TRUSTEE’S MOTION TO COMPROMISE AND SETTLE …

Case 16-07207-JMC-7A Doc 3391 Filed 05/07/19 EOD 05/07/19 14:19:34 Pg 1 of 23

UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF INDIANA

INDIANAPOLIS DIVISION

IN RE:

)

) ITT EDUCATIONAL SERVICES, INC., et al.,1 )

)

Debtors.

)

Case No. 16-07207-JMC-7A Jointly Administered

TRUSTEE'S MOTION TO COMPROMISE AND SETTLE ADVERSARY PROCEEDING NO. 17-50101

Deborah J. Caruso, the chapter 7 trustee (the "Trustee")2 in the above-captioned cases, by

counsel, respectfully submits this motion (the "Motion"), pursuant to sections 105(a) and 363 of

title 11 of the United States Code (the "Bankruptcy Code") and rule 9019 of the Federal Rules of

Bankruptcy Procedure (the "Bankruptcy Rules"), for entry of a final order, substantially in the

form attached hereto as Exhibit A (the "Proposed Order"), (a) approving the terms of a proposed

settlement (the "Settlement") by and between the Trustee, not individually but solely in her

capacity as Chapter 7 trustee for, and acting for and on behalf of the Debtors, and each of the

Debtors' respective bankruptcy estates, on the one hand, and Student CU Connect CUSO, LLC

(the "CUSO"), The Rochdale Group, Inc. ("Rochdale"), and Elements Financial Federal Credit

Union (formerly known as Eli Lilly Federal Credit Union), Bellco Credit Union, Credit Union of

America, Directions Credit Union, Veridian Credit Union, Workers Credit Union and

CommunityAmerica Credit Union (together, the "Participating Credit Unions") (the CUSO,

Rochdale and the Participating Credit Unions, together, the "CUSO Parties"), on the other hand,

1 The debtors in these cases, along with the last four digits of their respective federal tax identification numbers, are ITT Educational Services, Inc. [1311]; ESI Service Corp. [2117]; and Daniel Webster College, Inc. [5980].

2 Capitalized terms used but not defined herein have the meanings given to them in the Settlement Agreement (as defined herein).

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which is embodied in that certain settlement agreement (the "Settlement Agreement"), a copy of which is attached as Exhibit 1 to the Proposed Order, and (b) granting related relief. In support of the Motion, the Trustee respectfully avers as follows:

Jurisdiction 1. The Court has jurisdiction over the Motion pursuant to 28 U.S.C. ?? 157 and 1334. 2. This is a core proceeding within the meaning of 28 U.S.C. ?157 (b)(2). 3. Venue is proper pursuant to 28 U.S.C. ?? 1408 and 1409. 4. The statutory bases for the relief requested herein are sections 105(a) and 363(b)(1) of the Bankruptcy Code and Bankruptcy Rule 9019.

Background 5. On September 16, 2016 (the "Petition Date"), each of the Debtors filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code. The Trustee was appointed interim trustee in each of the Debtors' bankruptcy cases on the Petition Date pursuant to section 701(a)(1) of the Bankruptcy Code. The Trustee became the case trustee in each of the Debtors' bankruptcy cases following the conclusion of the first meeting of creditors on November 1, 2016, pursuant to section 702(d) of the Bankruptcy Code. 6. On October 4, 2016, the Court entered its Order Granting Motion for Joint Administration of Chapter 7 Cases [Docs 221-222], directing the Debtors' bankruptcy cases to be jointly administered for procedural purposes only. 7. Prior to the Petition Date, the Debtors as a whole were engaged in the for-profit enterprise of providing post-secondary degree programs in 137 campus locations in thirty-nine states and through online services.

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8. ITT was a publicly-held company that, as of June 30, 2016, employed over 8,000 employees. ITT offered master, bachelor, and associate degree programs to approximately 40,000 students at its campus locations and online programs to students located in all fifty states and the District of Columbia. All of ITT's campus locations were authorized by applicable education authorities of the states in which they operated and were accredited by an accrediting commission recognized at the time by the U.S. Department of Education.

9. Webster College was founded in 1965 in Nashua, New Hampshire, as the New England Aeronautical Institute (the "NEAI"). In 1978, the NEAI was merged with its juniorcollege division to form Webster College, a private institution with a focus on business education.

10. The CUSO is a credit union service organization, formed by the independent and separately owned and managed not-for-profit Participating Credit Unions, and administered by Rochdale. The CUSO was formed in order to take part in a student loan program (the "Program"), pursuant to which private, non-governmentally guaranteed student loans (the "Loans") were made to certain of the students enrolled in certain of the Debtors' schools (the "CUSO Borrowers"), to help them to fund their tuition and fees at those schools.

