In re CS Dip, LLC

In re: CS DIP, LLC (f/k/a Church Street Health Management, LLC), SSHC DIP, LLC (f/k/a Small Smiles Holding Company, LLC), and FNY DIP, LLC (f/k/a FORBA NY, LLC), Debtors.

Case No. 3:12-bk-01573

Case No. 3:12-bk-01574

Case No. 3:12-bk-01575

UNITED STATES BANKRUPTCY COURT FOR THE MIDDLE DISTRICT OF TENNESSEE

October 9, 2015

(Jointly administered under Case No. 12-01573)

Chapter 11

Hon. Keith M. Lundin

MEMORANDUM

Applying Papas v. Buchwald Capital Advisors, LLC (In re Greektown Holdings, LLC), 728 F.3d 567 (6th Cir. 2013), approval of the settlement of National Union Fire Insurance Company's liability in the reorganization of the Small Smiles Dental Clinics is denied in part.

1. The bankruptcy court has subject matter jurisdiction to review the settlement and to approve an appropriate injunction.

2. Stern v. Marshall¹ is satisfied.

3. The bankruptcy court has statutory authority to review the settlement and to approve an appropriate injunction.

4. The proposed injunction is too broad.

5. The settlement and proposed injunction fail the four-factor test for fairness in Bard v. Sicherman (In re Bard),² and fail the fairness review required by McDannold v. Star Bank, N.A.³

The following are findings of fact and conclusions of law. FED. R. BANKR. P. 7052.

I. FACTS

A. Prepetition Debtors

Prior to Chapter 11 filings in February, 2012,⁴ the Debtors⁵ provided dental practice management services to 67 dental clinics—typically doing business as "Small Smiles"—that served low income families in 22 States. The Debtors assembled this network of pediatric dental clinics in part by acquiring assets owned by members of the DeRose family.⁶

Investigations of the Debtors begun in 2007 by the U.S. Department of Health and Human Services and the U.S. Department of Justice—with parallel investigations by many state officials—resulted in settlement agreements in 2010. On top of millions spent defending the government actions, the settlement agreements obligated Debtors to pay $24 million and required compliance programs to ensure the quality of care at Small Smiles Dental Clinics.⁷

In addition to the government investigations, former patients filed personal injury, malpractice and fraud actions against the Debtors, clinics and individual dentists ("Patient Claims"). At the petition, 11 lawsuits were pending filed by more than 100 former patients and many additional patients were in various stages of filing or joining suits.

B. National Union Insurance and the Coverage Case

Small Smiles maintained professional liability insurance policies with National Union Fire Insurance Company. The Debtors, Dental Clinics and many individual dentists were named as insureds or additional insureds.⁸ Other policies were issued by other insurance companies—CNA, for example—directly to individual dentists employed at the Dental Clinics. Debtors tendered the patient lawsuits to National Union for defense and indemnity. National Union defended under a reservation of rights to contest coverage.

On August 5, 2010, National Union sued Debtors in the United States District Court for the Middle District of Tennessee (the "Coverage Case"). National Union sought a declaration that the Small Smiles policies were void or voidable because the insureds failed to disclose material information during the application and underwriting process.

C. Sale of Debtors' Assets

On May 30, 2012, the Debtors' assets were sold pursuant to § 363 of the Bankruptcy Code. Withheld from that sale were the National Union policies and avoidance actions under Chapter 5 of the Bankruptcy Code. After the sale, National Union sought relief from the stay to litigate the Coverage Case.

D. Liquidating Plan

Following the sale, a Joint Plan of Reorganization proposed by the Debtors and the Official Committee of Unsecured Creditors was confirmed on March 7, 2013.⁹ The Plan created a Liquidating Trust to hold the Debtors' insurance rights and to manage litigation of the Coverage Case. The Liquidating Trust was broadly empowered to compromise, settle, release and obtain the benefits of insurance on behalf of the Debtors, the Dental Clinics, dentists and the Patient Claims. The confirmed plan authorized the Liquidating Trust to identify, resolve and pay Patient Claims. The Plan established a Trust Advisory Committee with authority to veto any settlement of the Coverage Case. Dan B. Lain became Liquidating Trustee.

With respect to Patient Claims and claims for contribution or indemnity by dentists, the Plan contained the detailed provisions in Appendix A.

