The Third Amended Plan of Reorganization submitted by Martech and National Bank of Alaska (NBA), NBA's Motion for Approval of Settlement of Claims and Security Interests, and the sureties' Motion for Conversion duly came before the court for hearing on November 7 through November 9, 1994. Michael Mills and Robert Moore appeared for the debtor. David Bundy appeared on behalf of NBA. Peter Giannini and Scott Leo appeared for the sureties. Paul Koval and Rebecca Copeland appeared for the Unsecured Creditors' Committee. Steven Case appeared telephonically for the sub-debt. Additional briefs were filed on December 1, 1994, and the matters are ready for decision. Confirmation of the plan will be denied, the settlement will not be approved, and this case will again be converted to a Chapter 7 proceeding.

Background

The debtor Martech was an Anchorage-based contractor with offices throughout the United States and in some foreign countries. The company traditionally contracted for oil-field marine services but expanded into environmental remediation and general government contracting. It enjoyed a spectacular ascent, rapidly becoming a multi-million dollar company traded on the New York stock exchange, and an equally spectacular descent into insolvency. Following its Chapter 11
      4 ABR 44  filing in December of 1993, virtually all contracting work ground to a halt, and the debtor was unable to assume and complete its many projects, primarily with the federal government, throughout the United States. The sureties have been forced to take over the projects and have expended about $14.2 million towards their completion. Substantial work remains to be performed upon the projects even a year after the filing.

This court converted the case to a case under Chapter 7 in May of 1994. Following the negotiation of a plan sponsored by Martech and NBA, its largest secured creditor, I reversed the conversion order and allowed the debtor and NBA to present a plan for confirmation. In the interim, NBA received relief from stay and liquidated most of the debtor's significant assets. The fundamentals of the first NBA plan called for a limited distribution to unsecured creditors from NBA collateral and a release of both NBA and Ben Tisdale, Martech's C.E.O. and largest shareholder, from all claims. Tisdale balked at disclosing his assets through the disclosure statement and his release was dropped from the plan. NBA's release remains a part of the plan.

The plan is a liquidating plan. It provides a mechanism for the distribution of existing proceeds along with the establishment of a liquidating trust. On hand are approximately $10 million in proceeds from the sale of assets. An additional $2.9 million in real estate and other assets remain to be sold. The $2.9 million does not include any litigation claims held by the debtor. The trustee of the liquidating trust will pursue litigation on behalf of the unsecured creditors of the estate. Such litigation includes the debtor's claims arising out of its agreement with the sureties for use of cash collateral as well as director and officer claims against the principals of Martech. The proceeds of a disputed "bonded receivables account," in the sum of $5 million, are held in trust by Northrim Bank pending a resolution of the debtor-surety litigation. The sureties are actively pursuing those funds in the litigation.

NBA is the debtor's primary secured creditor. The debtor's proposed release of NBA is the cornerstone of the Martech-NBA plan of reorganization. Under the plan, NBA's claim would be allowed in the sum of $16,363,645. NBA would receive further relief from the stay and "conclusively be deemed" secured by all tangible assets of the debtor.       4 ABR 45  All claims of the debtor or the estate will be "irrevocably and finally released" as to NBA. NBA and the trustee will sell any remaining assets and NBA shall retain the proceeds, net of costs. After receipt of $4 million on NBA's allowed secured claims, the unsecured creditors will receive an initial distribution of $700,000 from NBA. Additionally, unsecured creditors would receive 50% of any surety litigation proceeds in excess of $1 million, plus their share of NBA's contributed director's and officer's claim. After NBA has received $11 million on its secured claims, NBA will receive 60% of the next $6 million realized from liquidation and unsecured creditors will receive 40%. NBA will receive the sub-debt's share of the unsecured distribution and reserve 50% of the distribution for professional fees of the debtor incurred after May 1, 1994. NBA will fund $1 million in priority and administrative claims. Additionally, NBA will provide an additional payment of up to $200,000 from its collateral to allowed fees and expenses of professionals in the case. NBA will also lend the trustee litigation committee the sum of $400,000 and assign its director's and officer's claim to the committee, subject to some monetary limitations. Stripped to essentials, NBA is paying a minimum of $1.9 million for the release it is to receive under the plan.

