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Discovery Regarding a Debtor’s Valuation and Solvency Held Relevant to Makewhole Dispute

In the CSC Trust Co. adversary proceeding pending in connection with the Energy Future Holdings Corp. bankruptcy proceedings, an indenture trustee for certain senior secured notes sought a declaration from the Court that certain debtors (the “EFIH Debtors”) are obligated to pay a redemption premium in connection with a proposed refinancing of the notes.  In his Opinion, Judge Sontchi held discoverable information regarding the EFIH Debtor’s valuation and solvency, finding that such information is relevant to the amount that may need to be paid should an enforceable makewhole provision be found.  Despite the foregoing, however, such information was held to be obtainable only from the EFIH Debtors and not from third parties—namely, an ad hoc committee of noteholders—as such parties did not take a position regarding, or intend to offer expert or other evidence on, the EFIH Debtors’ insolvency.

In reaching its conclusion regarding relevancy, the Court relied upon the broad standard of discovery set forth under Federal Rule of Civil Procedure 26(b)(1)—one which does not require discoverable information to be admissible at trial in order to be relevant to a party’s claim or defense, but only reasonably calculated to lead to the discovery of admissible evidence.  The EFIH Debtors argued that the requested solvency and valuation information was irrelevant because the plain language of the governing indenture does not provide for the disputed makewhole payment.  However, the Court made it clear that this contract interpretation issue was ultimately a threshold triable issue, but was of no consequence to the outcome of this discovery dispute.  Rather, of primary importance to the Court was the information’s potential bearing on the action—namely, that it will affect the amount of the makewhole payment required to be paid if the Court were to decide that such payment obligation was required by the indenture.  As explained by the Court, in cases of solvent debtors, bankruptcy courts tend to hold debtors to their legally contractual obligations so long as they are enforceable under applicable non-bankruptcy law, whereas in the case of insolvent debtors, courts may invoke their powers of equity to adjust contractual obligations to attempt a fairer distribution among creditors.  See, e.g.In re Chemtura Corp., 439 B.R. 561 (Bankr. S.D.N.Y. 2010); In re Los Angeles Dodgers LLC, 465 B.R. 18 (D. Del. 2011).

While the Court deemed the requested solvency and valuation information relevant and thus, discoverable from the EFIH Debtors, it did not find the same with respect to internal valuations of the EFIH Debtors prepared by a third-party ad hoc noteholder committee.  Citing Judge Shannon’s recent ruling in In re Dolan Co., No. 14-10614, Tr. Hr’g (May 2, 2014), the Court held that case law does not exist to support such a request where, as in the instant dispute, the targeted party does not intend to take a position or offer evidence regarding the valuation of a debtor.  Additionally, and more importantly, the requesting party was found by the Court to have failed to carry its burden of demonstrating the relevancy of the noteholders’ information to the dispute.  As observed by the Court, while the noteholders may have played a central role in the negotiations surrounding the note refinancing, no further explanation was proffered as to the relevancy of the noteholders’ valuation information to the allowance and enforcement of the asserted makewhole claim.

Practice Pointer:  Interestingly, while the Court deemed the solvency and valuation information discoverable from the EFIH Debtors, it acknowledged the practicalities of the situation—namely, that such discovery would be time consuming and expensive, and would delay resolution of the adversary proceeding.  Accordingly, the Court offered three alternatives, which practitioners should keep in mind when facing a similar situation:  first, that the EFIH Debtors concede their insolvency solely for purposes of the makewhole litigation; second, that the EFIH Debtors waive the right to assert any defense to payment of the makewhole premium upon solvency; and/or third, that the parties agree to bifurcate the trial such that the issue of solvency (and its related discovery) will arise only if the Court finds the EFIH Debtors liable for the makewhole premium.