E. Settlement Agreement

The Liquidating Trust and National Union hammered out a settlement of the Coverage Case. The Settlement Agreement provides that National Union will pay the Liquidating Trust $39,000,000.00. In exchange, the Liquidating Trust will release National Union from all claims under the policies and will sell the policies and coverage rights to National Union. The Settlement Agreement imposes a channeling injunction that directs all Patient Claims to the Liquidating Trust. There is an exception to this channeling injunction for claims against FORBA LLC, FORBA NY LLC, DeRose Management Company, DD Marketing, Inc., Danny DeRose, Edward DeRose, Michael DeRose, William Mueller, Michael Roumph, Richard Lane or Adolph Padula ("Former Owners," discussed below). Material provisions of the Settlement Agreement with respect to the channeling injunction and releases are in Appendix B.

The Settlement Agreement contemplates Trust Distribution Procedures to identify and pay Patient Claims. The Trust Distribution Procedures fix deadlines for submission of Patient Claims which must include "acknowledgment . . . that, upon payment of the Settlement Amount by the Insurers to the Liquidating Trust, any Claims that such Claimant might have been entitled to assert against the Insurers related to Small Smiles Claims are released and that any Small Smiles Claims that such Claimant may assert against any of the Insureds or the Clinic Dentists . . . are non-recourse . . . ."¹⁰

The Trust Advisory Committee approved the Settlement Agreement.

II. HEARING ON MOTIONS TO APPROVE SETTLEMENT AGREEMENT AND RELATED MATTERS

The Liquidating Trustee filed motions to: (A) Approve the Settlement with National Union, (B) Grant an injunction in favor of National Union, (C) Approve trust distribution procedures, and (D) Approve additional notice procedures.¹¹

At the June 2, 2015, hearing on these motions,¹² the Liquidating Trustee introduced 21 exhibits, presented the testimony of the Liquidating Trustee and the testimony of David Killalea—an expert on the reasonableness of the settlement amount. The only evidence offered by any other party was the testimony of James Robert Moriarty,¹³ called on behalf of Sterling Mustered (see below).

Three legal issues were staged for further briefing: 1) What standards would the Sixth Circuit use to measure the fairness of a post confirmation settlement agreement and channeling injunction in a mass tort case; 2) what choice of law informs the fairness of a settlement that exhausts policy limits when co-insureds object; and, 3) whether Stern v. Marshall, ___ U.S. ___, 131 S. Ct. 2594, 180 L. Ed. 2d 475 (2011), limits bankruptcy court authority to finally dispose of the Liquidating Trustee's motions.

III. POSITIONS OF THE PARTIES

Three objections were filed to the Settlement Motions—1) Continental Casualty Company ("CNA"); 2) Former Owners; and, 3) Sterling Mustered, an individual Small Smiles patient. The main sources of controversy are the releases granted National Union, the injunction that will cut off recovery for contribution, indemnity, subrogation and direct claims by co-insureds, and the exclusion of Former Owners from the benefits of the releases and injunction.

A. CNA

CNA issued professional liability insurance policies to four dentists formerly employed by the Debtors. CNA's insureds were also insured under Debtors' policies with National Union. CNA asserts a right of subrogation against National Union for any claims its insureds could make against National Union.¹⁴

CNA first argues that the bankruptcy court does not have subject matter jurisdiction to consider the Settlement Agreement insofar as it releases claims between nonsettling, nondebtor parties. Because CNA and its insureds may have state law claims against National Union that the bankruptcy court could not adjudicate, CNA concludes the bankruptcy court cannot approve a settlement that resolves those claims.

Second, CNA asserts the Settlement Agreement releases its subrogation rights against National Union without compensation. To the extent a Clinic Dentist was insured by both CNA and National Union, the Settlement Agreement would extinguish CNA's subrogation rights in that Clinic Dentist's claims against National Union.

Third, CNA makes a contract law argument that the Settlement Agreement fails for lack of consideration to CNA for its release of claims against National Union and Debtors.

Finally, CNA objects technically that the Settlement Agreement amends the Confirmed Plan without respect for 11 U.S.C. § 1127. The Settlement Agreement requires Clinic Dentists to provide a sworn statement that they in good faith believe they have coverage under the National Union policies. The Confirmed Plan does not require a sworn statement.

B. Sterling Mustered

Sterling Mustered, a minor, by next friend, originally challenged final disposition by the bankruptcy court under Stern v. Marshall. Mustered withdrew this Stern objection in a post hearing submission.¹⁵

Mustered maintains that the Settlement Agreement fails the standards for review of nondebtor releases and channeling injunctions in Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.),¹⁶ McDannold and in Bankruptcy Rule 9019.

Mustered contends the Settlement Agreement should have been offered in the context of confirmation because the releases and injunction require the special scrutiny that attends plan...