do you see a date there, March 5th, 2009. Is that when
you received this draft?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 131
A. No. I know that the meeting was on a later date than
that. It was after I signed the confi, so it -- you know, no.
That wasn't the date that I received this document.
Q. You received it on the date of the meeting, as far as you
recall?
A. Yeah. This was handed out in hard copy format, which is
why it has my handwritten notes on it.
Q. Okay. And all of these notes that we see here in the
document, those are your handwritten notes?
A. Yes.
Q. When did you take them?
A. At some pOint during the day.
MR. GLICKMAN: Your Honor, I would ask that EC-140 be
admitted into evidence.
MR. WALKER: No objection.
THE COORT: It's admitted.
(Term sheet for Owl Creek was hereby received into evidence as
Equity Committee's Exhibit 140, as of this date.)
Q. You'll note, for example, on the second page, that there
are various blanks in this term sheet. Can you tell us your
understanding of what was done with the term sheet at the
meeting?
A. My recollection of that meeting is that, you know, the
debtor and debtor's counsel were trying to use this as a
starting point to kick-start settlement discussions, basically.
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
I
WASHINGTON MUTUAL, INC., ET AL.
Page 136
bargaining table. And so I -- you asked me about settlement
discussions. I remember going to a meeting at Weil's offices,
believe it was in late November.
Q. Let's hold the discussion, if we can of that November
meeting for a moment, and just finish up with the
confidentiality period, if we can. But that November period is
your next recollection of involvement by Owl Creek in
settlement negotiations?
A. Yes.
Q. All right. So when the March confidentiality agreement
ended, did Owl Creek take WMI off its restricted list?
A. Yes, we did.
Q. And what steps did Owl Creek take to determine whether it
was appropriate to take WMI off its restricted list? And
before you answer, consistent with the Court's ruling yesterday
with respect to the issue of waiver, I'm going to ask you to
exclude any testimony as to whether Owl Creek consulted with
counsel.
MR. GLICKMAN: For the record, we would join in the
position that Aurelius expressed, but we're not going to
reargue the issue. We understand Your Honor'S ruling.
Q. So I'm asking you to exclude from your answer to that
question whether or not you consulted with counsel in making
the determination to take WMI off. Tell me anything else you
did in making that determination?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 137
A. Sure. We -- well, we certainly requested that the debtor
confirm that they had abided by that paragraph 13 that we spoke
about before, which they did. As we always do, we talked about
it internally. We talked about the facts of the case as we
knew them at that point in time, and along with some other
things that we did, we came to the conclusion that Washington
Mutual should be taken off of our restricted list.
Q. Would you take a look at tab 8? There's a document there
that was also produced by Owl Creek in connection with these
proceedings, that's been marked as EC-146. Can you identify
that document for us?
A. Yes. It's an e-mail fro
where he forwards an e-mail from Weil confirming that the
debtors believe that all required disclosure has been made.
Q. Okay. And do you believe that you received EC-146?
A. Yes, I did.
MR. GLICKMAN: Your Honor, I'd ask that it be admitted
into evidence.
THE COURT: Any objection?
MR. WALKER: Your Honor, we have no objection to the
extent it's -
THE COURT: Talk into a mic.
MR. WALKER: Sorry, Your Honor. We have no objection
to the extent it's just being admitted to show that he received
this e-mail. Obviously the lower e-mail from Brian Rosen to
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 138
Gerry Uzzi is hearsay, and so we don't want it admitted for the
truth of that point.
THE COURT: All right. But just for the fact that he
received it?
MR. WALKER: Yes, ma'am.
THE COURT: All right. It's admitted.
(E-mail from White , Case forwarding an e-mail from Weil to Owl
Creek was hereby received into evidence as Equity Committee's
Exhibit 146, as of this date.)
Q. We've looked at some term sheets during the course of your
testimony thus far. Did you consider them to be material
nonpublic information when you made the determination to take
WMI off the restricted list?
A. No, we did not consider them material nonpublic
information.
Q. Why not?
A. Well, no agreement had been reached. You know, the
parties at that point in time were extremely far apart. And,
you know, with those facts along with others, we knew that
those term sheets could not be considered material nonpublic
information.
Q. Okay. Let me go to the November meeting that you
testified was your next recollection of involvement in
settlement negotiations. Was Owl Creek being represented by
White' Case at the time of that
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
,------_.._--_._------------
Page 164
during that time, correct?
A. 241 through 259, correct?
Q. And the ones, for example, on lines 247 and 250 are PIERS,
is that correct?
A. Yeah, let me just quickly glance at these. From scanning
this, it looks like the purchases are of subordinated bonds and
PIERS.
Q. And did you consider the January 2009 settlement offer put
together by the large group of creditors represented by the
White & Case group, to be material information?
A. No.
Q. And why not, Mr. Krueger?
A. For to me, the first obvious reason that jumps out, is
that it was prepared by everybody who is on the same side, so,
you know, everybody always wants a lot, and to not -- to just
have an agreement amongst people who all own the same bonds, to
me, is not material.
Q. Mr. Krueger, you -- I believe you testified earlier that
you also attended a settlement meeting with the debtor and
JPMorgan, and some of the other creditors on March 10, 2009,
correct?
A. That's correct.
Q. Okay. And do you recall testifying in your deposition
that the purpose of that big hands-on meeting was to try and
start the process for a global settlement?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 165
A. That -- I don't remember those exact words in my
deposition, but if you're asking me the purpose of that
meeting, I think that's a fair characterization of the purpose,
yeah.
Q. And the fact that the debtor and JPMorgan Chase and the
FDIC and a number of powerful hedge funds managing a lot of
money, were participating in a settlement meeting that wasn't
public information as of March, 2009, was it?
MR. GLICKMAN: Your Honor, I'm going to object to the
characterization of the questions.
THE COURT: Sustained.
MR. WALKER: I'll re-ask the question, trying not to
characterize anything in there.
Q. The fact that the debtor and JPMC and the FDIC and a
number of hedge funds were participating in a settlement
meeting was not public information in March, 2009, was it?
A. I don't think it was public in the sense that you're
talking about.
Q. In what sense was it public?
A. Well, as I -- my memory of the White & Case group was that
there were a number of bond holders in that group -- I think it
was more twenty -- my memory is those other bond holders knew
that we were becoming restricted; I actually don't know if they
knew about the meeting or not, but to answer your question was
it printed in the Wall Street Journal or made public in that
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., ET AL.
Page 166
sort of way, no.
Q. Well, even if the other members of the White & Case group
knew about the meeting, would that be your definition of public
information?
A. No.
Q. Okay. And did you consider it material information that
all of the interested parties were starting the process for a
global settlement of billions of dollars of disputed assets?
A. Did I consider that meeting material in its existence?
I'm sorry, can you repeat the question, please?
Q. The information -- the knowledge that all of the
parties -- all of the interested parties, really -- were
starting the process for, in your words, a global settlement of
billions of dollars of disputed assets to Washington Mutual,
Incorporated; in your mind, would that be material information?
A. No.
Q. You testified earlier about having signed a
confidentiality agreement as a condition to participating in
the meeting, is that accurate?
A. Well, I'm not sure I'd use the word 'condition', I recall
that we signed a confidentiality agreement around the time
of -- shortly before -- attending that meeting.
Q. Um-hum. And the purpose for signing the confidentiality
agreement was so you could attend that meeting, correct?
L_A_.__w_e_l __ l_,_t_h_e_c_o_n_f_i_d_e_n_t_i_a_l_i_t_y_a_g_r_e_e_m_e_n_t_w_a_s_s_o_m_e_t_h_i_n_g_t_h_a_t__---'
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
EXHIBITF
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Page 1
UNITED STATES BANKRUPTCY COURT
DISTRICT OF DELAWARE
Case No. 08-12229(MFW)
- - - - - - - - - - - -x
In the Matter of:
WASHINGTON MUTUAL, INC., et a1.,
Debtors.
- - - - - - - - - - - - - - - - - - - - -x
United States Bankruptcy Court
824 North Market Street
Wilmington, Delaware
July 21, 2011
9:33 AM
B E FOR E:
HON. MARY F. WALRATH
U.S. BANKRUPTCY COURT, CHIEF JUDGE
ECR OPERATOR: BRANDON MCCARTHY
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Page 126
certainty to the estate within those claims and then be able to
project what the return would be back to creditors. So we
found this proposal to be really nonresponsive and really had
changed the whole dynamics and constructs of what we had been
talking about previously.
Q. Is it fair to say at this point it was your view that the
parties were very far apart in reaching a settlement?
A. Very far apart.
Q. Now after the exchange of term sheets, what further
negotiations did you have with JPMorgan during this November
confidentiality period?
A. I had continued to discuss getting the term sheets and
process back on track with Mr. McCree. And we had continued to
have direct dialogue between M. McCree and myself.
Q. Did there come a time where the debtor sent an actual term
sheet during December?
A. Yes.
Q. And if you'd take a look at the next tab, which is EC-305,
again, which I also believe has been admitted already, does
this reflect the offer that was made by the debtor during this
period?
A. It does.
Q. To your recollection, was this offer that was delivered to
the -- to JPMorgan ever disclosed to the settlement noteholders
at this
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Page 127
A. I can't be sure but not to my recollection did we share
this with any of the settlement noteholders.
Q. Now once again, at the end of the confidentiality period
that ended at the end of the year, did the debtor make a
determination whether it had shared material nonpublic
information with the settlement noteholders?
