A “third-party release” in bankruptcy refers to a release that is given to a non-debtor party by other non-debtors – like creditors.  Third-party release issues typically arise in the context of chapter 11 plan negotiations (which is essentially a contract between a debtor and its creditor constituents setting out the treatment of a debtor’s obligations for each class of its creditors and interest holders).

The purpose of granting non-debtor releases is typically to stop post-confirmation claims from being asserted against the released parties and the releases typically address claims that could arise in the post-petition period, through and including confirmation of a plan.

Under the Bankruptcy Code, a primary benefit afforded a chapter 11 debtor is the discharge that is obtained upon confirmation of a plan of pre-confirmation debt.  See 11 U.S.C. § 1141(d)(1).  In certain situations, however, a debtor may seek to extend releases to cover non-debtor parties, such as current or former directors and/or officers, lenders, parent companies, subsidiaries/affiliates, guarantors or other parties who might otherwise be able to assert post-confirmation indemnification claims against a debtor.

A split has emerged among various circuits as to the permissibility of non-consensual third-party releases.  The Third Circuit has adopted what is seen as the majority view, finding that non-consensual third-party releases are permitted in certain circumstances (joining the Fourth, Sixth, Seventh and Eleventh Circuits), relying on equitable powers granted to Courts under Section 105(a) of the Bankruptcy Code.[1]  In contrast, what is seen as the minority view, finding that non-consensual third-party releases are typically per se impermissible except where expressly authorized in the Bankruptcy Code, relies on the concept that general powers set forth in Section 105 of the Bankruptcy Code cannot supersede specific limitations set forth in Section 524 of the Bankruptcy Code.[2]

Some courts, like several in the Second Circuit, have characterized non-consensual releases as permissible but only in “rare cases.”  See, e.g., In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141-43 (2d Cir. 2005).  Courts that may approve non-consensual third-party releases engage in a highly intensive fact inquiry as to the propriety of the releases.  Whether a non-consensual third-party release will be approved often depends not only on what jurisdiction you are in, but on the facts of each case, including who is being released, the nature and extent of the claims, the creditors who are being asked to release claims, and the amount of the claims relative to recoveries.

Several courts, including those in the Third Circuit, have weighed the following factors in determining whether to grant or deny a non-consensual third-party release including:

i. lack of consideration given in exchange for the release;

ii. lack of evidence that reorganization’s success was related to the release in question;

iii. lack of financial contribution to plan by directors and officers to be released;

iv. evidence that plan would be feasible without the release;

v. lack of evidence of an eventual litigation if the release was not granted (if eventual litigation was likely, might otherwise justify the release); and

vi. lack of “identity of interest” between debtors (on the one hand) and directors and officers (on the other) to justify the release.

See Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 214 (3d Cir. 2000).

Courts in and out of the Third Circuit have also recently used a variation of the Continental factors in evaluating proposed non-consensual releases, including whether:

i. the released party made an important contribution to the reorganization;

ii. the release was essential to confirmation of the plan;

iii. a large majority of the creditors in the case approved the plan;

iv. whether there was a close connection between the case against the third-party and the debtor; and

v. the plan provided for the payment of substantially all of the affected claims.

See, e.g., In re Lower Bucks Hosp., 488 B.R. 303, 323 (E.D. Pa. 2013) (citing In re South Canaan Cellular Invs., Inc., 427 B.R. 44, 72 (Bankr. E.D. Pa. 2010)

In the chapter 11 case for Greek refueling company Aegean Marine Petroleum Network, Inc., Case No. 18-13374(MEW), Judge Michael E. Wiles was asked to approve a plan that included a sale of Aegean’s business to Mercuria Energy Group Ltd.  The plan originally proposed a non-consensual third-party release of the debtor’s current and former employees, directors and officers, as well as the purchaser, through an “opt-out” mechanism – essentially requiring creditors to affirmatively opt-out if they wished to preserve their claims (and avoid having them released).

Shortly after the plan was proposed, objections were filed by the Office of the United States Trustee and a proposed class action lead plaintiff.  In February 2019, as part of Court’s approval of the adequacy of the disclosure statement and proposed balloting forms, the Court required the debtors to modify their proposed ballot such that a third-party was required to “opt-in” to the release to waive its claims, rather than to “opt-out” and have to tick a box to preserve its claim.  See Docket No. 385.  Certain additional claims were also explicitly carved out from the releases – such as securities’ class action claims and other identified litigation claims. While the debtors agreed to the modification, they reserved the right in the plan to impose non-consensual releases on creditors and shareholders.

