MEMORANDUM DECISION AND ORDER DENYING MOTION FOR A RULE 2004 EXAMINATION
STUART M. BERNSTEIN, Bankruptcy Judge.
The Debtors, TerraForm Power, LLC ("TerraForm LLC") and TerraForm Power, Inc. ("TerraForm Inc." and, together with TerraForm LLC, "TERP") seek authorization to examine Madison Dearborn Capital Partners IV, L.P. and D. E. Shaw Composite Holdings, L.L.C. (collectively, "Shaw") pursuant to Rule 2004 of the Federal Rules of Bankruptcy Procedure ("Rule 2004"). (Joint Motion of the Debtors and TERP for an Order Pursuant to Fed. R. Bankr. 2004 Authorizing the Examination of D.E. Shaw Composite Holdings, L.L.C. and Madison Dearborn Capital Partners, IV L.P., dated Mar. 30, 2017 (the "Motion") (ECF Doc. # 2692).) The proposed examination relates to a certain sale agreement between the parties and related non-bankruptcy litigation brought by Shaw against TERP IN New York state court. Shaw opposed the Rule 2004 motion, the Court denied TERP's motion from the bench and reserved decision on the Debtors' motion to conduct a Rule 2004 examination. For the reasons that follow, the Motion is denied.
A. The Purchase and Sale Agreement
SunEdison, Inc. ("SUNE") and non-debtor TERP are affiliated entities, and SUNE's most valuable assets are its interests in TERP. On November 17, 2014, SUNE, TERP and Shaw, among others, entered into a Purchase and Sale Agreement ("PSA")
(PSA at § 2.04(g) (emphasis added).)
The definition of "Buyers" is the main source of the dispute between Shaw and TERP. The PSA defined the term "Buyers" to include both SUNE and TerraForm LLC. In addition, TerraForm Inc. guaranteed TerraForm LLC's PSA obligations. (PSA at § 6.21.) According to Shaw, these provisions are unambiguous, and their net effect rendered TERP severally liable with SUNE for the Accelerated Earnout Payment.
On November 18, 2015, Shaw wrote letters to TERP demanding confirmation of TERP's ability to pay its obligations under the PSA (the "November 18, 2015 Letters"). (State Court Amended Complaint at ¶¶ 10, 41.) Approximately three months later, TERP responded rejecting Shaw's interpretation of the PSA and denying responsibility for any Accelerated Earnout Payment that SUNE might have to pay. (State Court Amended Complaint at ¶¶ 10, 42.)
B. State Court Litigation
On April 3, 2016, Shaw commenced an action against TERP in the New York Supreme Court, Commercial Division (the "State Court Action") seeking a declaratory judgment regarding TERP's obligations under the PSA. The case was assigned to Justice Shirley Kornreich. SUNE's chapter 11 filing on April 21, 2016 triggered an Acceleration Event under the PSA,
C. The Brookfield/TERP Acquisition and the SUNE/TERP Settlement
In the meantime, the Debtors and TerraForm, Inc. were engaged in a joint marketing process for the sale of TerraForm Inc. (See Declaration of John S. Dubel In Support of Debtors' Motion for Order Pursuant to Bankruptcy Code Sections 105, 362, 363(b), and 365(a) and Bankruptcy Rules 6004, 6006, and 9019 and Local Bankruptcy Rule 6006-1 Authorizing and Approving Certain Settlement Agreements Among the Debtors and the Yieldcos, dated Mar. 10, 2017 ("Dubel Declaration"), at ¶ 13 (ECF Doc. # 2571).) On March 6, 2017, TerraForm Inc. entered into a definitive agreement with Brookfield Asset Management Inc. ("Brookfield") pursuant to which Brookfield agreed to become TerraForm Inc.'s sponsor and controlling shareholder (the "Brookfield/TERP Acquisition").
The Brookfield/TERP Acquisition is relevant to the Rule 2004 request. If it is consummated, SUNE will own 36.9% of TerraForm Inc.'s Class A shares, (see TERP Settlement at Section 2(a)), and an adverse judgment against TERP will diminish the overall value of SUNE's TerraForm Inc. shares. Moreover, TERP must issue additional Class A shares to Brookfield in accordance with a specific formula in the event of a loss resulting from the State Court Action. (See Selden Declaration, Ex. 3 at § 6.17; Motion at ¶ 12.) This will dilute the interests of the other Class A shareholders, including SUNE.
D. The Joint Rule 2004 Motion
On March 30, 2017, the Debtors and TERP jointly filed the instant Motion with this Court. The Motion seeks Rule 2004 discovery from Shaw through the following six requests (the "Requests"):
(Requests at 6-7.)
