In re Metromedia Fiber Network, Inc.

• Decision Date: 21 July 2005
• Docket Number: No. 04-2112-BK.,04-2112-BK.
• Citation: 416 F.3d 136
• Parties: In re: METROMEDIA FIBER NETWORK, INC., et al., Debtors. Deutsche Bank AG, London Branch and Bear, Stearns & Co., Inc., Appellants, v. Metromedia Fiber Network, Inc., et al., Debtors-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

416 F.3d 136

In re: METROMEDIA FIBER NETWORK, INC., et al., Debtors.

Deutsche Bank AG, London Branch and Bear, Stearns & Co., Inc., Appellants, v. Metromedia Fiber Network, Inc., et al., Debtors-Appellees.

No. 04-2112-BK.

United States Court of Appeals, Second Circuit.

Argued: January 31, 2005.

Decided: July 21, 2005.

COPYRIGHT MATERIAL OMITTED

Edward J. Estrada, Leboeuf, Lamb, Greene & MacRae, LLP, New York, N.Y. (John S. Kinzey, on the brief), for Appellants.

Ronald R. Sussman, Kronish Lieb Weiner & Hellman LLP, New York, N.Y. (Richard S. Kanowitz, Jeffrey L. Cohen, and Seth Van Aalten, on the brief), for Debtors-Appellees.

Before: JACOBS and CALABRESI, Circuit Judges, and RAKOFF, District Judge.^*

JACOBS, Circuit Judge.

Creditors Deutsche Bank AG (London Branch) and Bear, Stearns & Co., Inc. (collectively, "appellants") challenge the now-largely implemented Plan of Reorganization ("Plan") confirmed in the Chapter 11 bankruptcy proceeding of Metromedia Fiber Network, Inc. and its subsidiaries (collectively, "Metromedia"). This appeal is taken from a March 18, 2004 judgment of the United States District Court for the Southern District of New York (Brieant, J.), affirming the August 21, 2003 confirmation order of the Bankruptcy Court (Hardin, Jr., B.J.).

First, appellants challenge the reallocation to other creditors of stock warrants that were initially allocated to appellants under Metromedia's Plan. Without contesting that cash and stock allocated to appellants were properly reallocated to those creditors under the terms of a prior subordination agreement, appellants argue that they are allowed to keep the warrants by virtue of an exception in that subordination agreement, a so-called "X-Clause."

Second, appellants argue that releases in the Plan improperly shield certain nondebtors from suit by the creditors.

AboveNet, Inc., f/k/a Metromedia Fiber Network, Inc., and its subsidiaries (collectively, "appellees" or "the Reorganized Debtors") refute these claims on the merits, and also argue that this appeal should be deemed equitably moot because numerous transactions have occurred since the Plan's September 8, 2003 effective date, and because appellants failed to ask the bankruptcy court or the district court for a stay of confirmation pending this appeal.

Appellants' objections to the Plan were rejected on the merits by the bankruptcy court and the district court. At the same time, the district court ruled that relief (if justified by the merits) would not have been barred by the doctrine of equitable mootness because effective relief could have been afforded without "unraveling the Plan."

This Court exercises plenary review over the decisions of the district court and bankruptcy court; we review conclusions of law de novo and findings of fact for clear error. Superintendent of Ins. v. Ochs (In re First Cent. Fin. Corp.), 377 F.3d 209, 212 (2d Cir.2004). We conclude that the reallocation of the warrants was proper, but that the bankruptcy court erred in approving the nondebtor releases. Nevertheless, we affirm because this appeal is equitably moot.

I. The X-Clause

Before the bankruptcy, appellants purchased various Metromedia notes (the "Notes") governed by an indenture agreement that subordinated the rights of the note holders to those of other creditors ("the Senior Indebtedness") as follows:

Upon the payment or distribution of the assets of [MFN¹] of any kind or character ... to creditors upon any dissolution, winding-up, liquidation or reorganization of [MFN] ... any payment or distribution of assets of [MFN] of any kind or character ... to which the Holders [of the Notes] or the Trustee on behalf of the Holders would be entitled ... shall be paid or delivered ... to the holders of the Senior Indebtedness....

However, a so-called X-Clause exempted from subordination:

securities of [MFN] as reorganized or readjusted, or securities of [MFN] or any other Person provided for by a plan of reorganization or readjustment, junior, or the payment of which is otherwise subordinate, at least to the extent provided in this Article 12, with respect to the Notes, to the payment of all Senior Indebtedness.

