In re Republic Airways Holdings Inc.

582 B.R. 278

IN RE: REPUBLIC AIRWAYS HOLDINGS INC.

17–CV–3442 (JPO)

United States District Court, S.D. New York.

Signed March 28, 2018

Gary D. Ticoll, Bruce Robert Zirinsky, Gary D. Ticoll, Greenberg Traurig, LLP, Christopher K. Kiplok, Erin Eileen Diers, Gabrielle Glemann, Gregory Charles Farrell, Hughes Hubbard & Reed LLP, Sharon Jill Richardson, Zirinsky Law Partners PLLC, New York, NY, for Republic Airways Holdings Inc.

OPINION AND ORDER

J. PAUL OETKEN, District Judge:

This is a bankruptcy appeal involving commercial aircraft leases. At issue is a procedure called substantive consolidation. Substantive consolidation allows a bankruptcy court to pool the assets and liabilities of distinct corporate entities for the purposes of confirming a bankruptcy plan. The question here is whether the bankruptcy court improperly consolidated two debtors or discriminated against the appealing creditors. Because it did not, its decision is affirmed.

I. Background

The appellants are two creditors: Wells Fargo Bank Northwest, N.A., and ALF VI, Inc. (collectively, "Residco"). The case concerns the debts of two companies: Republic Airways Holdings, Inc. and Shuttle America Corporation (collectively, "the Debtors"). Republic is a holding company, and is the parent of Shuttle America.

This appeal stems from seven leases of commercial aircraft to Shuttle America by Residco and its predecessors. Republic guaranteed the leases, meaning that it was on the hook for Shuttle America's obligations. Both Republic and Shuttle America filed for bankruptcy and rejected the leases. This triggered a damages provision in the leases. This provision calculates the amount of liquidated damages using a formula. Both debtors are potentially liable to pay these damages: Shuttle America is liable as the lessee, while Republic is liable as a guarantor. Residco claims total damages under the leases of about $57 million. (Dkt. No. 9 at 8.)

But there is a twist: While both Republic and Shuttle America are potentially liable for the breached leases, Residco's claim against Republic might be more valuable than its claim against Shuttle America. This is because there are unique defenses that Shuttle America might be able to assert based on New York contract law. Republic, however, made an unconditional guarantee of Shuttle America's obligations, and therefore may not be able to assert those defenses. According to Residco, its guarantee claim against Republic may be worth up to $50 million more than its lease claim against Shuttle America. (See Dkt. No. 8–2 at 7.)

The Debtors proposed a plan which substantively consolidated Republic and Shuttle America. The substantive consolidation combined all the assets and liabilities of the two companies and treated them as though they were merged. (See Dkt. No. 8–2 at 6.) It also eliminated all guarantee claims, including Residco's guarantee claims against Republic. (See id. ) Essentially, it combined the two Debtors into one entity and required that all claims be asserted against that one entity. The plan estimated that, due to the benefits of substantive consolidation, unsecured creditors would be paid about forty-five cents on the dollar. (Dkt. No. 8–2 at 6.) Without substantive consolidation, unsecured creditors of Republic (the parent) would get as little as two cents on the dollar. (Dkt. No. 8–2 at 15.)¹

Residco objected to substantive consolidation on the grounds that it eliminates Residco's valuable guarantee claims and leaves it with its less-valuable lease claims only. In response, the Debtors revised the plan to include a carve-out. The carve-out allowed Residco to opt out of substantive consolidation and have its claims treated as if consolidation had not occurred. This gave Residco two options: It could opt into substantive consolidation, lose its guarantee claims, and get forty-five cents on each dollar of its allowed lease claims. Or, it could opt out of substantive consolidation, keep both its lease and guarantee claims, and receive what it "would have recovered [on both its lease and guarantee claims] if the Plan Consolidation had not taken place." (Dkt. No. 8–2 at 26.) The carve-out also provided that, if Residco chose to opt out of substantive consolidation, the Debtors would bear the burden of proving "the estimated percentage distributions that would have been received" if substantive consolidation had not occurred—i.e. , in the counterfactual world in which Republic's and Shuttle America's debts had been administered separately with respect to all creditors. (Id. )

Residco still objected. The bankruptcy court overruled the objections and confirmed the plan. Residco appealed. This Court heard oral argument on February 16, 2018. Despite this appeal, the bankruptcy plan has largely been consummated, though the Debtors put money in reserve to satisfy any award to Residco.

