Bankruptcy Lawyers Better Tune Up Their ADR Skills Best Products Is One Case Where Mediation Really Worked
—Chief Justice William Howard Taft, 1921 In September 1996, Best Products, a national retailer, filed a "chapter 22" in Richmond, Va. The case was the fourth largest chapter 11 case in terms of assets ($710 million) filed in 1996. Best had previously filed for chapter 11 in the Southern District of New York in January 1991, and had obtained confirmation of its plan of reorganization in May 1994. However, Best was forced to file chapter 11 a second time, even before it had completed payments under its first chapter 11 plan.
Shortly after Best's second bankruptcy filing, all constituencies in the case determined the business could not be reorganized and that the company should be liquidated and final distributions paid to creditors with valid claims as soon as possible. Thus was set in motion a fast and furious process of liquidating inventory, leases and other assets and resolving claims that resulted in a distribution to unsecured creditors totalling almost 96 cents on the dollar by the end of 1998, 27 months after the petition filing. Most remarkably, 38 cents had been distributed by June 1997 (nine months after the filing), 53 cents total by September 1997 (one year after the filing), and 84 cents total by November, 1997 (14 months after the filing). These results were obtained in a case involving a retailer with 169 stores in 23 states, 9,600 employees and more than 7,000 creditors.
Several factors contributed to the remarkably high and swift dividend in Best's second and last chapter 11 case. One of these factors was the wind-down team assembled at Best, several of whom had been through the first bankruptcy and were familiar with the preparation, prosecution and negotiation of multiple omnibus claims objections. Another factor was the willingness of the bankruptcy court to enforce bar dates and deadlines established in various administrative orders that accelerated discovery and set firm trial schedules for claims objection contested matters.
A major factor was the mediation process proposed by the debtor and approved by the bankruptcy court. In the second filing, the bankruptcy court empowered the debtor to require the holder of a disputed claim to participate in non-binding mediation before a qualified mediation firm approved by the bankruptcy court and retained by the estate. The bankruptcy court permitted the debtor to schedule a disputed claim for mediation while a claim objection was pending but not yet heard by the court. This provided a dual-track procedure that prevented mediation from slowing down the claims objection process and permitted both parties the discovery rights provided for in claims objection contested matters. Generally, in mediation the parties have only those discovery rights that are agreed to by both parties.
Failure of a claimant to participate in the mediation resulted in the disallowance and extinguishment of its claim. The mediation was required to take place within 30 days of the debtor's referral of the claim to mediation, and the bankruptcy court also provided for expedited discovery once a claim objection was filed. In addition, the bankruptcy court deferred ruling on personal injury claimants' motions for relief from stay until the parties had attempted to mediate the claim.
Mediation of disputed claims was the exception rather than the norm in the Best case. The vast majority of the creditors in the case were sophisticated and experienced participants in the omnibus claims objection process that prevails in large chapter 11 cases. These creditors, many of whom had purchased their claims from trade vendors, recognized the give-and-take involved in resolving claims in bankruptcy cases, and were amenable to telephone negotiations with the accounts payable department at Best or the debtor's attorneys to resolve their disputed claims.
Experienced participants in the bankruptcy claims resolution process are equipped to gauge the likely result of a contested claims objection hearing, balance that against the expected dividend from the case and reach a negotiated resolution of the amount of the allowed claim. Thus, no mediations were conducted in Best relating to claims held by claims traders.
However, certain claimants were unaccustomed to the omnibus claims objection process and dissatisfied with the rapid-fire negotiations that accompany the resolution of disputed claims in a large chapter 11 case. These claimants—primarily customers, personal injury or products liability claimants, and landlords—were resistant to telephone negotiations and desired a fuller hearing with the debtor regarding their particular claim. It was for these types of claimants that mediation was an attractive option.
The less experienced participants in the bankruptcy system appreciated the opportunity to negotiate face-to-face with a real-person representative of the debtor. Moreover, once a settlement was reached in mediation and the stipulation was filed with the court finalizing the settlement, the claimant was vested in the settlement and more accepting of the outcome because it had participated in producing that result, rather than having it imposed by a court.
Nationally, in all manner of civil disputes, approximately 85 percent of mediated cases reach settlement. The success rate in Best exceeded that percentage. In fact, bankruptcy lends itself to mediation, and vice versa. Creditors generally come into the bankruptcy process with bad feelings toward the debtor and its management, and are skeptical about court-imposed resolutions to claims disputes. Mediation provides the creditor with an opportunity to explain and justify its claim directly to a decision-maker from the debtor, without the intervention of professionals. In addition, the process lends itself to a frank discussion of the size of the "bankruptcy dollars" that the creditor can reasonably expect to receive from the case.