Class One, the unsecured creditors, rejected the plan. While 126 creditors accepted the plan and 47 opposed it, $28,008,692 in claims rejected the plan and $8,996,258 approved it. NBA accepted the plan. The sub-debt, with claims in excess of $20 million, rejected the plan. While numerous objections to confirmation were raised by creditors, the settlement issue is dispositive of confirmation.

Analysis

Compromises are a "normal part of the process of reorganization." In administering reorganization proceedings in an economical and practical manner it will often be wise to arrange the       4 ABR 46  settlement of claims as to which there are substantial and reasonable doubts. At the same time, however, it is essential that every important determination in reorganization proceedings receive the "informed, independent judgment" of the bankruptcy court. The requirements of §§ 174 and 221(2) of Chapter X, 52 Stat. 891, 897, 11 U.S.C. §§ 574, 621(2), that plans of reorganization be both "fair and equitable," apply to compromises just as to other aspects of reorganizations. The fact that courts do not ordinarily scrutinize the merits of compromises involved in suits between individual litigants cannot affect the duty of a bankruptcy court to determine that a proposed compromise forming part of a reorganization plan is fair and equitable. There can be no informed and independent judgment as to whether a proposed compromise is fair and equitable until the bankruptcy judge has apprised himself of all facts necessary for an intelligent and objective opinion of the probabilities of ultimate success should the claim be litigated. Further, the 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. Basic to this process in every instance, of course, is the need to compare the terms of the compromise with the likely rewards of litigation.

. . . .

If the quoted statement [approving the settlement] of the trial court had been the result of an adequate and intelligent consideration of the merits of the claims, the difficulties of pursuing them, the potential harm to the debtor's estate caused by delay, and the fairness of the terms of settlement, then it would without question have been justifiable to approve the proposed compromises. It is essential, however, that a reviewing court have some basis for distinguishing between well-reasoned conclusions arrived at after a comprehensive consideration of all relevant factors, and mere boilerplate approval phrased in appropriate language but unsupported by evaluation of the facts or analysis of the law. Here there is no explanation of how the strengths and weaknesses of the debtor's causes of action were evaluated or upon what grounds it was concluded that a settlement which allowed the creditor's claims in major part was "fair and equitable." Although we are told that the alternative to       4 ABR 47  settlement was "extensive litigation at heavy expense" and "unnecessary delay," there is no evidence that this conclusion was based upon an educated estimate of the complexity, expense, and likely duration of the litigation. Litigation and delay are always the alternative to settlement, and whether that alternative is worth pursuing necessarily depends upon a reasoned judgment as to the probable outcome of litigation. The complaint voiced by counsel for the petitioner Committee to the trustee's report on the compromises, that "this is a bare statement of conclusion," seems equally applicable to the trial court's statement approving those compromises. In these circumstances it was error to affirm that aspect of the District Court's judgment approving the inclusion of the proposed compromises in the internal plan of reorganization.

. . . .

With regard to the M-S claims, respondent contends that the record contains "an abundance of pleadings and allegations" respecting them. To make an informed and independent judgment, however, the court needs facts, not allegations.

In determining the fairness, reasonableness and adequacy of a proposed settlement agreement, the court must consider:

(a) The probability of success in the litigation; (b) the difficulties, if any, to be encountered in the matter of collection; (c) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it; (d) the paramount interest of the creditors and a proper deference to their reasonable views in the premises.

In re Flight Transportation Corporation Securities Litigation, 730 F.2d 1128, 1135 (8th Cir. 1984) (citations omitted), cert. denied, ___ U.S. ___, 105 S. Ct. 1169, 84 L. Ed. 2d 320 (1985). Accord, Matter of Jackson Brewing Co., 624 F.2d 605, 607 (5th Cir. 1980) (court must review the particular facts and circumstances with adequate detail and       4 ABR 48  explanation to determine (1) the probability of success in the litigation, with due consideration for the uncertainty in fact and law, (2) the complexity and likely duration of the litigation and any attendant expense, inconvenience and delay, and (3) all other factors bearing on the wisdom of the compromise).