Confirmation of the plan with the proposed non-consensual releases was opposed by the UST as well as the Securities and Exchange Commission, which detailed the prior investigation into the debtors’ SEC filings and the numerous class action lawsuits.  Briefing followed, including by the debtors detailing why they believed the proposed releases were limited in scope and time, including as to parties who first became involved as new management (or as the purchaser in the case), all characterized as being unrelated to the prior alleged bad conduct.

The Court ultimately confirmed the Plan by an Order entered on March 29, 2019, but stripped the proposed non-consensual releases and the Debtors’ reservation, detailing the reasoning for such findings in a Bench Decision, entered on April 8, 2019 (and as modified by the Errata Order on April 12, 2019).  See In re Aegean Marine Petroleum Network Inc., — B.R. –, 2019 WL 1527968 (Bankr. S.D.N.Y. Apr. 8, 2019).

The Court, in denying the non-consensual third-party releases, posited that such releases should be treated as extraordinary.  Judge Wiles’ analysis began by finding that the Court lacked in rem jurisdiction to determine anything regarding the third-party claims, noting that such claims are property of third parties, not the estate.

Some courts have found that subject matter jurisdiction exists to consider and approve confirmation of plans with non-consensual third-party releases by reason of the releases coming up in the context of confirmation (meeting the necessary tests for “arising under” and “arising in” subject matter jurisdiction (see 28 U.S.C. § 157(b)(2)(L)), as well as finding related to jurisdiction in 28 U.S.C. § 1334)).

In contrast, the Court in Aegean found that subject matter jurisdiction (even if derived from Sections 157 and 1334) is insufficient to allow the court to exercise its power over potential claims – when no claim exists.  The Court further posited that it lacked the power to determine a third-party’s claims because there was inadequate due process or notice to a creditor about the potential release.  The court contrasted the required formal service of process when an adversary proceeding is initiated – like to recover a money judgment – versus the lack of formal service of process for a non-consensual release of a claim.

The Court expressed its general discontent with plans containing broad releases that lacked detail as to why the release of specific claims is integral to the reorganization and the utility of “contribution efforts” to explain why releases should be granted.  The Court stated plainly its belief that “third-party releases are not a merit badge that somebody gets in return for making a positive contribution to a restructuring.  They are not a participation trophy, and they are not a gold star for doing a good job.”  Aegean, *7.   The Court, in relying on Metromedia stated that “[n]on-consensual releases are not supposed to be granted unless barring a particular claim is important in order to accomplish a particular feature of the restructuring.”  Id.  The Court reasoned that since there were no specifically articulated claims or claimants against whom the releases were intended to be enforced, it could not approve the requested broad releases.

The Court also rejected the assertion that releases are otherwise earned because the directors perform under difficult circumstances.  The Court articulated that such claims sounded like a bonus should have been requested, but instead of the debtors paying that bonus, the “bonus” is essentially being assessed on yet to be identified third-parties, including some that might be shareholders.

The Circuit split amongst the Courts was previously categorized as the “majority” – where courts permit non-consensual releases in certain circumstances versus the “minority” that have a per se bar against such findings.  The Aegean decision is an example of a court within the Second Circuit, which typically is categorized as being among the “majority” courts, as nonetheless finding that such releases are impermissible and highlighting at least in the Court’s view that such releases should be the rarity and the exception, not the rule.  The Court’s reasoning appears to draw from some of the same reasoning that the minority courts rely upon in finding that they are unable to grant non-consensual releases.  While the Court in Aegean rejected the requested broad non-consensual third-party releases, it is possible that other courts in the “majority” Circuits may have decided the same issues differently.

Non-consensual releases were also just addressed on May 29, 2019, when Judge Thomas Saladino denied confirmation of a proposed plan in the Shopko bankruptcy cases (In re Specialty Retail Shops Holding Corp., et al., Case No. 19-80064(TLS)), pending in the District of Nebraska.  The basis for his denial was due to the plan’s expansive non-consensual third-party releases, hinting that the other non-fatal issues could be overcome if the release issue was addressed.  On May 31st, the debtors filed an amended plan that appears to have removed or otherwise modified the targeted broad releases.

Stay tuned for more on non-consensual releases…

[1] Section 105 of the Bankruptcy Code grants broad, equitable powers to empower courts to “issue any order, process or judgment that is necessary or appropriate to carry out the provisions of this title.”  11 U.S.C. § 105(a).

[2] The Bankruptcy Code only expressly authorizes third-party releases under Section 524(g), which addresses the permissibility and requirements to obtain a so-called “channeling injunction.”  See 11 U.S.C. § 524(g).  Section 524(e) of the Bankruptcy Code provides that the “discharge of a debt of a debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”  11 U.S.C. § 524(e).