The Debtors and TERP contend that they need the Rule 2004 discovery because an adverse outcome in the State Court Action will reduce the value of SUNE's stake in TERP. (Motion at ¶ 2.) "Uncertainty about the nature or magnitude of [Shaw's] claims could therefore complicate the financing and implementation of the Debtors' plan of reorganization" and affect recoveries. (Id. at ¶¶ 2, 4.) The discovery may mitigate any concerns among SUNE's financing sources and TERP's stockholders, (id. at ¶ 3), and it will allow the Debtor to evaluate Shaw's proofs of claim. (Id. at ¶ 20.) The movants concluded that the discovery "is necessary to facilitate the Debtors' prosecution of these Chapter 11 Cases and stockholder approval of the Brookfield Acquisition. The disposition of TERP is critically important to the formulation of a plan of reorganization of the Debtors, as well as proceeds available for distribution to secured and unsecured creditors of the estate." (Id. at ¶ 22.)
Shaw objected to the Motion. As a preliminary matter, Shaw maintains that the Requests violate the "pending proceeding" rule in light of the pending State Court Action. (Objection of D. E. Shaw Composite Holdings, L.L.C. and Madison Dearborn Capital Partners IV, L.P. to the Joint Motion of the Debtors and TERP for an Examination Order Pursuant to Federal Rule of Bankruptcy Procedure 2004, dated Apr. 13, 2017 ("Shaw Objection"), at ¶¶ 1, 37, 40-51 (ECF Doc. # 2783).) As to the merits, although the Debtors say they need the disclosure to present a confirmable chapter 11 plan, plans are frequently confirmed notwithstanding pending, unresolved litigation. (Id. at ¶¶ 52-53.) Similarly, while TERP contends that greater disclosure is necessary for shareholders to vote on the Brookfield/TERP Acquisition, TERP has acknowledged that closing the Brookfield/TERP Acquisition is not contingent upon resolution of the State Court Action. (Id. at ¶¶ 54-56.) More fundamentally, any uncertainty regarding the State Court Action will not be resolved through the Rule 2004 Requests. (Id. at ¶¶ 64-73.) Rather, the only way to dispel any uncertainty is to litigate the State Court Action to judgment. (Id. at ¶ 64.)
E. The Subsequent Case Events
After the Motion was filed but while it remained undecided, the Debtors made substantial progress in bringing the cases to a successful conclusion. In addition to obtaining approval of the TERP Settlement and the Voting Support Agreement, they procured $640 million in replacement debtor in possession financing, (Order (I) Authorizing Debtors to (A) Obtain Senior Secured, Superpriority, Replacement Postpetition Financing Pursuant to Bankruptcy Code Sections 105, 361, 362, 364(c)(1), 364(c)(2), 364(c)(3), 364(d)(1), and 364(e), and (B) Utilize Cash Collateral Pursuant to Bankruptcy Code Section 363, (II) Authorizing Use of Proceeds to Repay Existing Senior Secured Superpriority, Postpetition Financing, and (III) Granting Adequate Protection to Prepetition Secured Parties Pursuant to Bankruptcy Code Sections 361, 362, 363 and 364, dated May 1, 2017 (ECF Doc. # 2880)), secured up to $300 million in exit financing through a rights offering, equity commitment and backstop agreement, (Order Authorizing and Approving (I) (A) Entry into the Backstop Commitment Letter, (B) Equity Commitment Agreement, (C) Payment of the Fees and Expenses and (II) the Rights Offering Procedures and Related Forms, dated June 6, 2017 (ECF Doc. # 3283)), and filed a joint plan and obtained approval of their disclosure statement. (Order (A) Approving the Adequacy of the Debtors' Disclosure Statement; (B) Approving Solicitation and Notice Procedures with Respect to Confirmation of the Debtors' Joint Proposed Plan; (C) Approving the Form of Various Ballots and Notices in Connection Therewith; and (D) Scheduling Certain Dates with Respect Thereto, dated June 13, 2017 (ECF Doc. # 3319).) The hearing to confirm the Debtors plan of reorganization is scheduled for July 20, 2017.
Rule 2004 provides in relevant part that the Court may authorize the examination of any entity relating "to the acts, conduct, or property or to the liabilities and financial condition of the debtor, or to any matter which may affect the administration of the debtor's estate." FED. R. BANKR. P. 2004(b). In chapter 11 cases, the examination may extend to matters relating "to the operation of any business and the desirability of its continuance, the source of any money or property acquired or to be acquired by the debtor for purposes of consummating a plan and the consideration given or offered therefor, and any other matter relevant to the case or to the formulation of a plan." Id. The party seeking Rule 2004 discovery has the burden to show good cause for the examination it seeks, and relief lies within the sound discretion of the Bankruptcy Court. Picard v. Marshall (In re Bernard L. Madoff Inv. Secs. LLC), Adv. Pro. No. 08-01789, 2014 WL 5486279, at *2 (Bankr. S.D.N.Y. Oct. 30, 2014); see In re Bd. of Dirs. of Hopewell Int'l Ins. Ltd., 258 B.R. 580, 587 (Bankr. S.D.N.Y. 2001) (Rule 2004 gives the Court "significant" discretion).
