Restructuring

Contributed by Yvanna Custodio
Last month, we featured a North of the Border Update on broad third party releases upheld by the Ontario Superior Court of Justice (Commercial List) in the context of proposal proceedings under the Bankruptcy and Insolvency Act (Canada).  Today, we focus your attention on a decision closer to home:  In In re Lower Bucks, a decision currently on appeal, Judge Eric L. Frank of the United States Bankruptcy Court for the Eastern District of Pennsylvania discussed the propriety of a third party release in a chapter 11 plan of reorganization and held he could not approve the third party release because of inadequate disclosure prior to the bondholders’ vote on the plan.  The issue arose from “an odd procedural posture” because the court had previously confirmed the plan, but reserved for decision whether the release should be approved and included as part of the plan.  Ultimately, Judge Frank rejected the third party release, but deferred final decision on whether the release should be stricken from the confirmed plan in order to give the parties an opportunity to be heard on the issue of the bondholders’ resolicitation.
Although the third party release at issue had been incorporated into a settlement resolving a preference action between the debtor and the indenture trustee, which the court approved, and although the bondholders affected by the third party release had voted in favor of the plan, the court hinged its denial of the release on both non-compliance with Rule 3016(c) of the Federal Rules of Bankruptcy Procedure and the failure of the disclosure statement to provide the affected bondholders with “information regarding the merits or value of the potential claims against [the indenture trustee] that would be released by the [p]lan.”  In analyzing whether the disclosure statement and certain notices that were sent to the bondholders complied with Bankruptcy Rule 3016(c), the court determined whether any “effort was made to bring the existence of the [t]hird [p]arty [r]elease to the eyes and attention of the [b]ondholders.”  The court noted that the placement of the third party release among boilerplate disclosures was not a CONSPICUOUS disclosure and remarked that the existence of the third party release was not called to the court’s attention, which is contrary to “chapter 11 practice and culture [that] imposes on counsel an affirmative obligation to flag the key issues for the court to consider.”  Moreover, the court observed that the disclosure statement failed to inform the bondholders of the consequences of the third party release in favor of the indenture trustee.
In the 77-page decision, Judge Frank also discussed at length the fiduciary obligations of an indenture trustee.  As noted above, the third party release at issue had been incorporated into a court-approved settlement that, among other things, provided for a release of the indenture trustee’s contractual right of indemnification against the debtor.  The indenture trustee, in negotiating the settlement, hinged its acceptance on obtaining the third party release because of “the impending discharge of its indemnification rights” against the debtor.  In determining whether the indenture trustee acted appropriately, the court recognized the indenture trustee’s two distinct roles in the settlement process.  In one capacity, the indenture trustee served as the bondholders’ representative in settlement negotiations.  In another capacity, the indenture trustee was acting on its own account and took positions that protected its personal interests.  Although the court acknowledged “the prevailing view . . . that an indenture ‘trustee’ is not a traditional ‘trustee’ with fiduciary duties to bondholders[,]” the court rejected the indenture trustee’s argument that it could place its interests ahead of the bondholders’ interests.
When drafting disclosure statements (particularly those containing third party releases in favor of indenture trustees), Lower Bucks calls bankruptcy professionals’ attention to the requirement that the existence and consequences of such releases must be specifically and CONSPICUOUSLY disclosed to the affected bondholders.  Perhaps a general rule drafters of disclosure statements should bear in mind when faced with provisions concerning third party releases is:  THERE SHOULD BE NO WALLFLOWERS HERE.