                                                                                                                           Opinions of the United
2007 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


3-20-2007

In re: Insilco Tech
Precedential or Non-Precedential: Precedential

Docket No. 06-2162




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http://digitalcommons.law.villanova.edu/thirdcircuit_2007/1381


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                                     PRECEDENTIAL

   UNITED STATES COURT OF APPEALS
        FOR THE THIRD CIRCUIT


                  No. 06-2162



IN RE: INSILCO TECHNOLOGIES, INC., ET AL.,

                                   Debtors


  CHAD SHANDLER, as Trustee to the Insilco
           Liquidating Trust,

                                   Appellant



   Appeal from the United States District Court
            for the District of Delaware
      (D.C. Civil Action No. 04-cv-01567)
   District Judge: Honorable Gregory M. Sleet


             Argued March 6, 2007
      Before: SLOVITER and AMBRO, Circuit Judges
               THOMPSON,* District Judge

               (Opinion filed March 20, 2007)

Michael R. Lastowski, Esquire
Richard W. Riley, Esquire
Duane Morris LLP
1100 North Market Street, Suite 1200
Wilmington, DE 19801

Andrew I. Silfen, Esquire (Argued)
Michael S. Cryan, Esquire
Heike M. Vogel, Esquire
Arent Fox PLLC
1675 Broadway
New York, NY 10019

      Counsel for Appellant

Karen E. Wagner, Esquire (Argued)
James I. McClammy, Esquire
Davis, Polk & Wardwell
450 Lexington Avenue
New York, NY 10017

Neil B. Glassman, Esquire
Charlene D. Davis, Esquire


  *
   Honorable Anne E. Thompson, Senior United States District
Judge for the District of New Jersey, sitting by designation.

                              2
The Bayard Firm
222 Delaware Avenue, 9th Floor
Wilmington, DE 19801

       Counsel for Appellee


                  OPINION OF THE COURT


AMBRO, Circuit Judge

       This appeal arises out of the claim allowance process in
a Chapter 11 bankruptcy liquidation.1               Specifically, a
liquidating trustee appeals an order dismissing his objections to
a proof of claim. It is common practice in bankruptcy cases for
parties-in-interest to attack the validity and priority of the claims
of creditors higher in the pecking order than they. Two of the


        1
           While we typically think of Chapter 11 as the
“reorganization” section of the Bankruptcy Code (as opposed to
Chapter 7, the “liquidation” section), it is not uncommon for
debtors to use the Chapter 11 process to liquidate. This is
because Chapter 11 provides more flexibility and control in
determining how to go about selling off the various aspects of
the debtor’s business and distributing the proceeds. A typical
mechanism for effecting a Chapter 11 liquidation is the creation
of a “liquidating trust”—a state-law trust managed by a group of
creditors that succeeds to the debtor’s assets and administers the
liquidation and distribution process.

                                 3
most common attacks are “recharacterization” (seeking to treat
an asserted debt as an equity interest) and “equitable
subordination” (seeking to subordinate a claim’s priority
because of inequitable conduct). These actions, while often
asserted in tandem, are distinct. Here, the Trustee asserted both,
but the Bankruptcy and District Courts ruled that he is barred
from asserting them by the terms of a previous settlement that
the Court entered as a consent order (the “Settlement
Agreement”) and the confirmed plan of reorganization (the
“Plan”).

      While we take a slightly different view of the Settlement
Agreement than the Bankruptcy and District Courts, we
nonetheless affirm.

I.       Facts & Procedural History

       The debtors are Insilco Technologies, Inc. and its
subsidiaries (“Insilco” or the “Debtors”), an erstwhile
manufacturing enterprise and victim of a seemingly ill-advised
leveraged buyout (“LBO”).2 Chad Shandler is Trustee of the


     2
       In an LBO, the buyers use the target corporation’s own
money to pay the previous owners. Typically, the transaction
requires the target corporation to incur secured debt to acquire
the cash to pay to the sellers. Problems occur when the target
corporation incurs more debt than it can service, thus rendering
it insolvent. More than a little bankruptcy litigation stems from
these sorts of transactions. In Mellon Bank, N.A. v. Metro

                                4
Insilco Liquidating Trust (the “Trust”), an entity created by
Insilco’s creditors that succeeded to all of Insilco’s assets on
confirmation of its Plan. The Trust exists to sell Insilco’s assets
and distribute the proceeds in accordance with the Plan. As the
successor of both Insilco and the Official Committee of
Unsecured Creditors (the “Creditors’ Committee”), the Trust
may assert either entity’s causes of action.