11. On or about February 20, 2009, the CUSO, ITT and others entered into various agreements (as have been amended from time to time, the "Program Agreements"), through which they specified the terms and conditions of the Program and of their respective roles in connection therewith. Pursuant to the Program Agreements, the CUSO is now the owner of the Loans.

12. Among the Program Agreements is the Risk Sharing Agreement between ITT and the CUSO, dated as of February 20, 2009 (as has been amended from time to time, the "RSA"),

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pursuant to which, inter alia, ITT guaranteed to the CUSO the repayment of a portion of the amount due and owing on non-performing Loans, once the amount charged off under the Program Agreements in respect of non-performing Loans exceeded a certain threshold.

13. The CUSO asserts that that threshold amount has been exceeded, triggering ITT's guaranty obligations to the CUSO under the RSA. Pursuant to certain other Program Agreements, ITT agreed to secure a portion of its guaranty obligations to the CUSO under the RSA, and, accordingly, ITT deposited funds into Account No. XXXXX8776 (the "Collateral Account"), a deposit account maintained with JPMorgan Chase Bank, NA ("Chase"), which has a current balance of approximately $8.8 million.

14. On April 4, 2013, the CUSO issued to Chase and ITT a notice that the CUSO has exclusive control over the Collateral Account. The Trustee has disputed the CUSO's exclusive control over the Collateral Account.

15. Certain governmental entities commenced investigations into the practices of Debtors and Debtors' former management and/or formally alleged that the Debtors and Debtors' former management engaged in misconduct, including without limitation consumer fraud, in connection with, among other things, the Program.

16. In September 2016, the Debtors closed their campuses and, on the Petition Date, each of the Debtors filed a voluntary petition for relief under Chapter 7 of Title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of Indiana (the "Bankruptcy Court"), which petitions are being jointly administered by the Bankruptcy Court under Case No. 16-07207-JMC-7A (the "Bankruptcy Case").

17. The CUSO asserts that ITT is indebted to the CUSO, and the CUSO has a claim against the Debtors, for certain of the losses the CUSO has incurred, and will incur, in

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connection with the Program (the "CUSO's Claim"), in the amount of $159,248,725.66, plus the CUSO's attorneys' fees and costs. The CUSO's Claim is substantially greater than the amount of the funds in the Collateral Account, which constitutes the CUSO's sole collateral for the CUSO's Claim.

18. On November 10, 2016, the CUSO moved for relief from the automatic bankruptcy stay [ECF 608], seeking (inter alia) the release and payment to the CUSO of all funds in the Collateral Account (the "Stay Relief Motion"), which Stay Relief Motion the Trustee opposed.

19. On January 3, 2017, a class action adversary proceeding against the Debtors in the Bankruptcy Case was filed on behalf of a class (the "Student Class"), putatively consisting of all students, including the CUSO Borrowers, who were at any time enrolled in any of the educational programs offered by the Debtors between January 1, 2006 and September 16, 2016 (the "Students"), in which proceeding the Student Class alleges, among other things, that the Debtors engaged in misconduct, including without limitation consumer fraud, in connection with the Program, and disputes the validity of the Loans.

20. On January 24, 2017, the CUSO filed proofs of claim (the "CUSO Proofs of Claim") against each of the Debtors for the CUSO's claimed losses (claim numbers 359 (DWC), 436 (ESI) and 1775 (ITT)), which the CUSO asserts were calculated based upon accrued, and then-current estimates of future, amounts owed by ITT to the CUSO.

21. On March 29, 2017, the CUSO voluntarily withdrew the Stay Relief Motion without prejudice [ECF 1492].

22. On March 30, 2017, the Trustee filed a complaint in the Bankruptcy Case [Adv. Pro. ECF 1] (the "Complaint"), thereby commencing Adversary Proceeding No. 17-50101 (the