From the debtor's perspective, the availability of the mediation process enabled it to resolve a greater number of disputed claims in a shorter period of time than if it had been relegated to relying on the bankruptcy court's finite claims resolution capacity. As to personal injury and products liability claims specifically, which the bankruptcy court lacks jurisdiction to liquidate, the debtor was able to avoid protracted discovery and litigation in non-bankruptcy courts that would have severely delayed the distributions in the Best case.
The mediation process in Best directly impacted the debtor's ability to pay such high dividends so early in the case. This impact was particularly potent in the area of determining appropriate reserves for disputed lease rejections and personal injury/products liability claims.
Under Best's liquidating plan, when the debtor sought to pay an interim dividend, it was obligated to reserve an amount sufficient to pay a total dividend on the uninsured portion of the face amount (proof of claim amount) of each disputed claim. The practice among personal injury plaintiffs' attorneys, none of whom lack confidence in their persuasive abilities, is to file on behalf of their clients a claim asserted in the amount the most generous jury in the most liberal jurisdiction in the nation might award in the most egregious negligence case. This predilection is heightened by the fact the claimants can expect a "bankruptcy dollar" return on the uninsured portion of their claims. Similarly, commercial landlords frequently file lease rejection damage claims in disregard of the cap on such claims contained in §502(b)(6) of the Bankruptcy Code. If Best had been required to reserve the uninsured portion of the proof of claim amount of these claims until the claims were resolved by direct negotiation or estimated/liquidated by a court of competent jurisdiction, the dividends in the Best case would have been both substantially delayed and diminished.
However, the mediation process established by the bankruptcy court enabled Best to identify early in the case those troublesome claims that would require intense efforts at resolution and to maximize the possibility of a quick, consensual resolution. The successful mediation of these claims freed up millions of dollars for distribution early in the case.
In addition, while attorneys play an integral role in the mediation and substantial preparation is required, the professional fees involved in preparing for and mediating a disputed claim pale in comparison to the fees involved in full-fledged discovery and trial in either the bankruptcy court or a non-bankruptcy court. The savings obtained in professional fees alone through the mediation program contributed materially to the distribution in Best.
Future of Alternative Dispute Resolution in Bankruptcy
While it may have been one of the first large chapter 11 cases in which a mediation program was established and available to resolve disputed claims of all types and sizes, Best Products was certainly not the first bankruptcy case in which an alternative dispute resolution (ADR) program was established. Bankruptcy courts also authorized ADR for certain types of claims in cases involving Eastern Airlines, St. Johnsbury Trucking and LTV. In the Greyhound case, the bankruptcy court required personal injury claimants to participate in arbitration before it would consider motions for relief from stay to prosecute actions in non-bankruptcy courts. And in Macy's, the bankruptcy court appointed Cyrus Vance in 1994 to mediate negotiations regarding the formulation of a reorganization plan, which resulted in the confirmation of a plan eight months later.2
While certain courts have questioned the bankruptcy courts' authority to require parties to use ADR, the majority position among the courts appears to have been that bankruptcy courts have this authority, both under §105 of the Bankruptcy Code and under the courts' inherent authority, to manage and control their own dockets.
In October 1998, Congress resolved this dispute by the relatively unpublicized enactment of the Alternative Dispute Resolution Act.3 This law requires all district courts to authorize by local rule the use of ADR procedures in all civil actions, including adversary proceedings in bankruptcy court.4 In addition, the act provides that all district courts must require by local rule that litigants in civil cases consider the use of an ADR process at an appropriate stage in the litigation.5 Finally, the act authorizes the district courts and, by extension, the bankruptcy courts, to require mediation or early neutral evaluation in civil cases, even without the parties' consent.6
Based on the experience in the cases mentioned above and, more importantly, as a result of the enactment of the Alternative Dispute Resolution Act, the use of mediation, arbitration and other forms of ADR will undoubtedly proliferate in bankruptcy cases in the near future. While the admonition "I'll see you in mediation, counselor!" has an unfamiliar and not very macho ring to bankruptcy litigators, it will soon become very familiar.
2 For a discussion of mediation in Macy's, see Mott, Cassandra G., Macy's Miracle on 34th Street: Employing Mediation to Develop the Reorganization Plan in a Mega-Chapter 11 Case, 14 Ohio St. J. on Disp. Resol. 193 (1998). Return to article