A. Yes.
Q. And what determination did it make?
A. We determined that we had material nonpublic information
and we disclosed it in our November 2009 MOR which was filed on
December 30th, 2009.
Q. If you could take a look at the next tab in your binder,
which is AU-32 -- I'm sorry -- which is -- I apologize -- which
is Debtors' Exhibit 428, do you recognize this document?
A. Yes.
Q. And what is it?
A. This is the 8K we filed on December 30th with the SEC
which filed our November 2009 MOR.
Q. And in the November monthly operating report that was
filed with this court and the SEC, was there a disclosure of
the information that the debtor had provided to the settlement
noteholders?
A. Yes.
Q. And what information was set forth in the monthly
operating report?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Page 128
A. Under note 5, under "Taxes", the second paragraph, we had
filed -- we disclosed that we estimated under the Workers'
Homeowner and Business Assistance Act of 2009 that our
potential NOL could result in tax refunds of up to 2.6 billion
dollars of which we also disclosed that there could be
competing claims of ownership.
MR. SLACK: Your Honor, I would move the admission of
Debtors' Exhibit 428.
MR. SARGENT: No objection, Your Honor.
THE COURT: It's admitted.
(Debtors' Exhibit 428, 8K filed by the debtors on 12/30/09 with
the SEC and the Court which filed the November 2009 monthly
operating report, was hereby received into evidence as of this
date.)
Q. Was there a determination made by the debtor with respect
to the materiality of information pertaining to the back and
forth of negotiations between the debtor and JPMorgan during
this period?
A. Yes.
Q. And what was the determination that was made by the
debtor?
A. The debtor, in connection with its advisors and lawyers,
determined that there was not any material nonpublic
information that needed to be disclosed.
Q. Now when did the November 2009 confidentiality agreements
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et at.
Page 129
with the settlement noteholders in fact terminate?
A. December 30th.
Q. And that was a day earlier than set forth in the
confidentiality agreements, correct?
A. That's correct.
Q. How did it come that the termination of the
confidentiality agreements occurred on December 30th rather
than December 31st?
A. I believe that Fried Frank had requested that we terminate
the confidentiality agreement a day earlier on behalf of one of
its noteholders.
Q. And why did the debtor agree to do that?
A. We had already put in to the public the required
disclosures that we needed to make. And we agreed with their
request of reducing the confidentiality period that day.
Q. So on December 30th, the debtor had already filed its MOR,
correct?
A. That's correct.
Q. Now at the end of this confidentiality period, can you, in
your own words, describe how far apart in dollars or otherwise
you believe the debtor was from reaching agreement with
JPMorgan?
A. Well, I would say that it was not just JPMorgan that we
needed to reach agreement with. The prior term sheet had a
clause in there that we had to reach agreement also with the
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Page 136
up?
A. Yes. The morning of March 12th, in a conference not too
far from here, we wrapped up the remaining items of which we
thought, and then Mr. Rosen came into court and read those
terms into the record.
Q. And was this agreement the final agreement?
A. No. There were -
Q. There were changes, correct?
A. There would be changes.
Q. NOw, in reaching this agreement that you just described up
through March 12th, what was the involvement of the settlement
noteholders in those negotiations during this period?
A. The settlement noteholders had no involvement in the
negotiations. There was one meeting when one of the settlement
noteholders in Fried Frank attended with JPMorgan. I believe
that meeting was on March 1st. But exclusive of that one
meeting there was no involvement with them.
Q. And why weren't they involved in this process during this
period?
A. There wasn't any need to involve them. We're the debtor.
We have -- we're -- it is our responsibility to determine what
we believe is in the best interest of the debtor, and that's
what we did.
Q. And who in fact made the decision to enter into the final
settlement agreement that was reached?
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Paqe 137
A. I did, and it was later ratified by the board.
Q. NOw, are you aware that in this proceedinq the equity
committee has contended that the debtor was controlled and
dominated by certain of the noteholders?
A. I'm aware of that.
Q. And what is your reaction to that a11eqation?
A. It's completely false.
Q. And why is that?
A. Well, I think there's been numerous instances here that we
have talked about in this discussion as well as others of where
the settlement noteholders wanted the debtor to do somethinq
and we rejected their ideas and did what we thouqht was best
for the estate. We led the neqotiations; the settlement
noteholders did not. The unsecured creditors' committee
participated with us throuqhout this case. And ultimately the
debtor exercised its judqment, its sole judqment in enterinq
into the qlobal settlement aqreement.
MR. SLACK: Thank you very much, Mr. Kosturos. I have
no more questions.
THE COURT: All riqht. I think this is a qood time to
take a lunch break. Let's qet back at 1. Well, let me ask how
lonq the parties think they'll need for cross.
MR. SARGENT: I expect my cross to be between an
hour -- certainly no more than an hour and a half, Your Honor.
MR. COFFEY: Your-
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Page 138
THE COURT: Let me hear from others.
MR. COFFEY: Your Honor, Jeremy Coffey with Brown
Rudnick. I can really try to pare it back, working with Mr.
Sargent. I think we can get it done in forty-five minutes. A
large part of our cross is going to be dealing with a
particular set of documents we think should be included in the
record. So if we're able to stipulate to the inclusion of
those I think I can cut my cross back significantly.
THE COURT: All right. Why don't you talk during
lunch? Do we want to make it a half an hour for lunch and the
parties just stay and talk about exhibits?
MR. COFFEY: I'm happy to do that, Your Honor.
THE COURT: All right. Well, let's come back at 1:30
then.
MR. SLACK: Your Honor, one clarification, since the
witness has not yet started cross, I want to make it -- I want
to make sure that we can in fact talk to the witness.
THE COURT: You may.
MR. SLACK: Thank you.
THE COURT: And just for counsel's edification, I
believe, in looking at my calendar for next week, that there
may be time next Thursday. The debtor has an omnibus on
Thursday, is that right?
MR. ROSEN: There is an omnibus hearing, Your Honor.
know that that's also the time that the equity committee has
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et at.
Page 151
Q. I'm going to ask you that question today and see if your
answer has gotten any more specific, Mr. Kosturos. Does the
debtor believe that the confidentiality agreements with the
settlement noteholders require the funds to maintain
confidentiality after the sixty-day term expires?
A. Well, again, I am not a lawyer and I'm a fact witness
here, but my understanding is, first of all, the document does
speak for itself so I won't change that part of it, but my
understanding is that at the conclusion of the confidentiality
agreements that the parties are released from whatever
agreement that we have.
Q. So the debtor would not have considered it a breach if one
of the settlement noteholders had attached the settlement terms
to a filing in court or had polished it in The Wall Street
Journal? That would have not been a breach of the
confidentiality agreement from the debtors' perspective, is
that your testimony?
MR. SLACK: Your Honor, I object to the extent that
that particular question calls for a legal conclusion.
THE COURT: Well, I'll -- overruled and he can answer
his understanding.
A. Mr. Sargent, can you just repeat the question? I want to
make sure I get this exactly right.
Q. Sure. I just want to -- I'm trying to get the debtors'
understanding whether it would have been a breach, in the
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Page 152
debtors' view, of the confidentiality agreements for one of the
hedge funds to publicly disclose the settlement terms after the
confidentiality agreement expired, after May 8th, in other
words, when we're speaking of the March confidentiality
agreement.
A. I believe that would not be a breach of the agreement.
Q. At the same deposition designated on the same topics, I
asked you if the debtor believed it would be a breach of this
agreement if the settlement noteholders traded based on
information that they obtained in these settlement proposals.
Do you recall that question?
A. I do.
Q. And your testimony then was you didn't -- the debtor did
not have an opinion one way or the other whether that would be
a breach. Do you recall that?
MR. SLACK: Your Honor, I believe that he can't -
mean, that's a different question and I believe he can't
impeach the witness without asking the same question.
THE COURT: I agree. You've got to ask him a
question -- are you impeaching you can't just -- what are
you offering the deposition for? To impeach him you have to
ask him the same question first.
MR. SARGENT: I'm sorry, Your Honor, I will. Let me
rephrase.
Q. Do you have an opinion -- does the debtor have an opinion
VERlTEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
I
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et at.
Page 153
whether or not it would be a breach of the confidentiality
agreement for the hedge funds to have traded based on the
information that they learned during the pendency of the
agreement?
A. I believe that at the conclusion of the confidential
period in agreements the parties are free to do whatever they
want to do, that the agreement is no longer in place.
Q. The debtor made a determination, made a conscious
determination, did it not, about whether or not the terms being
exchanged between itself and JPMorgan were material. And it
made that determination in conjunction with its disclosure
obligations under the confidentiality agreement, is that right?
A. The debtor, with advise from counsel, made that
determination, yes.
Q. And so when you considered that issue you knew, you
understood the possibility that the hedge funds might trade on
this information, didn't you? The debtor understood that?
A. Well, again, the confidentiality period extends for as
long as the confidentiality period extends. And then after it
expires, we have a duty to disclose material nonpublic
information, and then at the conclusion of the confidentiality
agreement, the agreement is no longer in place.
Q. And there's some confidential information, the information
that was confidential at least during the pendency of the
agreement, that you determined was not material, isn't that
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
WASHINGTON MUTUAL, INC., et al.
Paqe 154
riqht?
A. Yes.
Q. And one example of that were the settlement terms that
were beinq exchanqed, isn't that riqht?
A. I think the facts a ~ e on the record that we thouqht that
that was that we did not need to disclose that.
Q. And so the debtor understood -- when the debtor made the
determination it did not need to disclose that, the debtor
understood that the hedqe funds miqht trade on that
information, didn't the debtor know that?