II. Standard of Review

A Bankruptcy Court's findings of fact are reviewed for clear error. In re Bayshore Wire Prods. Corp. , 209 F.3d 100, 103 (2d Cir. 2000). Questions of law and mixed questions of law and fact are generally subject to de novo review. In re Grumman Olson Indus., Inc. , 467 B.R. 694, 699 (S.D.N.Y. 2012) ; see also U.S. Bank Nat. Ass'n ex rel. CWCapital Asset Mgmt. LLC v. Vill. at Lakeridge, LLC , 200 U.S. 218, 138 S.Ct. 960, 962, ––– L.Ed.2d –––– (2018) ("[T]he standard of review for a mixed question all depends—on whether answering it entails primarily legal or factual work.").

III. Discussion

Substantive consolidation does not originate in the Bankruptcy Code; rather, it is a product of a judicial gloss on the equitable power of bankruptcy courts. See In re Augie/Restivo Baking Co. , 860 F.2d 515, 518 (2d Cir. 1988) ; see generally In re Owens Corning , 419 F.3d 195, 205 –07 (3d Cir. 2005) (reviewing the history of substantive consolidation). "Substantive consolidation usually results in, inter alia , pooling the assets of, and claims against, the two entities; satisfying liabilities from the resultant common fund; eliminating inter-company claims; and combining the creditors of the two companies for purposes of voting on reorganization plans." Augie/Restivo , 860 F.2d at 518. Because of the dangers in forcing creditors of one debtor to share on a parity with creditors of a less solvent debtor, the Second Circuit has stressed that substantive consolidation should be used "sparingly." Id. (quoting Chemical Bank New York Trust Co. v. Kheel , 369 F.2d 845, 847 (2d Cir. 1966) ).

Residco's arguments on appeal boil down to three points: (1) that the plan discriminates against Residco, (2) that the bankruptcy court misapplied the Augie/Restivo factors in deciding that substantive consolidation was appropriate, and (3) that Residco did not receive adequate disclosures. Importantly, Residco is not trying to unwind the entire plan or argue that substantive consolidation was inappropriate as to the other creditors. It merely argues that substantive consolidation was inappropriate as to Residco's claims.

A. Does the Plan Discriminate Against Residco?

Residco's strongest argument is that the plan discriminates against it. Residco argues that, under the plan, Residco can reap the benefits of substantive consolidation only if it gives up its strong guarantee claim against Republic. Residco maintains that it is the only creditor that was forced to give up something in order to benefit from substantive consolidation, in violation of 11 U.S.C. § 1123(a)(4), which requires that similar claims be treated equally.

The core question is about the baseline for fair treatment and the distinction between benefit and harm. In other words, is Residco seeking to avoid being treated worse than other creditors, or is it seeking an added benefit beyond that afforded to other creditors?

To answer this question, we need to go back in time. Specifically, we need to back to when the substantive consolidation provision was proposed. At that time, the debtors and creditors were faced with two options: Option A was to treat Republic and Shuttle America as separate entities, preserve all guarantee claims, and endure a costly and inefficient claims process that would reduce the value of all creditors' claims. Option B was to substantively consolidate the two entities, eliminate all guarantee claims, and increase the value of the creditors' claims. If we accept the narrative that these were the only two options available, Residco's claim surely fails because the carve-out allows Residco to choose between those very two options.

But Residco argues that this a false dichotomy because there should have been an option C. In option C, the two Debtors are consolidated, but only overlapping guarantee claims are eliminated. In this scenario, non-overlapping guarantee claims—i.e. , where the amount claimed against the parent is different than the amount claimed against the subsidiary—are not eliminated. And in this scenario, Residco would both keep its guarantee claim and get the benefit of the higher recovery that accompanies substantive consolidation.

But this argument rests on a fallacy: there really was no option C. Residco's argument ignores the fact that there were numerous creditors holding potentially non-overlapping guarantee claims. Republic had guaranteed over 90 percent of the claims against its airline subsidiaries, and all of the aircraft leases had liquidated-damages provisions similar to the one giving rise to Residco's claim. (Dkt. No. 8–2 at 27.) Therefore, at the time the substantive consolidation provision was proposed, it appears that the only way substantive consolidation could work was to eliminate all guarantee claims, overlapping and not. Option C likely would not have worked because it would have been impossible to preserve non-overlapping guarantee claims while also getting the benefits of substantive consolidation.² The only viable options were A and B, and the opt-out allows Residco to choose whichever one of the two it prefers. (See Dkt. No. 8–2 ...