       The Term C Lenders are a group of limited partnerships
managed by DLJ Merchant Banking Partners II (“DLJ;” thus,
the Term C Lenders are known interchangeably as the “DLJ
Group”). In 1998, the DLJ Group gained control of Insilco
through an LBO. According to the Trustee, the buyout was too
leveraged; it, in conjunction with an overly aggressive program
of buying and selling subsidiaries, rendered Insilco unable to
service the debt it incurred. By 2001, Insilco was in serious
financial distress, and the DLJ Group loaned the company an
unsecured $15 million. Known as the “Term C Loans,” these
debts were added to Insilco’s omnibus credit facility with the
consent of its secured lenders.

       Despite the loans, Insilco’s financial situation continued
to deteriorate. In December 2002, it petitioned for Chapter 11
relief. Only three months later, the Creditors’ Committee


Communications, Inc., 945 F.2d 635 (3d Cir. 1991), we noted
that LBO transactions can spawn fraudulent conveyance liability
and described how this works in more detail at pages 645–46 of
that opinion.

                                5
moved for the appointment of a trustee.3 The parties resolved
that motion through the Settlement Agreement, in which the
secured creditors agreed to contribute money to the Trust for
payment of the unsecured creditors’ claims in return for a full
release from the unsecured creditors’ challenges to their claims.
In addition, by agreeing to the creation of a liquidating trust
controlled by the creditors, the Debtors’ management (then
acting as debtors in possession) effectively agreed to cede
control over the bankruptcy estate.

        Following approval of the Settlement Agreement, Insilco
filed the Plan. It divides Insilco’s creditors into seven classes4


   3
     Unlike in Chapter 7 proceedings, an outside trustee is not
typically appointed in Chapter 11 proceedings. Rather, the
default rule is that the debtor remains in control of the
bankruptcy estate and operates its business as “debtor in
possession.” When acting as debtor in possession, the debtor is
bound by all of the fiduciary duties of a bankruptcy trustee. The
Bankruptcy Court oversees the reorganization process and may
appoint an outside trustee if it finds that doing so is in the best
interest of the parties and the estate. See 11 U.S.C.
§ 1104(a)(2); In re Marvel Entm’t Group, Inc., 140 F.3d 463,
474 (3d Cir. 1998).
       4
        Equity holders are an eighth class in the Plan, but it
provides for the cancellation of equity interests upon
confirmation of the Plan. Thus, equity holders were not entitled
to vote on the Plan, 11 U.S.C. § 1126(g) (providing that any
class that receives no recovery is deemed to reject a plan), and,

                                6
and provides for the distribution of proceeds from the sale of
Insilco’s assets to each class. The Plan “impaired”5 the claims
of four classes of creditors: (1) general unsecured creditors, (2)
senior discount noteholders, (3) senior subordinated noteholders,
and (4) the Term C Lenders. All four classes of impaired
creditors voted to approve the Plan, and the Bankruptcy Court
confirmed it over the deemed rejection of the equity holders.

       In order to recover against a bankruptcy estate, creditors
typically must file proofs of claims.6 See Pioneer Inv. Servs.
Co. v. Brunswick Assoc. Ltd. P’ship, 507 U.S. 380, 383 (1993).
Similarly, equity holders file proofs of interests. See 11 U.S.C.


as is typically the case with insolvent debtors, the Plan was
approved over their deemed objection, see 11 U.S.C.
§ 1129(b)(1) (allowing confirmation of a plan over the objection
of classes of claims and interests).
        5
         Under the Bankruptcy Code, creditors’ claims are
“impaired” if the plan of reorganization does not provide those
creditors with full recovery. 11 U.S.C. § 1124. Classes of
creditors whose claims are impaired in Chapter 11 are entitled
to vote whether to accept the plan. 11 U.S.C. § 1126(a) & (f).
    6
     An exception is that if a creditor’s claim is listed on the
debtor’s schedule of assets and liabilities and is not listed as
disputed, contingent, or unliquidated, then filing a proof of
claim is not required. See Fed. R. Bankr. P. 3003(c)(2). Even
those creditors, however, are entitled to (and often do) file a
proof of claim. Fed. R. Bankr. P. 3003(c)(1).