A. The hedqe funds miqht have done a lot of thinqs after the
conclusion of the confidentiality aqreement, and quite frankly,
they're qoinq to do what they're qoinq to do.
Q. The March neqotiations were not the only time that the
settlement noteholders were allowed to participate in
settlement neqotiations with JPMC, were they?
A. That's correct.
Q. The debtor also entered into confidentiality aqreements
with those four funds for the same purpose in November of 2009.
You testified about that on direct, correct?
A. Yes.
Q. And the debtor also souqht the settlement noteholders'
views on other issues relevant to the bankruptcy at other
times, is that true?
A. I think that outside of the confidentiality aqreement
VERITEXT REPORTING COMPANY
212-267-6868 www.veritext.com 516-608-2400
EXHIBITG
Davis Polk
September 20, 2011
CLIENT NEWSLETTER
Insolvency and Restructuring Update
Second Washington Mutual Plan Confirmation Denial
May Have Significant Impact on Claims Trading and Plan Negotiation
On September 13, 2011, Judge Mary Walrath of the United States Bankruptcy Court for the District of
Delaware surprised many parties in interest and observers of the case by issuing an opinion denying
confirmation of the modified proposed plan of reorganization of Washington Mutual, Inc. (UWMI") and its
affiliated debtors. The modified plan incorporated certain changes Judge Walrath had indicated were
necessary in a January 2011 opinion denying confirmation of a prior version of the plan, and many
expected that these changes would be sufficient to ensure confirmation of the modified plan. Although
the decision turned primarily on the rate of post-petition interest awarded to certain creditors of WMI, the
Court's extensive discussion of allegations of "insider trading" raised against certain claims purchasers is
likely to attract the most attention. Judge Walrath's findings on these allegations may have a significant
impact on claims trading and negotiation dynamics in complex chapter 11 cases going forward.
Case Background
In order to best understand the opinion, it is helpful to have a basic understanding of the primary events
that have taken place in the Washington Mutual cases. WMI, the lead debtor in the case, is the former
parent of Washington Mutual Bank ("WMB"), frequently referred to as WaMu. During the financial crisis
of 2008, after a steady decline in revenues at WMB culminated in credit rating downgrades for WMI and
WMB and a "run on the bank," WMB was taken over by the Office of Thrift Supervision, and the Federal
Deposit Insurance Corporation (the "FDIC") was appointed as receiver. In an FDIC assisted transaction
conducted on the same day as the regulatory takeover of WMB, JPMorgan Chase Bank, NA ("JPMCB")
acquired substantially all of the assets of WMB for an aggregate purchase price of $1.88 billion, plus
assumption of over $145 billion in deposit and general liabilities of WMB.
After the takeover of WMB by JPMCB, WMI and its affiliated debtors commenced bankruptcy proceedings
in Delaware on September 26, 2008. Because WMI was left with minimal assets following the collapse of
WMB, initial recovery expectations for WMI's creditors were low, claims against WMI traded at very low
prices, and many of the claims were purchased by professional distressed debt investors. Although WMI
had few assets of its own and no material ongoing business, it became clear early in the case that WMI
would assert several potential causes of action against JPMCB arising from the takeover of WMB, and
that recoveries of WMI creditors would be primarily driven by any value that could be obtained for WMI
from litigation or settlement of those claims. Described very generally, the claims asserted were for
turnover of assets - the ownership of which was disputed as between JPMCB, WMI and the FDIC
receivership for WMB - and miscellaneous other claims the parties to the transaction asserted against
one another. Chief in importance among the disputed assets were (i) roughly $4 billion in cash held in
accounts at WMB in the name of WMI (the "Deposited Funds") and (ii) various large tax refund claims
and tax assets ariSing from prior losses of WMB.
The claims arising from the takeover of WMB were partially litigated in bankruptcy court, federal district
court and the federal court of claims. As is common, however, settlement negotiations were ongoing
during this preliminary litigation. A "global settlement" (the "GSA") of all issues relating to the WMB
takeover was first announced on March 12, 2010, and this GSA formed the foundation of (and primary
source of value for distributions under) WMl's Sixth Amended Plan. A confirmation hearing for the Sixth
Davis Polk & Wardwell LLP davispolk.com
DavisPolk
Amended Plan was held in December 2010. At this hearing, allegations of improper trading in public WMI
debt by a group of four hedge funds (the so-called "Settlement Noteholders") that had participated, to
varying degrees, in settlement discussions, were raised for the first time by an individual investor that held
subordinated WMI securities and believed that the GSA had been improperly structured to benefit the
Settlement Noteholders at the expense of other creditors. Generally, the investor alleged that the
Settlement Noteholders had strategically bought and sold public debt in different parts of WMl's capital
structure while in possession of material nonpublic information ("MNPl
h
) gained through their participation
in confidential settlement negotiations with JPMCB, which informed their expectations as to recoveries of
the different classes.
In an opinion issued in January 2011, the Court approved the GSA, but denied confirmation of the plan
for other reasons, primarily deficiencies in the release, indemnity and exculpation provisions. Although
the allegations of insider trading did not playa rote in the Court's decision to deny confirmation (as no
evidence had been presented at that time), Judge Walrath noted in her opinion that plan releases for the
Settlement Noteholders would not be appropriate in light of the allegations and that further discovery
would be helpful.
After the January 2011 opinion was issued, negotiations began around a modified plan remedying the
cited deficiencies. At this time. a committee of equity security holders of WMI (the "Equity Committee"),
that were expected to receive no recovery under the plan and had been one of the main objectors to the
GSA at the first confirmation hearing, sought and obtained discovery from the Settlement Noteholders
relating to the insider trading allegations. Efforts of the plan supporters to reach a consensual settlement
with the Equity Committee ultimately failed. In its objection to plan confirmation, the Equity Committee
focused on the insider trading allegations, and then presented extensive argument and testimony on the
insider trading allegations at the confirmation hearing on the modified plan in July 2011. In early July, the
Equity Committee also moved for standing to pursue claims against the Settlement Noteholders for
equitable subordination or equitable disallowance based on the insider trading allegations.
Involvement of the Settlement Noteholders in the Case
Certain basic facts of the role that the Settlement Noteholders played in the case and in negotiations
between WMI and .IPMCB are not in dispute. The negotiation process between WMI and JPMCB began
in early March 2009 and continued intermittently until the announcement of the GSA in March 2010.
During this period of intermittent negotiations, the Settlement Noteholders were parties to confidentiality
agreements with WMI, and were subject to two formal "lockup periods" in which the Settlement
Noteholders were required either to restrict trading of the Debtors' securities or to establish an ethical wall
screening their traders from any confidential information. At the end of each lockup period, WMI was
required to publicly disclose any MNPI that had been given to the Settlement Noteholders during the
lockup period and to confirm that they had done so. After the Settlement Noteholders were thus
"cleansed: they would resume active trading in the Debtors' securities. Information to which the
Settlement Noteholders were exposed during the lockup periods included the size and amount of a tax
refund the Debtors believed they would receive (which the Debtors made public at the end of the lockup
period) and terms and offers in settlement term sheets that were exchanged and discussed (which were
not made public at the end of the lockup period). It is not in dispute that outside of the lockup periods,
when the Settlement Noteholders were actively trading, they did have some involvement in settlement
negotiations with JPMCB either directly or through conversations with WMI; the Settlement Noteholders
take the position however, that any such involvement did not expose them to information that was
material, even if non public.
2
Davis Polk & Wardwell LIP
DavisPolk
Analysis of Insider Trading Allegations and the Settlement Noteholders' Asserted
Defenses
It is important to note that the Court did not reach any final judgment on the merits of the insider trading
allegations against the Settlement Noteholders. Rather, Judge Walrath's analysis was limited to whether
those allegations gave rise to "colorable" claims sufficient to confer standing on the Equity Committee to
pursue claims for equitable disallowance against the Settlement Noteholders based on their allegedly
improper trading. In undertaking this analysis, Judge Walrath described the relevant standard as an
exceedingly low one, commensurate with "the standard applicable to a motion to dismiss for failure to
state a claim." 1
Elements of Insider Trading
Under section 10(b) of the 1934 Act, two theories of insider trading are recognized: the classical theory
and the misappropriation theory. Under the classical theory, insider trading occurs when a corporate
insider (i) trades in the securities of his corporation (ii) on the basis of (iii) MNPI (iv) in violation of a
fiduciary duty owed to shareholders. Under the misappropriation theory, insider trading occurs when a
corporate outsider "misappropriates confidential information for securities trading purposes, in breach of a
duty owed to the source of the information" rather than a duty owed to the shareholders of the securities.
2
The Settlement Noteholders argued that the only MNPI they received during the lockup periods were the
estimated amounts of the Debtors' tax refunds, which were disclosed to the public before the Settlement
Noteholders actually resumed trading, and that any other nonpublic information on which they traded was
not material.
