This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece). In our prior ABI Commission post, we covered the Commission’s recommendations regarding “Exculpatory Clauses” in plans. In this post, we’ll cover the Commission’s recommendations regarding “Third-Party Releases” in Section E.3 of the Report. Third-party releases often go hand-in-hand, and are grouped close together, with exculpatory clauses in plans. However, they’re far more unsettled and controversial. The Commission attempts to sort out that controversy.

Although third-party releases (“TPRs”) appear in plans in all shapes and sizes, they usually release a non-debtor from claims or causes of action that a third-party may have against the non-debtor. For example, in SE Property Holdings, LLC v. Seaside Engineering & Surveying, Inc., a recent 11th Circuit case, the TPR at issue provided as follows:

[N]one of the Debtor, . . . Reorganized Debtor, Gulf Atlantic . . . (and any officer or directors or members of the aforementioned [entities]) and any of their respective Representatives (the “Releasees”) shall have or incur any liability to any Holder of a Claim against or Interest in Debtor, or any other party-in-interest . . . for any act, omission, transaction or other occurrence in connection with, relating to, or arising out of the Chapter 11 Case, the pursuit of confirmation of the Amended Plan as modified by the Technical Amendment, or the consummation of the Amended Plan as modified by this Technical Amendment, except and solely to the extent such liability is based on fraud, gross negligence or willful misconduct.”

The issue that courts have struggled with is whether TPRs are permitted under the Bankruptcy Code. A discussion of whether they’re permitted usually starts with the bankruptcy discharge. As the Commission reminds us, under Section 1141(d)(1)(A) of the Code, a confirmed Chapter 11 plan “discharges the debtor from any debt that arose before” confirmation. Section 524(a) and Section 524(e) operate together to provide that, whereas the discharge voids judgments, collection actions, and the like relating to debts discharged under a plan, the debtor’s discharge does not extend to a non-debtor or its property. Inevitably, then, TPRs collide with Section 524.

Some courts reject TPRs under Section 524(e) while recognizing a limited statutory exception for asbestos trust claimants. Others permit TPRs on some basis or the other, including Section 105(a) of the Code. In short, there’s an established Circuit split. Seaside, which this 11th Circuit-located blog is long overdue in covering, describes the split this way (with Seaside reaffirming that the 11th Circuit takes the majority view):

  • “Pro-Release” Circuits (Majority View): 2nd, 3rd, 4th, 6th, 7th, 11th (and likely the 1st and D.C.) Circuits
  • “Anti-Release” Circuits (Minority View): 5th, 9th, and 10th Circuits

On the one hand, the minority view Circuits read Section 524(e) as strictly prohibiting TPRs. The Commission quotes the 9th Circuit’s In re Lowenschuss case, for example: This court has repeatedly held, without exception, that § 524(e) precludes bankruptcy courts from discharging the liabilities of nondebtors.” On the other hand, the majority view courts emphasize the lack of prohibitory language in Section 524(e) and then focus on overused Section 105(a), which authorizes a court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code].” The majority view courts will approve TPRs “under appropriate circumstances” based on some version of a fact-intensive factors test.  For example, in Seaside, the 11th Circuit confirmed in March that it focuses on the 6th Circuit’s “Dow Corning” factors: 

  1. Identity of interests between the debtor and the third party (e.g., “indemnity relationship”);
  2. Non-debtor has contributed substantial assets to the reorganization;
  3. The injunction is essential to the reorganization;
  4. There is overwhelming acceptance of the plan by the impacted class or classes;
  5. The plan provides a mechanism to pay all, or substantially all, of the impacted classes;
  6. The plan provides an opportunity for claimants who choose not to settle to recover in full;
  7. The Court makes specific factual findings that support its conclusions.

After considering whether the Code should prohibit TPRs in plans, the Commission made the following recommendations:

First, neither blanket prohibition nor carte blanche approval of TPRs is appropriate, as TPRs can be beneficial or harmful.

Second, consensual releases are outside of Section 524(e) and should be respected.

Third, courts should review non-consensual releases under W.D. Missouri’s Master Mortgage factors (esp. the bolded ones):

  1. Identity of interests between the debtor and the third party (e.g., “indemnity relationship”);
  2. Non-debtor has contributed substantial assets to the reorganization;
  3. The injunction is essential to the reorganization;
  4. There is overwhelming acceptance of the plan by the impacted class or classes;
  5. The plan provides a mechanism to pay all, or substantially all, of the claims of the impacted classes;

Notably, the Commission, without any apparent explanation, “recommended a standard based on the [5] Master Mortgage factors and rejected application of the [7] Dow Corning factors.” Unless we’re missing something, it’s a strange recommendation, as the 5 Master Mortgage factors seem to line-up perfectly with the first 5 Dow Corning factors. The 7th Dow Corning factor (findings of fact) can’t possibly be objectionable. That leaves the 6th factor: whether the “plan provides an opportunity for those claimants who choose not to settle to recover in full.” We’re scratching our heads over why the Commission might have a problem with that factor. Perhaps the Commission believes that satisfaction of the first 5 factors, particularly when the issue is whether a release can be crammed down on those who don’t want to settle, trumps satisfying the dissenters (a pro-debtor view).

Fourth, the Commission rejected “separate identification of unique or unusual circumstances” as a factor. 

Frankly, other than answering the threshold question of whether third-party releases should be prohibited, per se, there wasn’t much that the Commission could add in this area, as factor tests dominate the landscape. Factor tests are like that–they soften the contours of a bankruptcy issue, excuse courts from handing down strict catechisms on tough issues, and simply articulate the “best interests” standard for a discrete issue. Suits us.

In our next post, as we head into the final stretch of the Commission’s “Exiting the Case” piece, we’ll begin tackling the Commission’s recommendations on “Plan Voting and Confirmation Issues.”

Also, if you missed it, we did a 2-part series on the Supreme Court’s Bullard v. Blue Hills Bank case from earlier this week (regarding the finality of orders denying confirmation): Part 1 and Part 2.