                                7
§ 501 (distinguishing between claims and interests). The Term
C Lenders filed proofs of claims for a total of $22,221,128.07 in
principal and pre-petition interest due under the Term C Loans.
The Trustee timely filed an objection to those claims, arguing
that they should be recharacterized as equity investments and, if
not, they should be subordinated to all other claims. The
Bankruptcy and District Courts ruled that section 4C of the
Settlement Agreement precluded the Trustee from bringing both
actions, and he now appeals to us.7

II.    Discussion

       A.     The Settlement Agreement and Plan

        This dispute centers on the meaning of two sections of
the Settlement Agreement. Its essential bargain is the unsecured
creditors’ agreement not to seek the appointment of a trustee to
administer the estate or to challenge the validity, perfection, or
priority of the secured creditors’ claims in return for the secured
creditors’ agreement to remit some of their recovery to the
unsecured creditors and to waive any rights to pursue deficiency
claims. The Term C Lenders did not participate in the
Settlement Agreement as such (though their interests likely were
represented by Insilco, as it was still controlled by the DLJ

  7
    We have jurisdiction to review the final order of the District
Court under 28 U.S.C. §§ 158(d)(1) and 1291. We review the
construction of consent orders de novo. Holland v. N.J. Dep’t
of Corr., 246 F.3d 267, 277 (3d Cir. 2001).

                                8
Group at that time).

         In section 1 of the Settlement Agreement, the Debtors
and unsecured creditors agreed that “[t]he Senior Lenders’ . . .
claims against the Debtors . . . are fully and finally allowed in
the amount of $254,933,571.49.” Footnote 1 of the Settlement
Agreement stipulates that the Term C Lenders are included as
“Senior Lenders” for purposes of section 1. Hence, it was
agreed that the Term C Lenders could assert allowable claims
against the estate. In the Bankruptcy Code, “claim” is a term of
art. It is defined as a “right to payment” or “right to an equitable
remedy.” 11 U.S.C. § 101(5). Similarly, “allowed” is a term of
art, referring to the Bankruptcy Court’s determination that a
claim is valid and in line for distribution. See 11 U.S.C. § 502.
The concept of an “allowed claim” lies at the heart of the
bankruptcy process, for only those who possess allowed claims
are entitled to distribution from the bankruptcy estate. In re
Johns, 37 F.3d 1021, 1023 n.1 (3d Cir. 1994) (“An ‘allowed
claim’ is one that will serve as the basis for distribution.”).

       In section 4 of the Settlement Agreement, the Debtors
and the Creditors’ Committee released the Senior Lenders8 and
Term C Lenders from liability on a variety of actions. The
releases are worded as follows:

   8
     In a rather confusing act of contract construction, the term
“Senior Lenders” includes the Term C Lenders in section 1 of
the Settlement Agreement only. Yet, in section 4 the two groups
are treated separately.

                                 9
         A. Release by the Debtors and Creditors’
Committee—The Debtors and the Creditors’
Committee, on behalf of themselves and the
estates of the Debtors . . . (the “Releasing Estate
Parties”), hereby fully waive, release, and forever
discharge the . . . Senior Lenders . . . (“Released
Lender Parties”) from any and all manner of
actions, causes of action, in law or in equity, suits,
debts, liens, contracts, agreements, promises,
liabilities, claims, damages, losses, controversies,
trespasses, remedies, defenses, set-offs,
surcharges, costs or expenses of any nature
whatsoever, known or unknown, fixed or
contingent, which the Releasing Estate Parties
have had, now have, or may hereafter have
against the Released Lender Parties, by reason of
any matter, cause or thing whatsoever, from the
beginning of time through and to the Settlement
Effective Date; provided however, that nothing in
this Paragraph 4A releases any Parties’
obligations or agreements pursuant to this
Settlement Agreement, or bars claims directed
solely at enforcing the provisions of this
Settlement Agreement.

       ....