Classical Insider Trading Analysis
Materiality of Nonpublic Information. As to nonpublic information that was either provided to the
Settlement Noteholders outside of lockup periods or not disclosed at the end of lockup periods - primarily
the existence and substance of settlement discussions with JPMCB - the Settlement Noteholders argued
that such information failed to meet the materiality threshold because of the speculative nature of the
settlement discussions and the uncertainty inherent in any fluid negotiation. Materiality of nonpublic
information is generally determined by an objective "reasonable investor" test that asks whether the
information in question would be important to a reasonable investor in making his or her investment
decision.'" With regard to information on transformative corporate events like a potential merger, courts
use a balancing test that looks to the "indicated probability that the event will occur and the anticipated
magnitude of the event in light of the totality of the company activity:' The parties did not dispute the
potential magnitude of a settlement with JPMCB, but rather focused on the probability that such a
settlement would occur. The Settlement Noteholders argued that settlement negotiations were too
tentative, the parties' positions too far apart, and the core terms of the settlement proposals too fluid for
the settlement that was uHimately struck to be sufficiently probable to constitute material information. The
Settlement Noteholders contended that settlement discussions in the context of complex, multi-party,
multi-issue negotiations such as those that occurred between the parties became material only after an
agreement-in-principle had been reached or when the parties had become sufficiently close to reaching a
deal as to suggest a high probability that the deal would be consummated.
I In re Washington Mutual, Inc., Case No. 08-12229 (MFWJ, slip op at p. 109 (Bankr. D. Del. 2011).
2 U.S. v. O'Hagan, 521 U.S. 642, 652 (1997).
3 1n re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1425 (3d. Cir. 1997).
4 Basic, Inc. v. Levinson, 485 U.S. 224, 238 (1988) (emphasis added).
3
Davis Polk & Wardwell UP
DavisPolk
The Court rejected this argument. It is again important to note that the Court did not definitively hold that
any of the relevant settlement discussions were material, only that some of those discussions may have
gone to the "material end of the spectrum" and that several rules for determining materiality proposed by
the Settlement Noteholders were not correct. Addressing certain specific issues, Judge Walrath found
the fact that the parties executed confidentiality agreements, exchanged significant amounts of
information and engaged in multi-party discussions for more than a year to be indicative of materiality and
evidence that the parties to the agreements regarded the information as material. In rejecting arguments
by the Settlement Noteholders that they reasonably believed after each confidentiality period had ended
without a definitive agreement that the deals were "dead, and therefore, that past discussions were not
material, Judge Walrath pOinted to other facts, such as the Debtors' continued negotiations with several
key parties outside of the confidentiality periods and the unhappy reaction of other parties that were
excluded from those discussions, as evidence that the discussions were potentially material. Judge
Walrath also suggested that the actions of certain of the Settlement Noteholders in restricting their own
trading during separate negotiations with the Debtors outside of the formal confidentiality periods belied
any notion that such Settlement Noteholders believed the negotiations to be over.
Importantly, the Court also discussed the relevance of trading activity in determining materiality, and
whether materiality in this case could be adduced from the trading patterns of the Settlement Noteholders
immediately following each confidentiality period. The Equity Committee asserted that the trading
patterns of the parties was suggestive of such a finding because the Settlement Noteholders engaged in
what amounted to a "buying spree" in junior claims, which the Equity Committee contended was based on
knowledge that the settlement was likely to yield enough value to generate a recovery for the junior
claims in excess of their trading prices. In response, the Settlement Noteholders argued that such a
conclusion was not supported by the evidence because many of the Settlement Noteholders took
different and even opposite trading positions. The Settlement Noteholders argued that had such
information been material, all parties would have had economically similar trading patterns.
The Court again sided with the Equity Committee and found the evidence of contrary or random trading
unpersuasive. Although the Court found it difficult to draw any conclusions based on the Settlement
Noteholders' trading activity, the Court went on to state that it believed that (1) the "negotiations may have
shifted towards the material end of the spectrum," and (2) the Settlement Noteholders "traded on that
information, which was not known to the public." Consequently, the Court concluded that a colorable
claim existed that the Settlement Noteholders possessed MNPI while trading.
Insider Status. In support of its argument that the actions of the Settlement Noteholders constituted
insider trading under the classical theory, the Equity Committee argued that although the Settlement
Noteholders were not insiders of WMI in the typical sense of directors or officers, they were "temporary
insiders" of the Debtors and thus assumed a duty not to trade. Recognized case law suggests that
"insiders" for purposes of classical insider trading are not limited solely to officers and directors of a
corporation but also include in certain instances "temporary insiders" who have "entered into a special
confidential relationship in the conduct of the business of the enterprise and are given access to
information solely for corporate purposes."s The Equity Committee argued that such a relationship was
created between the Debtors and the Settlement Noteholders when the Settlement Noteholders were
given MNPI, triggering a fiduciary duty on their part to other creditors and shareholders. Additionally, the
Equity Committee asserted that the Settlement Noteholders' blocking positions in two subordinated
classes of creditors potentially conferred fiduciary obligations on the Settlement Noteholders with respect
to those two classes of creditors. The Settlement Noteholders countered that temporary insider status
5 Dirks v. SEC, 463 U.S. 646, 655 n.14 (1983).
4
Davis Polk & Wardwell LLP
DavisPolk
was not conferred where. as here, the Debtors and the Settlement Noteholders were working toward a
goal in which each had diverse interests.
The Court did not wholly adopt the Equity Committee's first argument - that insider status should be
imputed to the Settlement Noteholders purely on account of their possession of MNPI - but, nonetheless,
found that there was a colorable claim that such status existed because the Debtors (i) gave the
Settlement Noteholders confidential information and (ii) allowed the Settlement Noteholders to participate
in negotiations with JPMCB for the shared goal of reaching a settlement that would form the basis of a
consensual plan of reorganization. The Court agreed with the Equity Committee's second assertion
that the Settlement Noteholders could be considered "insiders as a consequence of their status as
holders of blocking positions in two classes of the Debtors' debt structure - because such significant
holdings could create a duty to other members of those classes to act for their benefit. Interestingly,
although the Equity Committee couched this second argument as conferring a potential fiduciary duty on
the Settlement Noteholders as to other members of the two classes in which the Settlement Noteholders
owned blocking positions, Judge Walrath's analysis is unclear and could be interpreted to mean that such
duties also ran to other classes. including the equity class to which standing was granted.
Knowledge. In order to meet the scienter requirement for classical insider trading. it must be shown that,
at the time of trading, the defendant "knew or recklessly disregarded" that it possessed MNPI. In support
of their position that this requirement was not satisfied. the Settlement Noteholders argued that (1) their
confidentiality agreements explicitly required the Debtors to disclose any MNPI at the end of each
confidentiality period, (2) the Debtors certified that they had disclosed all MNPI, and (3) the Settlement
Noteholders independently confirmed that such disclosure had occurred. The Settlement Noteholders
also argued that the inconsistent trading patterns exhibited by different Settlement Noteholders
throughout the periods in question further supported the notion that any information received during
settlement talks that was not subsequently made public was not material.
The Court disagreed with the Settlement Noteholders on all counts, finding that the Settlement
Noteholders' reliance on the Debtors for proper disclosure of any applicable MNPI did not provide a safe
harbor with respect to the Settlement Noteholders' trading activity. Further, notwithstanding each
Settlement Noteholder's own internal policies, the Court found that the Settlement Noteholders traded
while in possession of the knowledge that the Debtors were engaged in discussions with JPMCB relating
to issues of which the trading public was unaware. Based on these findings, the Court concluded that
there was a colorable claim that the Settlement Noteholders were at least reckless as to their use of MNPI.
In response to the additional assertion by the Settlement Noteholders that their inconsistent trading
patterns undercut any argument that they traded based on MNPI, Judge Walrath stated that the statute
only required that the Settlement Noteholders have knowledge that they were in possession of MNPI
while trading. not that they profited from such knowledge or actually applied such knowledge in their
trading.
Misappropriation Theory Insider Trading Analysis
The misappropriation theory of insider trading examines whether (i) the defendant possessed MNPI (ii)
which he had a duty to keep confidential and (iii) breached that duty by acting on or revealing the
information in question: S Liability attaches when the person who received MNPI trades on the
misappropriated information under circumstances in which that person knew or should have known the
MNPI was misappropriated. 7 Here. the evidence presented suggested that the Debtors shared
information with counsel to certain of the Settlement Noteholders pursuant to a strict confidentiality
a SEC v. Lyon, 605 F. Supp. 2d 531, 541 (S.D.N.Y. 2009).
7 SEC v. WifliS, 777 F. Supp. 1165,1169 (S.D. N.Y. 1991).
5
Davis Polk & Wardwell LLP
DavisPolk
agreement restricting any further distribution of such shared information to the law firm's clients unless the
receiving party had entered into a separate confidentiality agreement directly with the Debtors.
Notwithstanding such restrictions, the law firm allegedly shared summaries of April negotiations with two
of its clients who were freely trading at the time and who had not entered into the required confidentiality
agreements. After receipt of this information, one client continued to trade, while the other voluntarily
restricted its trading. In light of the foregoing, the Court found that there was a colorable claim against the
fund that had continued trading on a misappropriation theory, because the fund "knew or should have
known" that the information was restricted and subject to the law firm's confidentiality obligation to the
Debtors (it was also alleged that the law firm breached its confidentiality agreement with the Debtors in
sharing the MNPI with its clients). The Court also concluded that a colorable claim of insider trading
under the misappropriation theory existed with respect to whether the same attorneys had similarly
breached their confidentiality agreement by allegedly sharing protected MNPI with the Settlement
Noteholders.
