March 11, 2021

Preparing for Mediation in Bankruptcy

In a facilitative mediation, a neutral party serves as a mediator and works with the litigants to reach a settlement. The mediator has no power to rule or bind the parties to a judgment or decision, but rather facilitates a dialogue that potentially leads to a resolution.

Many bankruptcy judges order, or at least, strongly encourage, parties to go to mediation in contested matters. Many adversary proceedings, which are similar to traditional lawsuits involving plaintiffs and defendants in the bankruptcy court, are referred to mediation. Disputes in bankruptcy cases are fertile ground for mediations because they involve (a) businesses struggling to survive that cannot afford to waste resources on litigation, (b) individuals that lack financial resources to pay significant legal fees, and/or (c) creditors who do not want to throw good money after bad trying to collect from an individual or business that can only afford to pay so much.

The key to a successful mediation in bankruptcy is preparation, and mediation will likely fail if the litigants fail to prepare. Some litigants expect a mediator to wave a magic wand to get the other side to “see the light” and capitulate. Because facilitative mediation is non-binding, and you cannot ‘lose’ the case at mediation, some attorneys do not prepare for mediation like they would for a contested court hearing.

Here are some key insights on preparing for mediation in bankruptcy:

Pick the right mediator: The parties should select a mediator well-versed in bankruptcy law. Many bankruptcy courts, like the Eastern District of Michigan, have established a mediation panel comprised of experienced bankruptcy practitioners who have been trained as mediators and vetted by the court. The parties should select a mediator who has experience practicing in, and mediating, the subject matter of the contested case. For example, a mediator/attorney specializing in Chapter 13 consumer bankruptcy may not be the best candidate to mediate a complex Chapter 11 commercial dispute.

Mediate at the right time: The timing of a mediation is critical to its success and should be determined on a case-by-case basis.  Going to mediation early in a dispute is often preferred before the parties have incurred significant legal fees. Early mediation works best where the parties have general understanding of the material facts and legal positions.  In some bankruptcy disputes, a debtor and creditor have had a relationship for years, and there may have been state court litigation proceeding the bankruptcy. Under these circumstances, a mediation that takes place as soon as possible may be beneficial.

Alternatively, there is a risk in pursuing mediation too early, before there is a fundamental understanding of the facts. Mediation is not the proper venue for exchanging information regarding a contested matter. A mediator can help to narrow the issues and resolve discovery disputes, but can only do so much to achieve a settlement. Consider a case where a bankruptcy trustee seeks to avoid an alleged fraudulent transfer of real estate and recover the property for the estate. It may be difficult to settle the case without having an understanding of the value of the real property that was transferred.

Review the bankruptcy court filings: In many mediations, the financial wherewithal, or collectability, of a company or individual is a key issue. In business cases, parties should analyze potential recoveries to creditors under a reorganization and liquidation scenario. For example, a creditor with a claim of $500,000 against a business in bankruptcy may only receive 10% its claim under a Chapter 11 plan. In a Chapter 7 liquidation, the creditor may receive nothing.

Companies and individuals filing for bankruptcy are required to file detailed disclosures of assets and liabilities under the penalty of perjury, so there is a significant amount of information for parties to analyze. If collectability is a potential factor in settlement discussions, that issue should be discussed in advance of mediation, so documents may be exchanged by the parties.

Caution: further approval may be needed: A debtor or trustee in a bankruptcy case is often required to obtain court approval of any settlement, after notice is provided to all creditors. Accordingly, while a debtor or trustee may sign a binding settlement term sheet at mediation, that settlement will be subject to court approval.  Counsel for creditors or other parties litigating with a trustee or debtor should discuss in advance of mediation whether court approval is required, and if any other major constituencies in the case (e.g., an unsecured creditors’ committee) will have a major impact on whether the settlement will be approved

Talk to your client before mediation: Know what your client wants and what your client will accept. Too many attorneys begin a mediation without a clue as to what their clients really want or what they would settle for. Also, clients must understand the ‘give and take’ of the mediation process. They must understand the risks if they fail to settle.

Preparation is the key to succeed in court or at mediation.  Following these guidelines will improve the prospects for settlement.

Jason W. Bank is the chair of the firm’s Bankruptcy and Restructuring department. He focuses his practice in the areas of commercial bankruptcy, out-of-court workouts, corporate restructuring and creditors’ rights. Jason has successfully guided numerous businesses through out-of-court restructurings and Chapter 11 reorganizations. He has negotiated resolutions of complex financial issues and debtor-creditor disputes and achieved consensual restructurings while avoiding bankruptcy or litigation.

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Jason W. Bank