The use of third-party releases in Chapter 11 has become more permissible in recent years, and, because it is such a potent tool, the exact contours and limits of these releases have been hotly debated. We first blogged about third-party releases last year in our series on the confirmation-related recommendations in the ABI Commission Report. As a part of that post, we covered the Eleventh Circuit’s Seaside opinion regarding third-party releases. As a follow-up, we’ll now review last month’s HWA Properties, Inc. opinion out of the Middle District of Florida. HWA, which applies Seaside, provides a good illustration of the limits of the third-party releases.
HWA Properties, Inc., represented by our friends at Stichter, Riedel, Blain & Postler, P.A., filed its Chapter 11 case in the Middle District of Florida. HWA was a corporation owned by real estate developers, Mr. and Ms. Albright, who also owned or controlled numerous other real estate entities. Shortly before filing, HWA owned 13 undeveloped lots and 5 acres of vacant land in Florida and vacant land in Michigan. HWA had transferred several of the lots prior to bankruptcy. Some creditors asserted in the bankruptcy case that the transfer was, under § 548, an avoidable fraudulent transfer.
The Debtor and the Albrights negotiated a global settlement with their creditors. Consenting creditors included BB&T, FineMark National Bank & Trust, Least, LLC, FMIRE, Inc., and BCB Tarpon, LLC. Under the settlement, each of those creditors was to release HWA, the Albrights, and their other entities in exchange for cash or for the land owned by HWA prior to the transfers.
The global settlement required, as a condition precedent to its enforceability, that the bankruptcy court enter a bar order barring all claims against BCB Tarpon (the recipient of all shares of HWA under the plan), the Albrights, and their entities “that relate in any way to the Debtor.” The settlement did not include the Davis Group, which held the senior mortgage on four of the lots that the debtor transferred before filing. Under its plan, HWA proposed to restructure the mortgage by lowering the interest rate from 12% to 6% and extending the maturity rate from July 2016 to fifteen years after confirmation. The global settlement also did not include Community & Southern Bank. Although not one of HWA’s creditors, C&S held a $1,912,000 judgment against Mr. Albright.
The United States Trustee, the Davis Group, and C&S objected to the bar order. They contended that the proposed release and bar order (as well as the Plan, which incorporated those provisions) could not be confirmed. The bankruptcy court agreed and denied confirmation of the plan and approval of the compromise.
Judge Delano first looked to the Eleventh Circuit’s release of non-debtors in In re Munford. In Munford, the debtor sued several defendants for breach of fiduciary duties. When one defendant offered to settle, the offer was conditioned on the bankruptcy court issuing a bar order preventing the other defendants from pursuing contribution or indemnity claims against it. The Eleventh Circuit cited three justifications for entering a bar order: (i) public policy strongly favors pretrial settlement due to the potential of a complex case to drain resources; (ii) litigation costs are particularly burdensome on the bankruptcy estate given the financial instability of the estate; and (iii) bar orders play an integral role in facilitating settlement.
Judge Delano then reviewed In re Dow Corning Corp., the seminal Sixth Circuit case that first listed seven factors for courts to consider when faced with a request to enjoin a non-consenting creditor’s claim against a non-debtor. We covered Dow Corning in a prior post.
Judge Delano concluded her survey by reviewing the Eleventh Circuit’s Seaside opinion from March 2015. She noted that Seaside focused on the ability of the bar order “to prevent claims against non-debtors that would undermine the operations of, and doom the possibility of success for, the [reorganized] debtor.” She also focused on the requirement that the bar order be fair and equitable under the facts and circumstances and be used cautiously and infrequently.
Ultimately, Judge Delano considered each of the seven Dow Corning factors. She found that two of the factors were inapplicable and that five of the factors suggested that entering the bar order would be inappropriate. Most importantly, though, she focused on two intertwining issues: (1) the liquidating nature of the proposed plan and (2) the lack of a relationship between the two objecting creditors and the debtor.
Judge Delano concluded that “the fundamental problem in this case is that the Plan does not propose a true reorganization; instead the Plan is a restructuring of various obligations in an effort to obtain releases for Mr. and Mrs. Albright and their entities.” Indeed, it appeared that the Albrights were attempting to use the bankruptcy court’s jurisdiction over a single one of their entities to resolve disputes between all creditors of themselves, the debtor, and various Albright entities.
Judge Delano viewed with special distaste the Albrights’ attempt to resolve the judgment against Mr. Albright in favor of C&S in the context of HWA’s case. “If Mr. Albright wants a discharge of his obligation to C&S, he should file his own bankruptcy. It is not fair and equitable for a judgment debtor to obtain what is, in effect, a Chapter 7 discharge when that party has not made full disclosure of his assets and liabilities and submitted to the administration of a Chapter 7 trustee.”
Therefore, the attempted third-party releases failed.
We can draw two lessons from HWA.
First, HWA highlights the need for a strong nexus between the requested bar order and the debtor to overcome the elimination of a creditor’s rights. The nexus can be in the form of a creditor’s refusal to settle a cause of action held by the debtor without the proposed bar order (as was the case in Munford). It can also be the potential to inhibit the post-confirmation operation of the debtor (as was the case in Seaside). When the debtor is liquidating, though, as in HWA, the concern for a strong nexus is even stronger because, all things being equal, there is no reason to protect a liquidating debtor post-confirmation.
Second, HWA also highlights the issues that arise when debtors seek to include within the bar order debts over which the bankruptcy court lacks jurisdiction. Judge Delano highlighted one of these concerns: obtaining what is, in effect, a discharge as to the barred creditors without accompanying full disclosure. We would add that this also raises due process concerns as to the creditor who is not before the bankruptcy court.
There very well may be an appropriate case for a non-debtor including in a proposed release a creditor who is not a creditor of the debtor. However, the debtor’s attorney must be careful to illustrate the strong nexus between this debt and the debtor and the necessity of the bar order to the debtor.