Possible Effects of the Decision
As noted above, although Judge Walrath discusses the law of insider trading in significant detail, the
Court did not reach any final conclusion as to the merits of the specific allegations at issue. The Court's
ultimate finding is only that the allegations meet the low bar of being "colorable" claims, justifying a grant
of standing to the Equity Committee to pursue the claims further. In spite of this, however, the Court's
analysis of the application of insider trading laws to claims traders in the bankruptcy process may have a
significant impact on the way claims traders do business and on the way settlement and restructuring
negotiations are conducted in bankruptcy. In concluding its analysis of the insider trading allegations, the
Court addressed this issue, noting that the Settlement Noteholders and others had warned that a finding
of insider trading would chill the partiCipation of creditors in settlement discussions in bankruptcy cases of
public companies. On this point the Court displayed little sympathy, contending that "[t]here is an easy
solution: creditors who want to participate in settlement discussions in which they receive material
nonpublic information about the debtor must either restrict their trading or establish an ethical wall
between traders and participants in the bankruptcy case."
8
Judge Walrath found these restrictions
appropriate and not unduly burdensome because these creditors were doing so in exchange "for a seat at
the negotiating table," which would not only allow them to receive confidential information in return but
would also give them the opportunity to influence the reorganization process.
Judge Walrath's decision seems to propose a bright line rule for the conservative investor: if you wish to
participate in nonpublic negotiations, you should not make trading decisions at any time after beginning
such negotiations. Institutions involved in negotiations would refrain from trading entirely or implement an
"ethical wall" between those engaged in negotiations and those making trading decisions for the duration
of the case. For investors that are willing and able to adopt one of these approaches, Walrath's decision
will not be problematic. For some investors, however, these approaches will be either difficult or
impossible, and these investors will not be willing to take the risk of becoming restricted indefinitely by
engaging in settlement discussions.
Investors unwilling to be indefinitely restricted have typically used confidentiality arrangements similar to
those used by the Settlement Noteholders, providing for intermittent restricted periods during which they
halted trading or walled off traders, followed by a publication of MNPI to which they were exposed at the
end of the restricted period, thus "cleansing" them before they resumed trading or removed the ethical
wall. The full impact of Judge Walrath's decision on market practice will not fully be known for some time.
In the wake of this opinion, however, confidentiality agreements that allow investors to move back and
8 In re Washington Mutual, Inc., Case No. 08-12229 (MFW). slip op at p. 138 (Bankr. D. Del. 2011).
6
Davis Polk & WardwellLl..p
DavisPolk
forth between restricted and unrestricted status through a "cleansing" of MNPI would seem to carry with
them either a burden on the debtor to disclose enormous amounts of information at the end of lockup
periods (some of which could be problematic for evolving negotiations), or a risk that determinations as to
materiality would later be vulnerable to attack. This could impact both claims trading and plan negotiation
dynamics. From the investor's perspective, inability to use these arrangements could discourage active
participation in negotiations by funds that are not able or willing to establish ethical walls for the duration
of a case, and thus limit such investors' ability to protect their interests. From the debtor's perspective,
this shrinking of the universe of negotiation participants could make it difficult to craft a plan the debtor
could be confident would succeed due to an inability to find a critical mass of creditors with whom to
negotiate. Needless to say, it is preferable for a debtor to be able to know with some certainty that its
proposed plan structure will succeed, and having to guess at what creditors will vote to support could lead
to an inefficient and drawn out plan process, prolonging case duration and expense.
If you have any questions regarding the matters covered in this publication, please contact any of the
lawyers listed below or your regular Davis Polk contact.
Donald S. Bernstein 2124504092 donald.bemstein@davispolk.com
Timothy Graulich 2124504639 timothy. 9 raulich@davispolk.com
Marshall S. Huebner 2124504099 marshall.huebner@davispolk.com
Benjamin S. Kaminetzky 2124504259 ben.kaminetzky@davispolk.com
Elliot Moskowitz 2124504241 elliot.moskowitz@davispolk.com
Brian M. Resnick 2124504213 brian.resniCk@davispolk.com
Damian S. Schaible 2124504580 damian.schaible@davispolk.com
Karen E. Wagner 212450 4404 karen. wagner@davispolk.com
Eli James Vonnegut 2124504331 eli. vonnegut@davispolk.com
2011 Davis Polk &Wardwell llP
Notice: This is a summary that we believe may be of interest to you for general information. It is not a full analysis of the matters
presented and should not be relied upon as legal advice. If you would rather not receive these memoranda, please respond to this
email and indicate that you would like to be removed from our distribution list. If you have any questions about the matters covered
in this publication, the names and office locations of all of our partners appear on our website, davispolk.com.
7
Davis Polk & Wardwell !..t.P
EXHIBITH
Ad Hoc Committees Owe Fiduciary Duties? WaMu Threatens to Tum a Molehill Into a... Page lof2
News & Publications
Ad Hoc Committees Owe Fiduciary Duties? WaMu Threatens
to Turn a Molehill Into a Mountain
September 19, 2011
Much has already been written about the "insider trading" aspects of Judge Walrath's September 13 Opinion
denying confirmation of WaMu's Chapter 11 plan of reorganization (the Opinion can be found hererlil). In a
nutshell, Judge Walrath expressed the view that a person in possession of MNPI (material non-pUblic information)
could be considered to be engaged in insider trading even after the MNPI restriction period ends.
While that part of the Opinion is certainly a blockbuster, we are focusing here on a different aspect of the Opinion,
namely Judge Walrath's view that members of an ad hoc committee can be considered to owe fiduciary duties to
other creditors holding the same class of securities. Yikes! The first time she said this, we noted her comments in
. "The WaMu Double Whammy," which can be found here. We repeat now what we said then, which is that this is a
frightening conclusion. Except then, Judge Walrath's comments were more speculative. In her latest Opinion,
although still dicta, all speculation is laid to rest.
Citing to the Supreme Court decision in Dirks v. SEC, 463 U.S. 646 (1983), Judge Walrath found two independent
bases for concluding that that a "colorable claim" existed for concluding that the "Settling Noteholders" owed
fiduciary duties to other noteholders in the same class. First, because the Settling Noteholders received MNPI in
the course of settlement discussions with the Debtors, they became "temporary insiders" of the Debtors and owed
the same fiduciary duties as other corporate insiders. Second, the Settling Noteholders (in Judge Walrath's view)
held themselves out as representing the entire class of noteholders, and therefore assumed fiduciary duties to act
in the best interests of the entire class.
Judge Walrath does not simply rely on the Dirks case or her own views, she also refers to several other decisions
(including her own earlier WaMu decision) and a law review article to reach the conclusion that ad hoc
committees in posseSSion of MNPI can owe fiduciary duties. Even so, the comments about fiduciary duties would
appear to be dicta, as Judge Walrath rests her decision on insider trading considerations rather than potential
breach of fiduciary duties.
So what is a large bondholder to do?
The primary reasons for forming ad hoc committees are self-evident. First, "size matters," and debtors are far
more willing to negotiate with a group of creditors who hold substantial claims in the aggregate rather than with a
series of individual creditors. Indeed, prepetition borrowers and issuers often encourage bondholders to form ad
hoc committees precisely for this purpose. While there are certainly no guarantees that a settlement negotiated by
an ad hoc committee will be accepted by the requisite bondholders generally in a consent solicitation or exchange
offer (if out-of-court) or a plan vote (if in-court), it is certainly beneficial to know whether a critical mass of
bondholders is willing to support a proposed solution. Second, teaming up with other bondholders enables cost
sharing of legal and financial advisor fees.
Judge Walrath's answer to the above question is simple. If you are an ad hoc committee and in possession of
MNPI, either don't trade in the securities or establish an internal wall between the private and public sides of your
shop, and further don't assume you are free to trade just because the agreed "restricted period" has terminated.
http://www.bracewellgiuliani.com/index.cfm/falnews.advisory/item/c95181 bc-db61-4bee-... 9/26/20 II
Ad Hoc Committees Owe Fiduciary Duties? WaMu Threatens to Turn a Molehill Into a ... Page 2 of 2
Fair enough, although whether the WaMu Settling Noteholders actually crossed the line rather than merely
presenting a "colorable claim" is left open for another day. But why does the concept of fiduciary duties need to be
brought into the discussion? There are plenty of remedies for improper trading while in the possession of MNPI,
but adding the burden of fiduciary duties opens up an entirely new category of risks that, potentially, expose ad
hoc committee members to legal claims having nothing to do with insider trading.
It is not difficult to imagine situations in which the foregoing scenario could play out. Suppose, for example, an ad
hoc committee consists of large bondholders interested in a debt-equity conversion. Some smaller non-committee
bondholders, however, may have no interest in holding equity, either because it is not part of their investment
. strategy or because their fund is precluded from holding equity securities. In a debt-equity conversion plan,
therefore, these latter bondholders could be compelled to sell their equity (or their right to receive equity) quickly,
and potentially at a low price given urgent timing considerations. Could these bondholders sue the ad hoc
committee members for not acting in the best interests of bondholders who did not want to, or could not, hold
equity in the reorganized company?
Or how about the very common scenario in which the debtors agree to reimburse the fees of the ad hoc
committee's professionals. Can non-committee bondholders sue the committee members because they did not
also negotiate for the reimbursement of professional fees incurred by non-committee members?
In fact, the WaMu dicta begs an even more basis question: if ad hoc committee members have fiduciary duties
like official committees, are they restricted from trading even if not in possession of MNPI unless they set up a
strict internal wall?
Whether the WaMu Settling Noteholders did, in fact, engage in improper insider trading is an issue that mayor
may not be resolved in the long run and is, of course, highly dependent on the unusual facts of the WaMu
situation. But whether ad hoc committee members owe fiduciary duties to non-committee members is, we fear, an
issue that may play out repeatedly in the years to come, whether simply through behind-the-scenes threats or
eventually through live litigation. That's too bad, because there are already ample remedies (such as insider
trading laws) for the rare abuse of an ad hoc committee position without layering on top of those remedies a
fiduciary duty construct that could turn a molehill into a mountain.
