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Bankruptcy: What do I need to know about Rule 9019?

by | Jul 2, 2021 | Corporate Bankruptcy & Restructuring

It is not uncommon for bankruptcy litigation to end in a settlement. In other legal matters both parties will generally agree to a proposed settlement before presenting it to the court, but this is not always the case for a settlement in bankruptcy. Instead, with bankruptcy it is common for at least some of the creditors to object to the trustee’s proposed settlement. Why? Because it is highly unlikely that all the creditors will get what they want — payment. If this were possible, there probably wouldn’t be a bankruptcy in the first place.

Because the bankruptcy process is its own special kind of beast, Congress decided to provide some additional guidance. This was given in the form of Rule 9019. This portion of the Bankruptcy Code essentially serves to help better ensure the settlement process for bankruptcy cases to move forward in a fair manner.

Why do we need a rule when it comes to settlements? Aren’t they a good thing?

Yes, settlements are a good thing and Congress was very clear in its desire to encourage the use of settlements instead of costly litigation whenever feasible through the rules included in the Bankruptcy Code. But there is the potential for abuse. It is possible for some creditors to attempt to arrange an agreement that jilts’ others with unfair, or even illegal, means. Rule 9019 helps avoid this by better ensuring the court reviews the agreement and that the proposed settlement is fair and equitable.

Determining what exactly is “fair and equitable” is no easy task. Bankruptcy courts follow the absolute priority rule to help reach this goal, which states senior creditors should be paid before their subordinates unless they expressly agree to a different arrangement. We know that this rule applies during a reorganization plan, but generally not outside of it. Thus during a settlement, courts have used other tools to reach this same goal. For example, the Fifth Circuit adopted a per se rule that essentially states the absolute priority rule should extend to pre-plan settlements while the Second Circuit has a seven-part test that aims to reach the same goal.