Bankruptcy judge mediation faces calls for further scrutiny

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The practice of using bankruptcy judges to mediate complex disputes in other bankruptcy judge cases has surfaced in recent high-profile Chapter 11 filings, reigniting questions from restructuring professionals about the transparency and fairness.

Chapter 11 debtors like to use judges as mediators because they are familiar with bankruptcy and, most importantly, are free. Recent cases like Purdue Pharma LP, Madison Square Boys & Girls Club Inc., and Brazos Electric Power Cooperative Inc. have involved a sitting bankruptcy judge other than the one assigned to their case to negotiate major settlements with creditors.

But allowing the debtor to set the parameters of mediation early in the case, such as selecting the mediating judge or participating creditors, raises questions of fairness, say skeptics of the practice. Using judges as mediators can create discomfort if the lawyers involved appear before the mediating judge in a separate case, they say.

“There is more urgency now in the bankruptcy world to consider whether Chapter 11 debtors immediately demand that certain parties be directed to mediation with a sitting judge from the first moments they enter the bankruptcy process,” said Melissa Jacoby, professor of bankruptcy at the University. of North Carolina, which plans to publish a report on the matter soon.

Transparency and disclosure are central to bankruptcy practice. But if debtors immediately embark on private and confidential mediation between only certain parties, other stakeholders – often those with little power – may be excluded from negotiations before they are “barely aware of the ‘case,” Jacoby said.

Using sitting judges as mediators remains “an effective tool,” said Clifford White, who was formerly director of the US Trustee, the Justice Department’s bankruptcy watchdog.

But the practice needs clearer rules because the risk of overspending is “substantial”, he said. “It has to be very carefully considered and should not be coasting.”

Central conflict mediation

In Chapter 11, the presiding bankruptcy judge makes rulings on nearly every aspect of the case, from approving the hiring of debtor’s attorneys to approving the plan of reorganization. But some disputes are best resolved by a “neutral” who can hear arguments and weigh evidence that might be inadmissible or that the parties don’t want to share with the presiding judge.

The “neutral” role is sometimes filled by a private mediator who bills by the hour, or by a judge.

The practice of appointing a local judge as mediator is quite common. But Madison Square Boys & Girls Club, a nonprofit for underserved young people in New York City, raised eyebrows with an unusual request to appoint a mediator judge – to resolve 149 sexual abuse complaints – the same day it filed for bankruptcy in June. . The organization asked for a specific judge, another unusual request.

That judge, Bankruptcy Judge Shelley Chapman of the Southern District of New York, also served as a mediator in Purdue Pharma’s opioid abuse case. After his involvement, members of the Sackler family who owned Purdue agreed to contribute $6 billion to a sweeping settlement of opioid-related claims.

Courts have also found in-court mediation helpful in municipal bankruptcies, including the two largest in history, Detroit and Puerto Rico. The Detroit case stood out because the mediator, Judge Gerald Rosen of the U.S. District Court for the Eastern District of Michigan, went beyond negotiating with the parties behind closed doors, according to White, the former director of the American administration.

White, who recently resigned after 17 years as director of the U.S. Trustee’s executive office, noted that Rosen had made public statements and lobbied lawmakers to help restructure the city.

Gravitas, Insider Knowledge

The main advantage of using bankruptcy judges as mediators is obvious: their services are free.

Judge-supervised mediation can also often be faster than private mediation, said Kevin Carey, a former Delaware bankruptcy judge and now an attorney at Hogan Lovells LLP. Judges come “with knowledge and seriousness, which really matters,” said Carey, who serves as a private mediator.

Additionally, a court mediator likely has “inside knowledge,” said Eugene Wedoff, a former bankruptcy judge with the U.S. Bankruptcy Court for the Northern District of Illinois.

The mediator usually knows – and often works in the hallway – the presiding judge. The mediating judge may say to any or all of the mediating parties, “I know your judge thinks x, y, and z” about a particular issue or legal issue, “so you may want to consider that”, Wedoff said.

A court-mediated settlement can also give the presiding judge confidence in the reasonableness of a proposed settlement. Settlement agreements must be approved by the bankruptcy judge, in accordance with the bankruptcy code and rules.

Confidential Information

That the opinions of the mediator judge have weight goes both ways. It can also potentially, and perhaps even unconsciously, affect how a party or their attorney makes decisions.

Lawyers and their clients often feel that the mediating judge and the presiding judge will discuss the case among themselves, Jacoby said. This is important because the mediator is often aware of information that a party would not want the presiding judge to have, or that may be inadmissible in court.

“The attorney was always concerned about that — judges communicating,” Carey said. Even though Delaware rules prohibit such communications, “I’m not sure the attorneys believed that,” he said.

A judicial mediator can also seem to have too much influence.

“Current judges still have robes, gavels and contempt powers,” Jacoby said.

If lawyers are required to participate in mediation before a judge and also appear before that same judge in a separate case, “they might be afraid if they do not follow the advice of the mediator, they may be harmed” in the other case, says Wedoff.

The mediating judge should also not force a compromise and ensure that everyone involved voluntarily participates in the talks, White said.

“Judges shouldn’t become defenders of an outcome,” White said.

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