Evan D. Flaschen
Phone: 860.256.8537
Email: evanJlaschen@bgllp.com
Kurt A. Mayr
Phone: 860.256.8534
Email: kurt.mayr@bgllp.com
David L. Lawton
Phone: 860.256.8544
Email: david.lawton@bgllp.com
http://www.bracewellgiuliani.com/index.cfm/falnews.advisorylitemlc95181bc-db61-4bee-... 9/26/2011
EXHIBIT I
WaMu Court Allows Equity Committee to Pursue
"Equitable Disallowance" of Noteholder Claims Based on
Allegations of Insider Trading
On September 13,2011, Judge Mary F. Walrath of the United States Bankruptcy Court for the District of
Delaware granted standing for an equity committee in In re Washington Mutua/, Inc. ("WaMu") to seek
"equitable disallowance" of daims held by noteholders that had traded claims after engaging in negotiations
with WaMu over the terms of a global restructuring. The decision highlights the question of whether
creditors may engage in restructuring negotiations with a debtor and continue to trade in claims without
establishing an ethical wall restricting traders from access to information related to the negotiations.
In WaMu, the equity committee argued that "equitable disallowance" of the claims held by certain hedge
funds that held Washington Mutual notes (the "Noteholders") was warranted because the Noteholders had
allegedly traded securities of the Debtors while in possession of material, non-public information concerning
plan-related setdement negotiations. The Noteholders had signed confidentiality agreements with WaMu that
required them either to establish an ethical wall or to refrain from trading during two specified limited
duration confidentiality periods. In exchange for the Noteholders submitting to those restrictions, WaMu
agreed to make cleansing disclosures of material, non-public information at the conclusion of the specified
confidentiality periods, so as to permit the Noteholders to resume trading without an ethical wall. Following
the confidentiality periods and cleansing disclosures by WaMu, certain of the Noteholders traded in WaMu
debt. WaMu did not include in its cleansing disclosures the fact that negotiations were ongoing or the
content of the various settlement term sheets that had been exchanged among the parties to the negotiations.
Despite the fact that the discussions and term sheets had not resulted in any agreement in principle, the
equity committee argued that the fact of the ongoing negotiations and the setdement terms under discussion
constituted material, non-public information.
The Bankruptcy Court made several notable statements in the course of concluding that the equity
committee had stated "colorable claims" relating to insider trading that could provide a basis for "equitable
disallowance" of the Noteholders' bankruptcy daims. The Court, in light of these rulings, granted the equity
committee standing to pursue these allegations and to seek "equitable disallowance."
Court's Discussion of Insider Trading Allegations
For a party to be held liable for insider trading, it must have traded while in possession of material, non
public information in breach of a duty of trust or confidence owed either to the issuer of the securities or to
the source of the information.
Materiality
The Bankruptcy Court held that the equity committee had stated colorable claims that the Noteholders
received material, non-public information during the specified confidentiality periods, even though the
parties did not reach any agreement. The Court rejected arguments that the content of plan negotiations
could only be material once an agreement in principle had been reached, and found unconvincing the
Noteholders' appeals to the impracticality of mandating disclosure of constandy changing settlement
proposals. The Court also dismissed the Noteholders' arguments that the information could not have been
material because the various Noteholders did not trade consistently after the specified confidentiality
periods-some of the Noteholders were selling while others were buying or not trading at all. In this regard,
ATTORNEY ADVERTISING
the Court commented that the fact that certain Noteholders may have made unwise or contrary trades does
not provide a defense to an insider trading action.
Insider Status
Under the "classical theory" of insider trading, the defendant must be a "corporate insider," which may
include "temporary insiders" as well as officers and directors. The WaMu Court held that the equity
committee had stated a colorable claim that the Noteholders became temporary insiders when they were
given material, non-public information during negotiations toward a shared goal of a consensual
reorganization, and that that insider status gave rise to a fiduciary duty on their part to other creditors in the
classes in which the Noteholders held blocking positions. In so holding, the Court relied on an observation
made by the United States Supreme Court in a footnote in the seminal case of Dirks v. SEC, which observed
in relevant part:
Under certain circumstances, such as where corporate information is revealed legitimately to
an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders
may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is
not simply that such persons acquired nonpublic corporate information, but rather that they
have entered into a special confidential relationship in the conduct of the business of the
enterprise and are given access to information solely for corporate purposes.
Thus, the WaMu Court appears to have extended the scope of the Dirks decision from contractual agents of
a corporation to a corporation's adversaries in a restructuring negotiation, solely because the parties have a
common purpose in achieving a reorganization.
The WaMu Court also held that the equity committee presented evidence that the Noteholders could be
considered "non-statutory insiders" because of their status as holders of blocking positions in two classes of
the Debtors' securities. The Court observed that the Noteholders with blocking positions could be found to
have owed a fiduciary duty to the other members of those classes to act for their benefit and, for this reason,
also found that the equity committee had stated colorable claims that the Noteholders were temporary
insiders for purposes of securities laws.
Scienter
As a defense to the insider trading allegations, the Noteholders asserted that the necessary element of scienter
was lacking. Specifically, they argued that they could not have engaged in insider trading knowingly or
recklessly because the Debtors had explicidy agreed to disclose any material, non-public information at the
expiration of the confidentiality periods and had, in fact, made cleansing disclosures, which the Noteholders
believed had included any material, non-pUblic information. Therefore, the Noteholders argued, they could
not have known that they still possessed material, non-public information. The Court rejected this defense,
noting that each Noteholder had explicit policies prohibiting insider trading and could not use the Debtor as
a shield if these policies were violated.
"Equitable Disallowance" Permitted as a Remedy to Benefit Equity Holders
Bankruptcy Code section 510(c) permits a Bankruptcy Court, under appropriate circumstances, to
subordinate all or a part of an allowed claim to all or part of another allowed claim, or to subordinate all or
part of an allowed equity interest to all or part of another allowed equity interest. It does not authorize the
subordination of claims to equity interests. This alone, the Noteholders argued, should have defeated the
?"''''- ___mNM
l
ATTORNEY ADVERTISING
J
claims of the equity committee-since what the equity holders were seeking was to subordinate the recovery
of the Noteholders to permit value to flow to the equity. The Court acknowledged that equitable
subordination was not an available remedy for the equity committee, but nevertheless approved the equity
committee's novel pursuit of the "equitable disallowance" of the Noteholders' claims, citing the decisions of
the Bankruptcy and District Courts in Adelphia as precedent for its authority to disallow a claim on equitable
grounds in "extreme" cases.
Implications of the WaMu Decision
Creditors holding substantial positions in bankruptcy cases, particularly in cases pending in Delaware, may be
concerned about the implications of the WaMu decision on a number of grounds.
First, creditors seeking to engage in plan negotiations with a debtor or creditors' committee must now
consider whether doing so results in a potentially indefinite restriction on trading, even where such creditors
take care to include protections and "cleansing" provisions in confidentiality agreements. The Court
dismissed concerns that its findings would chill the participation of creditors in restructuring discussions,
stating: "[TJhere is an easy solution: creditors who want to participate in settlement discussions in which they
receive material, non-public information about the debtor must either restrict their trading or establish an
ethical wall between traders and participants in the bankruptcy case." This choice will be unattractive to many
market participants.
Second, significant creditors and creditor groups may be concerned about suggestions in the decision that
participants in the restructuring process may become fiduciaries for the classes in which they hold claims,
despite the fact that they are not members of the official creditors' committee.
Third, creditors and investors may be concerned that the emergence of a novel doctrine permitting
"equitable disallowance" could undermine the structural seniority of claims to equity.
The WaMu Court's order granting standing to the equity committee has been stayed pending mediation, and
therefore, the likelihood of an appeal is uncertain. If no appeal is taken from the decision, there will be no
direct opportunity for the Noteholders, or other parties with an interest in these issues, to test the Court's
conclusions regarding the legal validity of the equity committee's claims of insider trading or the availability
of the remedy of "equitable disallowance." It should be noted that the WaMu decision is the view of one
Bankruptcy Court, albeit an important and potentially influential one, and that as a technical matter, the
decision does not have binding effect either on other Delaware Bankruptcy Courts or in Districts outside of
Delaware. Nonetheless, creditors seeking to participate in a restructuring process or considering investing in
securities that are, or may become, subject to such a process, will need to consider carefully the implications
of this decision.
For further information, please contact Air-son Allen, D. Ross Martin, or Keith H. Woft<)f(1.
This alert should not be construed legal advice or a legal opinion on any specific fads or cin:umatance. This alert is not inlendad to ClHte. and
ATIORNEY ADVERTISING
receipt of it does not constHute, a lawyer-client relationship. The contents are intended for general informational purposes only. and you are urged to
consuK your aHomey conceming any particular situation and any speCifIC legal question you may have. @2011 Rope. 8. Gray llP
EXHIBIT J
WILLKIErARR &GALLAGHER UP
I CLIENT
MEMORANDUM
KEY RULINGS FROM DELAWARE BANKRUPTCY COURT'S REJECTION OF
WASHINGTON MUTUAL'S PLAN OF REORGANIZATION
In a recent 139-page decision (the "Decision") with far-reaching implications for parties
involved in chapter 11 proceedings, Judge Mary F. Walrath of the Bankruptcy Court for the
District of Delaware denied, for the second time, confirmation of Washington Mutual, Inc.'s
("WMI") and WMI Investment Corp.'s (collectively, the "Debtors") plan of reorganization (the
"Plan").) Judge Walrath found several deficiencies in the Plan that violated the best interests of
creditors test articulated in section 1129(a)(7) of title 11 of the United States Code (the
"Bankruptcy Code,,).2
In addition to denying confirmation of the Plan, the Court also granted (and then stayed) a
motion by the Official Committee of Equity Security Holders (the "Equity Committee") to
prosecute an action to equitably subordinate or disallow the claims of certain
noteholders (the "Settlement Noteholders")? While denying standing to bring a claim for
equitable subordination, the Court held that the Equity Committee had standing to bring a claim
for equitable disallowance based on allegations of insider trading by the Settlement Noteholders.
