“Settlements and compromises are favored in bankruptcy as they minimize costly litigation and further parties’ interests in expediting the administration of the bankruptcy estate.” In accordance with this policy, Congress promulgated Federal Rule of Bankruptcy Procedure 9019 (the “Bankruptcy Rules”), which governs settlements in a bankruptcy case. Rule 9019 gives a bankruptcy judge discretion to approve a proposed settlement and states in relevant part, that: “[o]n motion by the trustee, the court may approve a compromise or settlement.” Rule 9019 applies to both settlements brought before the court on a standalone basis as well as those presented as part of a chapter 11 plan.
Although settlements are generally preferred in bankruptcy litigation, not all creditors may accept the terms of a given settlement. Rule 9019 settlements are often confirmed over the objection of prepetition unsecured creditors, even when it alters the normal order of priority of distribution. However, prepetition unsecured creditors have rights, albeit limited, and settlements between the debtor and other prepetition unsecured creditors can unduly harm their interests in the absence of proper judicial discretion. A question has arisen as to what standard bankruptcy judges must follow in deciding whether to approve a trustee’s Rule 9019 settlement proposal over the objection of other unsecured creditors. A separate question has also arisen about whether a bankruptcy judge can ever approve a settlement when it adversely affects rights of parties not involved in the settlement negotiations. Part I of this article defines the standards set out by the Supreme Court and Second Circuit which limit a bankruptcy judge’s discretion. Part II discusses the issue of whether a bankruptcy court abuses its discretion if it approves a settlement that adversely affects the rights of parties not involved in the settlement negotiations for a proposed Rule 9019 settlement.