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"Adversary Proceeding"), in which the Trustee alleged various claims against the CUSO Parties and, as alleged in the Complaint, sought, inter alia, to: (a) avoid the Debtors' obligations under the RSA, including, without limitation, the CUSO's claim to recover approximately $157 million in payments allegedly due by the Debtors thereunder as of the Petition Date; (b) avoid and recover from the CUSO Parties (as initial and/or subsequent transferees) approximately $42.6 million in payments that the Debtors' former management caused the Debtors to make under the RSA from 2011 through 2016; (c) avoid all liens, pledges and encumbrances that the Debtors' former management caused the Debtors to grant to the CUSO pursuant to that certain "Security Agreement," dated as of February 20, 2009, between the CUSO and the Debtors; (d) avoid the CUSO's alleged lien with respect to the moneys deposited into the Collateral Account; (e) avoid and recover from the CUSO Parties (as initial and/or subsequent transferees) approximately $7 million in payments that the Debtors' former management caused the Debtors to make to the CUSO Parties between November 2014 and June 2015 purportedly in lieu of posting additional collateral under the RSA and/or Security Agreement; (f) avoid the Debtors' obligations under that certain "Financing Program Agreement," dated as of February 20, 2009, between the CUSO Parties and the Debtors; (g) avoid and recover approximately $8.764 million in funds that the Debtors' former management caused the Debtors to make available to the CUSO Parties under the Financing Program Agreement to generate additional CUSO Loans; (h) avoid and recover all payments that the Debtors' former management caused the Debtors to make to Rochdale, directly or indirectly (as an initial and/or subsequent transferee) in connection with the conception, implementation and/or administration of the Program, including, without limitation, any and all payments made to Rochdale, directly or indirectly, pursuant to that certain "Management Services Agreement," dated as of February 20, 2009 between the CUSO and

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Rochdale; (i) avoid and recover any other obligations that the Debtors' former management caused the Debtors to incur and/or transfers that the Debtors' former management caused the Debtors to make to any of the CUSO Parties, directly or indirectly (as initial and/or subsequent transferees), in connection with the Program, including, without limitation, all membership fees that the Debtors paid to one or more of the CUSO Parties, directly or indirectly (as initial and/or subsequent transferees) on behalf of ITT's students; and (b) recover all damages allegedly sustained by the Debtors by reason of the CUSO Parties' aiding and abetting of the Debtors' former management's breaches of fiduciary duty and/or fraud in connection with the conception, implementation and continuation of the Program that contributed to the Debtors' closure and bankruptcy, including any liability the Debtors may have on account of the massive amount of student loans for which the U.S. Department of Education, the Debtors' former students or others are seeking, or may seek, to hold the Debtors liable.

23. The CUSO Parties deny any fault, wrongdoing and liability in connection with any claim alleged in the Complaint, and on May 31, 2017, moved to dismiss all counts in the Complaint as to all of the CUSO Parties [ECF 20-24] (the "Motions To Dismiss"), which Motions To Dismiss the Trustee opposed.

24. On January 3, 2018, the Trustee filed with the Bankruptcy Court, among other things, a motion seeking class certification of the Student Class, and on January 25, 2018, the Bankruptcy Court entered an order that, among other things, certified the Student Class.

25. The Trustee and the CUSO Parties have engaged in settlement discussions regarding resolution of the Parties' issues, claims and disputes, including without limitation any and all issues, claims and disputes contained in, arising out of, relating to and/or in connection with the Program, the Loans, the Program Agreements (including without limitation the RSA),

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the Collateral Account, the CUSO's Claim, all arguments, assertions and allegations in the Stay Relief Motion, the CUSO Proofs of Claim, the Complaint (including without limitation allegations of transfers), the Adversary Proceeding and the Motions To Dismiss, and all arguments, assertions and allegations made or invoked by or on behalf of the Students regarding and in connection with the Loans and the Program (the "Disputes").

26. The CUSO asserts that it has certain understandings with certain governmental entities, pursuant to which, without objection from the Trustee, (a) in accordance with procedures agreed upon by the CUSO with, and approved by, those governmental entities, (i) the CUSO will be required to discontinue the collection of all outstanding Loans (with more than a zero balance), both active and charged off, (ii) the CUSO will be required to make reasonable efforts to return, to reverse or otherwise effectively to reject any payment on the Loans that it may receive after the date of such discontinuance, and (iii) the consumer reporting agencies to which the CUSO and the servicer of those Loans have reported information about those Loans will be directed to delete the consumer trade lines associated with those Loans (the "Credit Report Deletions"), and (b) the CUSO will apply to the Internal Revenue Service (the "IRS") for a ruling or other guidance, for all CUSO Borrowers of Loans as to which collection will be discontinued, to the effect that the CUSO is not required to issue Form 1099's to those CUSO Borrowers (the "IRS Ruling").

27. The CUSO and the Trustee have agreed that $127,844,857 (which constitutes a 15% reduction of the adjusted amount claimed by the CUSO) is a fair and reasonable amount to be allowed as a general unsecured claim in resolution of the CUSO's Claim, accounting for the facts and circumstances (including without limitation the amounts owed by ITT to, and the amounts collected by, the CUSO) both before and after the Petition Date.

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