In so ruling, Judge Walrath found that the Equity Committee stated a colorable claim for
equitable disallowance, and ordered the parties to mediate to avoid a litigation morass which
would further drain the estates' resources.
While the Decision analyzed numerous objections to the Plan asserted by various creditors and
shareholders, certain of Judge Walrath's rulings are significant for practitioners and participants
in chapter 11 cases, namely, the rulings on: (i) jurisdiction; (ii) post-petition interest;
(iii) equitable disallowance; and (iv) non-statutory insider status under applicable law. These
key rulings are discussed in further detail below:
In rejecting the argument that the Court lacked jurisdiction over modification of the Plan,
Judge Walrath interpreted and applied the Supreme Court's recent decision in Stern v.
Marshall, which has generated much commentary and uncertainty regarding a bankruptcy
court's constitutional authority to enter a final judgment under certain circumstances.
In re Washington Mutual. Inc., Case No. 08-12229 (MFW) (Bankr. D. Del. Sept. 13,2011) [Docket No.
8612].
II U.S.C. I I 29(a)(7}.
Motion for an Order Authorizing the Official Committee of Equity Security Holders to Commence and
Prosecute Certain Claims ofDebtors' Estates, In re Washington Mutual. Inc., Case No. 08-12229 (MFW)
(Bankr. D. Del. July 12, 2011) [Docket No. 8179].
131 S. Ct. 2594 (2011).
NEW YORK WASHiNGTON PARIS loNDON MILAN ROME FRANKFURT BRUSSELS
in alliance with Dickson J\finto W.s., London and Edinburgh
2
WII.tKIE l ~ \ R R &GALI.AGllERu.l'
In detennining what constitutes the "legal rate" for payment of post-petition interest on
unsecured creditors' claims under section 726(a)(5) of the Bankruptcy Code, Judge
Walrath concluded that the federal judgment rate, rather than the contract rate, is
applicable.
5
This was surprising as many believed that Judge Walrath's decision in In re
Coram Healthcare Corp. provided support for the proposition that an unsecured creditor
may be entitled to its contract rate of interest.
6
The Court granted the Equity Committee's motion for standing to prosecute a claim for
equitable disallowance, even though the Settlement Noteholders argued that no such
cause of action exists as a matter of law.
The Court found that the "Settlement Noteholders owed duties as non-statutory insiders
under bankruptcy law" due to their blocking position in two classes of the Debtors' debt
structure.
7
The imposition of fiduciary duties on creditors with blocking positions goes
further than a previous decision in which Judge Walrath suggested that "members of a
class of creditors may, in fact, owe fiduciary duties to other members of the class" when
holding themselves out in a representative capacity.8
Background
During the global credit crisis in the Fall of 2008, the rating agencies significantly downgraded
the credit rating of Washington Mutual Bank ("WMB") and its holding company, WMI. A bank
run followed, resulting in $16 billion of withdrawals from WMB in a 10-day period.
On September 25, 2008, the Office of Thrift Supervision closed WMB and appointed the Federal
Deposit Insurance Corporation (the "FDIC") as receiver for WMB. Immediately after its
appointment as receiver, the FDIC sold substantially all of WMB's assets to JPMorgan Chase
Bank, N.A. ("JPMC"). On September 26, 2008, the Debtors filed petitions under chapter 11 of
the Bankruptcy Code.
The seizure and sale of WMB's assets gave rise to disputes among the Debtors, the FDIC and
JPMC "regarding ownership of certain assets and various claims that the parties asserted against
each other.,,9 Nearly three years into the contentious chapter 11 cases, negotiations led to a
global settlement agreement (the "GSA") that resolved issues among the Debtors, JPMC, the
Section 726(a){5) of the Bankruptcy Code provides that, after aU other priority claims, unsecured claims
(including certain tardily filed claims) and claims for fines, penalties or forfeitures are paid in full,
distributions will be made in "payment of interest [on such claims] at the legal rate from the date of the
filing of the petition." 11 U.S.c. 726(a)(5) (emphasis added).
315 B.R. 321, 346 (Bankr. D. Del. 2004).
Decision at 130, 132.
8
In re Washington Mutual. Inc., 419 B.R. 271,280 (Bankr. D. Del. 2009).
9
Decision at 2.
-2
FDIC and certain creditors, including the Settlement Noteholders. The GSA served as the
cornerstone of the Plan, and, although there were a myriad of objections, Judge Walrath found it
to be fair and reasonable in an initial January 7, 2011 opinion (the "January 7 Opinion") denying
confirmation. 10
Despite modifications to the Plan to address the deficiencies identified in the January 7 Opinion,
certain creditors and shareholders opposed the amended Plan. Following the July 2011
confirmation hearings and submission of post-hearing briefs, Judge Walrath issued the Decision
but once again denied confirmation of the Plan and reaffirmed the conclusion in the January 7
Opinion that the GSA was fair and reasonable. II
Jurisdictional Analysis
As an objection to confirmation of the Plan, certain creditors asserted that the Court could not
enter a final order to confirm the Plan in light of the Supreme Court's ruling in Stem, because the
Plan incorporated the GSA, and thus confirmation would require the Court to decide the estates'
claims against JPMC and the FDIC, for which the Court lacked jurisdiction.
12
These objecting
creditors further contended that the claims of the estate against JPMC and the FDIC were
traditional actions at common law (i.e., state corporate law, tort law and fraudulent conveyance
law, as well as federal intellectual property and tort claims) and, therefore, had to be decided by
an Article III court in accordance with Stern.
13
Proponents of the Plan disagreed for several
reasons, principally that the Stem Court characterized its ruling as narrow.
14
Judge Walrath concluded that Stem did not support the objecting creditors' argument.
1S
First,
Judge Walrath noted that bankruptcy court approval of settlements is a firmly established
historical practice, currently recognized by Federal Bankruptcy Rule 9019, which is based on a
similar provision ofthe Bankruptcy Act.
16
Judge Walrath then cited section 1123(b)(3)(A) ofthe
Bankruptcy Code, which states that a plan may provide for the settlement of any claim or
interest, and further explained that confirmation of such a plan is within the Court's core
jurisdiction.17
JO
In re Washington Mutual, Inc., 442 B.R. 314, 347 (Bankr. D. Del 2011).
IJ
Decision at 31-32.
12
Decision at 6.
13
Decision at 7.
14
Decision at 8.
J5
Stem held that a bankruptcy court, as a non-Article III court, "lacked the constitutional authority to enter a
final judgment on a state law counterclaim that is not resolved in the process of ruling on a creditor's proof
of claim." 131 S. Ct. at 2620. Although the Supreme Court viewed the issue before it as narrow, the Stem
decision has nonetheless been an area of uncertainty for many bankruptcy judges and litigants.
16
, , - - . , ~ , - . - at 9.
J7
Decision at 11.
- 3
WII.l.KIE J<i\HR &GAIl.AGIIER UJ'
Second, Judge Walrath distinguished approval of a settlement of claims from a ruling on the
merits of such claims, stating that a court does not need jurisdiction over the underlying claims to
approve a resulting compromise. IS Judge Walrath explained: "the January 7 Opinion was not a
decision on the merits of the underlying claims but merely a determination that the settlement of
those claims by the Debtors on the terms of the [settlement] was reasonable.,,19
Finally, Judge Walrath found that the approval of the GSA was particularly within the "core
jurisdiction" of the Court because approval includes a determination of what is property of the
estate. And, Judge Walrath held, "[i]t is without question that bankruptcy courts have exclusive
jurisdiction over property of the estate," including whether disputed property is property of the
estate.
20
As Stern is a recent decision being interpreted by the courts, the Decision provides insight into
how it could potentially affect numerous previously undisputed aspects of a bankruptcy court's
jurisdiction.
Post-Petition Interest
Certain creditors alleged that the Plan failed to comply with the best interests of creditors test
because it provided for the payment of post-petition interest on certain creditors' claims at their
contract rate of interest, as opposed to the federal judgment rate. The Court held the "legal rate"
for payment of post-petition interest on creditors' unsecured claims under section 726(a)(5) of
the Bankruptcy Code is the federal judgment rate?1
In support of this holding, Judge Walrath first observed that "section 726(a)(5) states that interest
on unsecured claims shall be paid at 'the legal rate' as opposed to 'a' legal rate or the contract
rate.'.22 Judge Walrath reasoned that since Congress specifically provided for the contract rate in
section 506(b) of the Bankruptcy Code, it would have been specific in section 726 as well had it
intended the contract rate to apply. Second, Judge Walrath reasoned that the payment of post
petition interest is procedural in nature, and as such is governed by federal law rather than state
law. From a policy standpoint, Judge Walrath added that the federal judgment rate promotes
"fairness among creditors and administrative efficiency.'.23
Judge Walrath relied heavily on In re Cardelucci in her post-petition interest analysis, especially
with respect to the lack of specific language in section 726(a)(5) suggesting that Congress
18
Decision at 12.