Applying the Anderson and A & C criteria to the instant case, I cannot conclude that the settlement of the debtor's claims against NBA is "fair and equitable." The only one of the debtor's possible claims against NBA that has received any attention is a preference claim. On November 19, 1993, within 30 days of the bankruptcy filing, the debtor mortgaged a number of its vessels to NBA for prior indebtedness. Those vessels were liquidated for $1.7 million post-petition. Under the terms of a cash collateral order, however, NBA was given a replacement lien on all of the debtor's assets, including the vessels. NBA has lost at least $4.5 million in cash collateral post-petition. These losses effectively render any preference argument moot. Any preference for the estate has been lost to the debtor's post-petition operations and NBA's replacement lien. The preference claim has no value.

The preference claim, however, is not the only potential claim against NBA to be released under the plan. Other potential claims against NBA include: Claims for overhead and sale costs relative to liquidation under 11 U.S.C. § 506(c); pre- and/or post-petition bad faith; equitable subordination arising from misconduct by the bank through its domination of the Debtor; fraud; unjust enrichment; failure to liquidate collateral in a commercially reasonable manner; claims arising under the strong-arm clause of § 544; unauthorized post-petition transaction under § 549(a) of the Code and others. Yet, other than the preference claim, there has been no investigation of NBA's conduct sufficient to allow this court to effectively perform its functions under Anderson and A & C. The debtor, through its president William Sheffield, has performed no independent analysis or valuation of the potential       4 ABR 49  claims against NBA. NBA itself has performed no such study or evaluation. John Siemers, the examiner appointed by the court to review the reasonableness of the proposed settlement, was unable, given the time and fiscal constraints imposed, to make a "serious investigation" of possible claims against the bank.

The tests of Anderson and A & C cannot be performed in a vacuum. It was incumbent upon the debtor and NBA to provide evidence in support of the settlement. The factual record presented here is insufficient to allow the court to compare the terms of the compromise with the likely rewards of litigation. This court is in no position to form an "intelligent and objective opinion on the probabilities of ultimate success" when the parties sponsoring the plan have not evaluated the debtor's claims against NBA. This court cannot determine the probability of success of litigation, the complexity of the litigation, and the expense, inconvenience, and delay necessarily attending it without such evidence.

Under A & C, deference to creditors and their "reasonable views" constitutes a factor for evaluating the reasonableness of the settlement. Unsecured creditors have voted against the settlement by nearly $48 million to $9 million in dollar amount. While most of those creditors have their own axes to grind, their views should not be ignored. I do not reject NBA's settlement simply because the sureties and the sub-debt oppose the release, however. Rather, I reject it because there has been insufficient evidence presented regarding the fundamental consideration for the release.

By denying approval of the settlement, I am in no way intimating that NBA has been guilty of any misconduct. I simply find that NBA and the debtor have failed to meet their burden of proof in establishing the reasonableness of the settlement.

The evidence presented at the hearing indicates that the debtor has lost a substantial amount of money through its post-petition operations. It has no ongoing business and no purpose will be served by further delays. As there are continuing losses to the estate and absence of reasonable likelihood of rehabilitation under 11 U.S.C. § 1112(b)(1), conversion is appropriate at this time.

Conclusion and Order

The confirmation of Martech and NBA's Third Amended Plan of Reorganization depended on approval of the debtor's settlement with NBA. NBA and the debtor failed to provide the court with facts justifying the release. Under the applicable Supreme Court and Ninth Circuit standards, the release cannot be approved. Conversion is also appropriate as the debtor has no active business and further delay diminishes the estate. Therefore, IT IS ORDERED:

1. Confirmation of Martech and NBA's Third Amended Plan of Reorganization is denied;

2. NBA's Motion for Approval of Claims and Security Interests is denied; and,

3. The sureties' motion for conversion of this case to a case under Chapter 7 is granted.

4. Martech shall:

a. forthwith turn over to the chapter 7 trustee all records and property of the estate under its custody and control as required by Bankruptcy Rule 1019(5); and

b. within 30 days of the date of this order, file an accounting of all receipts and distributions made, together with a schedule of all unpaid debts incurred after the commencement of the chapter 11 case, as required by Bankruptcy Rule 1019(6).

DATED: December 21, 1994.

BY THE COURT
DONALD MacDONALD IV
United States Bankruptcy Judge