The Notes were outstanding when Metromedia filed for relief under Chapter 11. The Plan provided in relevant (small) part that [i] on account of the Notes, appellants were to be paid a combination of cash, common stock in the Reorganized Debtors, and five- and seven-year warrants to purchase additional common stock at specified prices; but [ii] under the terms of the subordination agreement described above, appellants' entire distribution would be reallocated to the Senior Indebtedness.

Appellants concede that the Plan properly reallocated the cash and stock to the Senior Indebtedness; but they argue that the X-Clause allowed them to keep the stock warrants.

The stock warrants are covered by the X-Clause if they are "junior," or if their "payment ... is otherwise subordinate... with respect to the Notes, to the payment of all Senior Indebtedness." But the text is not self-reading; the applicability of the clause in a specific case is not readily apparent; and the parties have submitted no evidence as to the drafters' intentions. Still, such clauses seem to be common in the industry. See In re Envirodyne Indus., 29 F.3d 301, 306 (7th Cir.1994).

Helpful guidance is found in the American Bar Foundation's Commentaries on Model Debenture Indenture Provisions (1971) [hereinafter Commentaries].² In a nutshell, when subordinated and senior note holders are given securities under a plan of reorganization, an X-Clause allows the subordinated note holder to retain its securities only if the securities given to the senior note holder have higher priority to future distributions and dividends (up to the full amount of the senior notes). This provides for full payment of the senior notes before any payment of the subordinated notes is made. In such a case, the senior note holder enjoys unimpaired the priority to payment that it had under its notes, i.e., payments on the subordinated note holder's securities are "subordinate ... to the payment of all Senior Indebtedness." See Commentaries, supra, § 14-5, at 570 (X-Clause is triggered where "mortgage bonds, preferred stock or similar higher class security" are provided to senior note holders and "common stock" is provided to subordinated note holders because "this kind of distribution gives practical effect to the subordination and therefore turnover is not required")³; Ad Hoc Committee for Revision of the 1983 Model Simplified Indenture, Revised Model Simplified Indenture, 55 Bus. Law. 1115, 1221 (2000) ("If Senior Debt were to receive preferred stock and the subordinated debt were to receive common stock, for example, where the preferred stock precluded distributions to common stockholders until the preferred stock was redeemed, the X-Clause would permit that distribution."). This approach assures that the junior creditor remains fully subordinated without requiring it to yield assets that are not required for full payment of the senior creditor and that would therefore make a round-trip to the senior creditor and back, with the attendant delay, friction, and transaction cost.

The caselaw on X-Clauses is consistent with this approach. The Seventh Circuit considered an X-Clause virtually identical to the X-Clause in this case, and construed it to exempt from subordination securities allocated to junior creditors that "are subordinated to the claims of the senior creditors," and which therefore do not "erase the priority" of the senior class. Envirodyne, 29 F.3d at 303, 306; see also In re PWS Holding Corp., 228 F.3d 224, 244-45 (3d Cir.2000) (X-Clause allows securities to be retained if they "are subordinated to the same extent as the existing subordinated debt" (quotation omitted)).

The question thus presented is whether appellants can keep the stock warrants without impairing the priority assured to the Senior Indebtedness by the subordination agreement. The answer is no. Under the Plan, the Senior Indebtedness received cash, common stock, and warrants identical to those at issue here. It is undisputed that the Senior Indebtedness did not receive full payment for its debt under the Plan. If appellants can keep their warrants, they would be able to buy the same class of common stock allocated to the Senior Indebtedness, giving appellants and the Senior Indebtedness equal priority to any future distribution. Therefore, allowing appellants to retain the warrants would effect an impairment of seniority.

II. The Nondebtor Releases

Among the claims settled in the Plan are those of the Kluge Trust.⁴ Under the Plan, the Kluge Trust would [i] forgive approximately $150 million in unsecured claims against Metromedia; [ii] convert $15.7 million in senior secured claims to equity in the Reorganized Debtors; [iii] invest approximately $12.1 million in the Reorganized Debtors; and [iv] purchase up to $25 million of unsold common stock in the Reorganized Debtors' planned stock offering (collectively, "Kluge Consideration"). In return, the Kluge Trust would receive [i] 10.8% of the Reorganized Debtors' common stock and [ii] the "Kluge Comprehensive Release," which provides that

the Kluge Trust and each of the Kluge Insiders shall receive a full and complete release, waiver and discharge from ... any holder of a claim of any nature ... of any and all claims, obligations, rights, causes of action and liabilities arising out of or in connection with any matter related to [Metromedia] or one or more subsidiaries ... based in whole or in part upon any act or omission or transaction taking place on or before the Effective Date.

Appellants challenge this release, as well as two other releases that permanently enjoin creditors from suing various nondebtors.⁵ Appellants' sole argument—and the only argument that we consider—is that these nondebtor releases were unauthorized...