      C. Limitation on Release of Term C
Lenders—The releases and waivers contained in

                         10
       Paragraph 4A of this Settlement Agreement for
       the benefit of the Released Lender Parties shall
       also apply to the Term C Lenders . . . only in
       respect of the Term C Loans under the Credit
       Agreement (as defined therein) and
       notwithstanding anything herein to the contrary,
       the Term C Lenders . . . shall not otherwise be
       released or deemed released. Nothing contained
       herein shall be deemed to discharge, impair, or
       otherwise affect any claim, action, cause of action
       or right against the Term C Lenders . . . except as
       specifically set forth in the preceding sentence,
       provided however, that the reservation of non-
       released claims, causes of action or rights in this
       Paragraph shall not extend to the Released Lender
       Parties.

Boiled down, the Debtors and Creditors’ Committee released the
Senior Lenders from all manner of actions, while they released
the Term C Lenders only from actions “in respect of the Term
C Loans.”

       On the surface, the “in respect of” language in section 4C
seems to preclude any objection to allowing and paying a claim
based on the Term C Loans. It is puzzling, though, because the
Plan expressly contemplates the Debtors or Creditors’
Committee filing an objection to that claim. Section 4.8 of the
Plan, which defines a class of claims as the “Claims of the Term
C Lenders under the Term C Loans” and provides for the

                               11
treatment of those claims, prefaces its treatment of the Term C
Lenders’ claims under the Term C Loans with “[u]nless the
Debtors (or the Creditors’ Committee on behalf of the Debtors)
. . . have commenced an adversary proceeding or contested
matter prior to the Confirmation Date seeking to subordinate or
reclassify the [claims under the Term C Loans] . . . .” From this
it appears that the Plan drafters (a group quite similar to the
Settlement Agreement drafters) did not believe that objections
to the Term C Claims were barred if filed by the Debtors or
Creditors’ Committee. On the other hand, the Plan adopts and
subordinates itself to the Settlement Agreement; anything in it
that conflicts with the Settlement Agreement bows to the latter.
The Bankruptcy Court’s order confirming the Plan reiterates
this.

       B.     The Recharacterization Action

       Our task is to determine whether the Trustee’s actions for
recharacterization and equitable subordination are precluded by
the Settlement Agreement. We analyze these actions separately,
as they are distinct. Cohen v. KB Mezzanine Fund, II, LP (In re
SubMicron Sys. Corp.), 432 F.3d 448, 454 (3d Cir. 2005).

       In a recharacterization action, someone challenges the
assertion of a debt against the bankruptcy estate on the ground
that the “loaned” capital was actually an equity investment.
Bayer Corp. v. Massotech, Inc. (In re AutoStylePlastics, Inc.),
269 F.3d 726, 749 (6th Cir. 2001). Because only parties that
hold “right[s] to payment” against the estate hold valid

                               12
bankruptcy claims, 11 U.S.C. § 101(5)(a), the assertion that a
would-be debt should be treated as an equity investment
challenges the debt’s status as a claim. In re AutoStyle Plastics,
269 F.3d at 749. In the Bankruptcy Code, the distinction
between creditors (who hold “claims” against the estate) and
equity investors (who hold “interests” in the estate) is important,
for holders of claims receive much more favorable treatment
than holders of interests.9 Equity investment brings not a right
to payment, but a share of ownership in the debtor’s assets—a



     9
      As the Bankruptcy Court for the Western District of
Tennessee has explained:

      Creditors present their claims to the court by
      filing a proof of claim, whereas equity security
      holders assert their rights to distribution of the
      proceeds of a solvent corporate debtor by filing a
      proof of interest. While the filing of a proof of
      claim triggers the process of allowance and
      disallowance of claims and prompts the
      restructuring of the debtor-creditor relationship,
      the filing of a proof of interest, which applies only
      in Chapter 11 cases, is not recognized in the
      claims process and becomes significant only
      when the remaining assets of the solvent
      corporate debtor are being distributed to
      shareholders.
Crocker v. Namer (In re AVN Corp.), 235 B.R. 417, 423 (Bankr.
W.D. Tenn. 1999).

                                13
share that is subject to all of the debtor’s payment obligations.10
Thus, if a filed claim is rejected on the ground that it is not a
claim at all, but an interest, then the holder of that interest is
relegated to the end of the line, where any recovery is unlikely.