Relevance alone is not sufficient to justify a Rule 2004 request. In re Drexel Burnham Lambert Grp., Inc., 123 B.R. 702, 712 (Bankr. S.D.N.Y. 1991). A party seeking to conduct a Rule 2004 examination must also show good cause, such as the proposed examination "`is necessary to establish the claim of the party seeking the examination, or . . . denial of such request would cause the examiner undue hardship or injustice,'" In re Metiom, Inc., 318 B.R. 263, 268 (S.D.N.Y. 2004) (quoting In re Dinubilo, 177 B.R. 932, 943 (E.D. Cal. 1993)); accord In re AOG Entm't, Inc., 558 B.R. 98, 109 (Bankr. S.D.N.Y. 2016); Drexel Burnham, 123 B.R. at 712, and the Court must "balance the competing interests of the parties, weighing the relevance of and necessity of the information sought by examination." Drexel Burnham, 123 B.R. at 712; accord In re Coffee Cupboard, Inc., 128 B.R. 509, 514 (Bankr. E.D.N.Y. 1991); see In re SunEdison, Inc., 562 B.R. 243, 250 (Bankr. S.D.N.Y. 2017) ("The spirit of proportionality is consistent with the historic concerns regarding the burden on the producing party and is relevant to the determination of cause.")
B. The Pending Proceeding Rule
The Court denied TERP's request for Rule 2004 discovery from the bench based on the "pending proceeding" rule. Under the rule, "once an adversary proceeding or contested matter is commenced, discovery should be pursued under the Federal Rules of Civil Procedure and not by Rule 2004," In re Enron Corp., 281 B.R. 836, 840 (Bankr. S.D.N.Y. 2002); In re Bennett Funding Group, Inc., 203 B.R. 24, 28 (Bankr. N.D.N.Y. 1996) ("The well recognized rule is that once an adversary proceeding or contested matter has been commenced, discovery is made pursuant to the Fed. R. Bankr. P. 7026 et seq., rather than by a Fed. R. Bankr. P. 2004 examination."), and the principle applies to pending state court litigation. See Snyder v. Society Bank, 181 B.R. 40, 42 (S.D. Tex. 1994) aff'd sub nom. In re Snyder, 52 F.3d 1067 (5th Cir. 1995). The pending proceeding rule is based on the different safeguards that attend Rule 2004 and civil litigation discovery, and reflects a concern that a party to litigation could circumvent his adversary's rights by using Rule 2004 rather than civil discovery to obtain documents or information relevant to the lawsuit. In re Glitnir banki hf., No. 08-14757 (SMB), 2011 WL 3652764, at *4 (Bankr. S.D.N.Y. Aug. 19, 2011); In re Wash. Mut., Inc., 408 B.R. 45, 51 (Bankr. D. Del. 2009); Enron Corp., 281 B.R. at 840-41; Bennett Funding Group, 203 B.R. at 29-30.
The State Court Action is a pending proceeding within the meaning of the rule. TERP can seek discovery relating to the meaning of "Buyer" or the merits of the action pursuant to the NYCPLR. Although NYCPLR 3214(b) generally stays discovery upon the filing of a motion to dismiss unless the court orders otherwise, Justice Kornreich's Local Rules of Court governing the State Court Action explicitly provide that "[d]iscovery is not stayed by the filing of a dispositive motion or a mediation, unless otherwise directed by the court." N.Y. R. COM. N.Y. Part 54, at p. 1607 (McKinney 2017). TERP cannot circumvent the pending proceeding rule by seeking one-sided discovery through a Rule 2004 request in this Court.
C. The Debtors' Request
Shaw also argues that the Debtors are barred from taking Rule 2004 discovery under the pending proceeding rule. (Shaw Objection at ¶ 37.) The Debtors are not parties to the State Court Action, and hence, the rule does not apply to them. The Debtors are entitled to Rule 2004 discovery from Shaw if they can establish cause. They argue that cause exists because the outcome of the State Court Action will have a material effect on the value of an important asset, the TERP shares.
