In a plan of reorganization, the Bankruptcy Code outlines a priority scheme that must be strictly adhered to. 11 U.S.C. § 1129. According to the Code, “the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property.” 11 U.S.C. § 1129(b)(2)(B)(ii). When faced with the question of extending the codified priority rule to settlement approvals, the Fifth Circuit in United States v. AWECO Inc. (In re AWECO, Inc.), 725 F.2d 293 (5th Cir. 1984) held that the rule applied to all settlements, even those made prior to a plan of reorganization. Id. at 298. More recently, the Second Circuit in Motorola Inc. v. Official Comm. of Unsecured Creditors (In re Iridium Operating LLC), 478 F.3d 452 (2d Cir. 2007) was faced with the same issue but choose not to adopt the AWECO rule. Id. at 455. (“This case requires us to determine whether . . . Bankruptcy Code's priority scheme for reorganization plan distributions—applies to bankruptcy court approval of a settlement under Rule 9019.”). The Second Circuit Court of Appeals held that although a pre-plan settlement’s distribution plan’s compliance with the Bankruptcy Code's priority scheme is the most important factor to consider in approving a settlement under Bankruptcy Rule 9019, it was not necessarily dispositive. Id. at 464.
Rule 9019 requires that all settlements be approved by a court; however, the Bankruptcy Code does not provide guidelines for how to determine whether a settlement should be approved. Fed. Rules Bankr. Proc. 9019. This problem was addressed by the Supreme Court in TMT Trailer Ferry, Inc., v. Anderson, 390 U.S. 414, 424 (1967). In that case the Court adopted the statutory language “fair and equitable” from the Bankruptcy Act §§ 174, 221(2), which dealt with plans of reorganization. Id. at 424 (“The requirements of [ ], that plans of reorganization be both 'fair and equitable,' apply to compromises just as to other aspects of reorganizations.”) (citations omitted). Although the language was adopted from the Bankruptcy Act, which has been replaced by the Bankruptcy Code 11 U.S.C. § 1129, “its principles have been broadly held applicable to settlements under the Bankruptcy Code.” 2 NORTON BANKR. L. & PRAC. 2d § 41:10 (2007). In TMT Trailer Ferry, the Court lists several factors courts should look to in determining whether a settlement is “fair and equitable.” 390 U.S. at 424. Specifically the court held that “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.” Id.