        Because a recharacterization action implicates the
validity of the underlying claim, it is not section 4C of the
Settlement Agreement (as the Bankruptcy and District Courts
ruled), but section 1 that precludes the Trustee from bringing it
against the Term C Lenders. In section 1, the Debtors and
Creditors’ Committee conceded that the debts owed to the Term
C Lenders are allowable claims. Their loans cannot be both
allowable claims and equity investments; to repeat, the latter (an
interest) is not a claim at all. By agreeing that the Term C
Loans are an allowable claims, the Debtors and Creditors’
Committee necessarily agreed that the Term C Loans were true
loans. Thus, under section 1 of the Settlement Agreement, the


   10
      Even in the flexible world of Chapter 11 reorganizations,
the absolute priority rule, 11 U.S.C. § 1129(b)(2)(B), requires
that equity holders receive nothing unless all creditors are paid
in full. As the Supreme Court noted in Bank of Am. Nat’l Tr. &
Sav. Ass’n v. North LaSalle St. P’ship, 526 U.S. 434 (1999), this
is a long-standing principle of insolvency law. Id. at 444
(acknowledging “the pre-Code judicial response known as the
absolute priority rule, that fairness and equity required that ‘the
creditors . . . be paid before the stockholders could retain [equity
interests] for any purpose whatever.’”) (quoting Northern Pac.
R.R. Co. v. Boyd, 228 U.S. 482, 508 (1913)).

                                14
action of the Trustee (as successor to the Debtor and Creditors’
Committee) for recharacterization is barred.

       C.     The Equitable Subordination Claim

        Equitable subordination here is slightly more
complicated. An action for equitable subordination does not
challenge the existence or validity of the underlying debt.
Rather, it challenges granting the debt the priority to which it is
entitled under applicable law because of the creditor’s
inequitable conduct. In re SubMicron Sys., 432 F.3d at 454
(“Equitable subordination is apt when equity demands that the
payment priority of claims of an otherwise legitimate creditor be
changed to fall behind those of other claimants.”). Thus, it is an
action in equity to modify the legal treatment of the claim.
Because equitable subordination does not affect the allowance
of a claim,11 the action is not barred by section 1 of the
Settlement Agreement.

       Turning, then, to section 4C, we must determine what
sorts of actions are “in respect of” the Term C Loans, and
neither party provides a particularly compelling interpretation.

  11
      Indeed, there would be no point in equitably subordinating
anything but an allowed claim, as only allowed claims are
entitled to distribution from an insolvent debtor’s estate in the
first place. See Citicorp Real Estate, Inc. v. PWA, Inc. (In re
Georgetown Bldg. Assocs. Ltd. P’ship), 240 B.R. 124, 137
(Bankr. D.D.C. 1999).

                                15
According to the Trustee, the release provision merely means
that the Trust cannot challenge the allowance of the Term C
Lenders’ claims. The problem with this argument is that section
1 of the Settlement Agreement provides for the allowance of the
Term C Lenders’ claims; thus, the Trustee’s reading renders
paragraph 4C superfluous, which is disfavored under New York
law.12 LaSalle Bank Nat’l Ass’n v. Nomura Asset Capital Corp.,
424 F.3d 195, 206 (2d Cir. 2005).

       The Term C Lenders, on the other hand, are far more coy
in explaining the meaning of paragraph 4C. They contend that
a claim to subordinate equitably the debts to the Term C
Lenders is clearly “in respect of” the Term C Loans, and so the
release applies. Moreover, they note that any claim unrelated to
the Term C Loans would not be released—though they do not
elaborate as to what such a claim might be.

       We believe the best reading of section 4C is that the
section 4A release applies to all actions that relate to the Term
C Loans, as “in respect of” means “as relates to.” Oxford
English Dictionary 534 (1st ed. 1971). The question, then, is
whether the equitable subordination action relates to the Term
C Loans. It does, as it seeks to modify the treatment of the
allowed claims that arise from the Term C Loans. The Trustee
argues that the objections do not relate to the loans themselves


  12
    The Settlement Agreement and Plan contain choice-of-law
provisions selecting New York law.

                               16
but focus on the allegedly inequitable conduct of the Term C
Lenders. This is unhelpful, as the Bankruptcy Court is not
empowered to punish inequitable conduct in the abstract; rather,
it allows equitable concerns to modify its treatment of claims.
See 11 U.S.C. § 510(c)(1) (“[U]nder principles of equitable
subordination, [a bankruptcy court may] subordinate for
purposes of distribution all or part of an allowed claim to all or
part of another allowed claim . . . .”). Without an underlying
claim, equitable subordination is a non-starter. The argument
that the Bankruptcy Court should apply equitable subordination
necessarily relates to the underlying claims on the Term C
Loans and is subject to the 4C release.