Relevance, however, is not enough; the Debtors must show that they need the discovery for some appropriate purpose, or that the failure to get the discovery will result in hardship or injustice. This they have not done. Rule 2004 may permit a debtor to conduct discovery into the value of the stock owned in a non-debtor subsidiary in appropriate circumstances, such as where the debtor owns a controlling interest and must decide whether to take control of the subsidiary in order to sell or liquidate its assets. In re Petroforte Brasileiro de Petroleo Ltda., 542 B.R. 899 (Bankr. S.D. Fla. 2015). This is not the case here. Rule 2004 unquestionably allows a debtor to take pre-litigation discovery into claims that it owns. See In re Belton, No. 15 CV 1934 (VB), 2015 WL 6163083, at *2 n.3 (S.D.N.Y. Oct. 14, 2015) ("A Rule 2004 examination is a very broad, pre-litigation discovery process designed to assist the trustee in revealing the nature and extent of the estate, ascertaining assets, and discovering whether any wrongdoing has occurred.") (citing In re Corso, 328 B.R. 375, 383 (E.D.N.Y. 2005)). This is also not the case. But Rule 2004 does not reach so far as to allow a debtor to take discovery from participants in third-party litigation involving claims it does not own or defenses it will not assert simply because the outcome may affect the value of an asset the debtor does own. In fact, the Court requested supplemental briefing on this point, but the Debtors were unable to cite any authority to support their use of Rule 2004 to discover the merits of claims asserted in third party litigation against a subsidiary in order to value its stock ownership.
The Debtors have failed to demonstrate that the discovery they seek is needed to accomplish the purposes they have identified. They assert that they need the information to finalize their plan, ensure accurate disclosure, reassure lenders and secure exit financing, and confirm and implement their plan. Debtors frequently accomplish these goals despite litigation contingencies. More importantly, the Debtors procured $640 million in replacement debtor in possession financing and up to $300 million in exit financing, settled with TERP and committed to support the Brookfield/TERP Acquisition (which is not dependent on the outcome of the State Court Action), finalized a plan, obtained approval of their disclosure statement and scheduled a confirmation hearing, all without receiving the Rule 2004 discovery. The value of the Debtors' TERP shares may fluctuate as a result of the outcome of the State Court Action as well as for many other reasons, but the lack of discovery has not prevented the Debtor from achieving the goals it set.
The Debtors request to use Rule 2004 to estimate the contingent future value of a subsidiary's stock based on the outcome of pending litigation also lacks any limiting principle. The difficulties were evident during colloquy between the Court and counsel. At oral argument, the Court posed two hypotheticals. First, could a debtor use Rule 2004 to take discovery from a third party regarding claims it asserted against the debtor's most important customer in non-bankruptcy litigation that threatened the survival of that customer? (Tr. 4/20 at 26:11-16.) Debtors' counsel initially implied that the claim against the customer was too indirect, (Tr. 4/20 at 26:18-19), but then reconsidered and said the use of Rule 2004 to examine the strength of that claim was "possible." (Tr. 4/20 at 27:1-4.) The Court then hypothesized that a debtor's most significant asset was Microsoft stock and queried whether the debtor could use Rule 2004 discovery to obtain information from Microsoft's adversary in a patent litigation pending in another court. (Tr. 4/20 at 27:23-28:3.) Counsel intimated that it would depend on the percentage of Microsoft stock the debtor owned, (Tr. 4/20 at 28:11-12), and if the debtor owned 35% of Microsoft's stock and was a controlling shareholder, a Rule 2004 examination would be justified. (Tr. 4/20 at 28:25-29:3.)
Counsel's responses demonstrate the uncertainty involved in extending Rule 2004 to discover the merits of third party claims against other third parties. The demise of a key customer may have a significant effect on the debtor's business, but what about litigation against a less important customer or against a supplier? Counsel suggested in the Microsoft hypothetical that Rule 2004 discovery would be appropriate if the hypothetical debtor owned a 35% controlling interest in Microsoft, but what if he owned 25% or 10% or 1%? For that matter, why limit the use of Rule 2004 to litigation? Under the Debtors' reasoning, any item of information that may have an effect on the value of a debtor's asset would be subject to discovery under Rule 2004. There is no clear line that can be drawn between permissible Rule 2004 discovery and a request, if any, that exceeds its scope.
The circumstances of the joint Rule 2004 request also give me pause. The request and the movants' arguments focused on TERP's liability to Shaw. TERP could pursue that discovery in state court, and is therefore barred from seeking the same discovery through Rule 2004 under the pending proceeding rule. The Debtors and TERP are united in interest regarding the desired outcome of the State Court Action, and the Debtors appear to be using Rule 2004 to help TERP get through Rule 2004 what it should instead seek in the State Court Action. Although the Debtors also suggest that they need discovery from Shaw to evaluate its claims against the various estates, the Debtors have not disputed their liability or focused a single request on the computation of Shaw's claims against the estates. In fact, SUNE is committed to pay $231 million to Shaw under the Payment Agreement. (Motion, Ex. C.) In short, they have failed to show any necessity for the Rule 2004 discovery, or that they will suffer injustice or hardship if they do not get it.
Accordingly, the Motion is denied. So ordered.