19
Decision at 14.
20
Decision at 14-15.
2L
Decision at 77-78.
22
Decision at 78.
23
Decision at 78-79.
- 4
WILLKJE T ~ \ R R &G,,\U.AGHER IW
intended the contract rate to apply.24 There, the Ninth Circuit ruled that the legal rate meant the
federal judgment rate due to principles of statutory interpretation and policy considerations.
25
This aspect of the Decision was surprising given Judge Walrath's previous decision in Coram
"that the specific facts of each case will determine what rate of interest is 'fair and equitable.",26
Indeed, Judge Walrath acknowledged as much in a footnote stating, "[t]o the extent I suggested
in Coram that the federal judgment rate was not required by section 726(a)(5), I was wrong.'.27
Judge Walrath, however, identified some circumstances where creditors might receive interest at
the contract rate. For example, the Court found that oversecured creditors are entitled to interest
at the contract rate.
28
In addition, the Court recognized an entitlement to interest at the contract
rate where contractual subordination provisions explicitly require junior creditors to make
payments to senior creditors. Specifically, Judge Walrath addressed the argument of certain
subordinated creditors that if the federal judgment rate were found to be applicable, then they are
not obligated to pay the senior creditors the difference between what the Debtors pay under the
federal judgment rate and the contract rate of interest. In accordance with the Rule of
Explicitness that the Court held was applicable under New York law,29 Judge Walrath found that
the relevant indentures contained subordination provisions that "adequately apprised the
subordinated creditors that their payments were subordinate to all contractual post-petition
interest, even if the Court allowed none.,,30 Thus, the Court held that the Plan provisions "that
give effect to the subordination provisions in the indentures . . . are not violative of the
Bankruptcy Code.,,3l With the exception of these limited circumstances, the Decision establishes
that creditors are not entitled to their contract rate of interest in the Third Circuit.
Equity Committee Standing Motion
In addition to its objection to the Plan, the Equity Committee also sought standing to bring a
claim for equitable subordination or equitable disallowance against the Settlement Noteholders.
Not only did the Settlement Noteholders contend that the Equity Committee failed to allege a
colorable claim, they also vigorously argued that no such cause of action exists as a matter of
law. 32
24
285 F.3d 1231 (9th Cir. 2002).
25
at 1234-35.
26
315 B.R. at 346.
27
Decision at 78 n.35.
28
Decision at 80.
29
The relevant indentures containing the subordination provisions were governed by New York law. In
determining whether the Rule of Explicitness was valid under New York law, Judge Walrath relied on a
decision by the New York Court of Appeals that answered the question in the affirmative. Chern. Bank v.
First Trust of N.Y., 93 N.Y.2d 178, 186 (N.Y. 1999).
30
Decision at 97 (emphasis in original).
31
Decision at 97-98.
32
Decision at 113.
- 5
WI.UKIE FARR &GAU.AGHERLW
In considering whether the Equity Committee had standing, the Court held that it depended on
whether the Equity Committee "stated a 'colorable' claim which the Debtors have unjustifiably
refused to prosecute.',33 The Court first held that a claim for equitable disallowance exists as a
matter of law, and that the Equity Committee had stated a colorable claim against the Settlement
Noteholders.
34
However, Judge Walrath held, as did Judge Gerber in Adelphia, that equitable
disallowance should be limited to "those extreme instances - perhaps very rare where it is
necessary as a remedy.,,35 Notwithstanding this limitation, and given the draconian nature of the
remedy, parties involved in chapter 11 cases in the Third Circuit must be mindful of the potential
serious consequences that flow from the Decision.
Existence of Colorable Claims for Insider Trading
After finding that a cause of action for equitable disallowance exists as a matter of law, the Court
considered the merits of the insider trading allegations against the Settlement Noteholders and
concluded that the Equity Committee stated a colorable claim that the Settlement Noteholders
engaged in insider trading.
36
With respect to the Settlement Noteholders' status as temporary insiders by virtue of their access
to the Debtors' confidential information and participation in the settlement negotiations, Judge
Walrath also discussed the Equity Committee's alternative assertion that the Settlement
Noteholders "owed duties as non-statutory insiders under bankruptcy law.,,37 Among the cases
cited in support of this proposition was a previous decision in In re Washington Mutual. Inc.
(the "2019 Opinion"), where Judge Walrath held that an informal group of noteholders was
acting as an ad hoc committee or entity representing more than one creditor, and therefore was
required to comply with the disclosure provisions of Federal Bankruptcy Rule 2019.
38
In the
2019 Opinion, Judge Walrath stated that "members of a class of creditors may, in fact, owe
fiduciary duties to other members of the class" when holding themselves out in a representative
39
capacity. .
33
Decision at 108 (citing Official Comm. of Unsecured Creditors ofCybergenics Corp. v. Chinery, 330 F.3d
548,566-67 (3d Cir. 2003.
34
In recognizing the validity of equitable disallowance as a remedy for wrongdoing, Judge Walrath relied
heavily on Adelphia Recovery Trust v. Bank of America. N.A., which interpreted Pepper v. Litton as
providing for "the equitable disallowance of claims, not on the basis of any statutory language, but as
within the equitable powers ofa bankruptcy court." 390 B.R. 64, 76 (S.D.N.Y. 2008).
35
Adelphia Commc'ns Com. v. Bank of Am.. N.A., 365 B.R. 24, 73 (Bankr. S.D.N.Y. 2007).
36
The Court's discussion of whether the Equity Committee's allegations sufficed to establish a colorable
claim for insider trading was solely for the purpose of determining whether the Debtors' decision not to
pursue the claim was justified under In re STN Entemrises, 779 F.2d 901, 905 (2d Cir. 1985). Any
findings beyond those related to standing are merely dicta.
37
Decision at 130.
38
419 B.R. at 280.
39
Id. at 278 (quoting In re Mirant Corp. as imposing a fiduciary duty on parties that purport "to act for the
benefit of a class." 334 B.R. 787, 793 (Bankr. N.D. Tex. 2005. However, in In re Northwest Airlines
~ Judge Gropper assumed, for purposes of ruling on a motion to compel disclosure under Federal
Bankruptcy Rule 2019, that an ad hoc committee of equity security holders did not act as a fiduciary. 363
B.R. 704, 709 (Bankr. S.D.N.Y. 2007).
- 6
WIU,KJErARR &GALI.AGHERu.
While Judge Walrath found it unnecessary to determine the extent of fiduciary duties owed by
creditor groups in the 2019 Opinion, the Decision reasoned that due to the Settlement
Noteholders' "status as holders of blocking positions in two classes of the Debtors' debt structure
..., it could be found that they owed a duty to the other members of the classes to act for their
benefit.'.40 This goes further than the 2019 Opinion, which focused on actions rather than debt
holdings. Whether imposing fiduciary duties on a creditor group with blocking positions chills
the participation of similarly situated creditors in bankruptcy negotiations remains to be seen, but
the Decision will likely lead many such creditors to reassess the costs versus benefits of
maintaining or acquiring a blocking position.
The Decision is significant both because of the large number of chapter 11 cases filed in
Delaware, and because courts outside of the Third Circuit tend to view decisions from Delaware
bankruptcy courts as influential. Accordingly, all parties involved in chapter 11 cases must be
aware of the Decision's key holdings.
***************
If you have any questions regarding this memorandum, please contact Marc Abrams ( 2 1 2 ~ 728
8200, mabrams@willkie.com), Joseph G. Minias (212-728-8202, jminias@willkie.com), or the
WiIlkie attorney with whom you regularly work.
Willkie FaIT & Gallagher LLP is headquartered at 787 Seventh Avenue, New York, NY 10019
6099. Our telephone number is (212) 728-8000 and our facsimile number is (212) 728-8111.
Our website is located at www.willkie.com.
September 20,2011
Copyright 2011 by Willkie Farr & Gallagher LLP.
All Rights Reserved. This memorandum may not be reproduced or disseminated in any form without the express permission of
Willkie Farr & Gallagher LLP. This memorandum is provided for news and information purposes only and does not constitute
legal advice or an invitation to an attorney-client relationship. While every effort has been made to ensure the accuracy of the
information contained herein, Willkie Farr & Gallagher LLP does not guarantee such accuracy and cannot be held liable for any
errors in or any reliance upon this information. Under New York's Code of Professional Responsibility, this material may
constitute attorney advertising. Prior results do not guarantee a similar outcome.
Decision at 132.
-7
40
EXHIBITK
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF DELAWARE
In re:
WASHINGTON MUTUAL, INC., et al.,
Debtors.
AURELIUS CAPITAL
MANAGEMENT, LP, et al.
Appellants,
v.
THE OFFICIAL COMMITTEE OF
EQUITY SECURITY HOLDERS, et al.,
Appellees.
Chapter 11
Case No. 08-12229 (MFW)
Jointly Administered
Civil Action No.
'----'
[PROPOSED] ORDER GRANTING LEAVE TO APPEAL
Upon consideration of the motion (the "Motion") of Aurelius Capital
Management, LP on behalf of certain of its managed entities, for leave to appeal pursuant to 28
U.S.C. 158(a) and Rule 8003 of the Federal Rules of Bankruptcy Procedure from the Opinion
and Order of the United States Bankruptcy Court for the District of Delaware dated September
13,2011, and due and proper notice of the Motion having been given, it is hereby
ORDERED that the Motion is GRANTED.
Dated:
UNITED STATES DISTRICT JUDGE