       The Trustee claims that this reading renders the Term C
release limitless (because it releases all claims that might
actually exist), and thus cannot be correct given that the section
heading specifically indicates that the Term C release is limited.
Contrary to his assertions, we can imagine claims against the
Term C Lenders that are not related to the Term C Loans. The
Term C Lenders were, after all, the Debtors’ controlling
shareholders. Their conduct in controlling and managing the
Debtors—quite apart from the Term C Loans
themselves—could give rise to liability to the Debtors.13 This

   13
     We note that the debtors here are Delaware corporations.
Without getting into the details, the controlling shareholders of
a Delaware corporation can owe the entity fiduciary
duties—thus giving rise to claims for breaches of those duties.
See Weinstein Enter., Inc. v. Orloff, 870 A.2d 499, 507 (Del.

                               17
liability would presumably inure to the benefit of either the
creditors or any minority equity stakeholders. Thus, the
Trustee’s argument that the Term C Lenders’ liability could
only reasonably arise from the Term C Loans is incorrect, as the
Term C Lenders’ primary relationship to Insilco was as equity
holders and controlling shareholders, not as lenders.

       The Trustee next argues that the Bankruptcy Court
should have avoided a conflict between the Settlement
Agreement and the Plan by construing 4C so that it does not
prevent the subordination and reclassification claims that the
Plan clearly contemplates. See Kass v. Kass, 696 N.E.2d 174,
180–81 (N.Y. 1998) (noting that contracts should be read and
construed as a whole). While it is true that the most natural
reading of the Plan and Settlement Agreement creates a conflict
between the two, the parties anticipated that conflicts might
exist and provided for them through a subordination clause in
the Plan; the Plan defers to the Settlement Agreement in the
event of conflict. Moreover, the Trustee overstates the conflict.
While the Plan contemplates the Debtors or Creditors’
Committee attempting to reclassify or subordinate the Term C


2005). We express no opinion as to the potential validity of any
such claims in this case, but merely note that a natural reading
of the contract—precluding actions on the Term C Loans but
allowing actions against the Term C Lenders in their capacity as
controlling shareholders—is not absurd, nor does it render the
“limitation” on the release of the Term C Lenders meaningless.


                               18
Loans claims, it does not explicitly authorize those attempts;
rather, it merely assumes that the attempts are permissible (and,
indeed, they are for interested parties not bound by the
Settlement Agreement). While that assumption conflicts with
the Settlement Agreement, it is not as severe a conflict as we
would have if the Settlement Agreement barred the claims while
the Plan explicitly allowed them. In any event, while we
recognize that the Plan and Settlement Agreement are not
entirely in synch, because the agreed-upon prevailing
document—the Settlement Agreement—is clear, we follow it.
John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48, 58 (2d Cir.
2001) (noting that courts applying New York law must “give
effect to the parties’ intent as expressed by the plain language of
the provision”).

       In the alternative, the Trustee suggests that, because the
language of section 4C is ambiguous, we should remand for
discovery or an evidentiary hearing to determine its meaning.
This is probably his best argument, but it cannot succeed
because the language of section 4C is clear: it bars any actions
related to the Term C Loans, and equitable subordination is
necessarily related to the loans. No reasonable construction of
the phrase “in respect of” would render a different result.

       None of this is to say that the Trustee is left without
recourse against the Term C Lenders. The 4C release is limited:
it does not prevent him from bringing any claims against the
Term C Lenders that do not relate to the Term C Loans.


                                19
                        * * * * *

       Because the Settlement Agreement prevents the Trustee
from bringing recharacterization and equitable subordination
actions against the Term C Lenders, we affirm the District
Court’s order dismissing his objections to the Term C Lenders’
claims.




                             20
