The Latest on Third Party Releases

on January 15, 2013 ·

Posted in Releases and Exculpations

The Bankruptcy Code facilitates settlements and settling parties almost always want to ensure that any concessions they make buy a complete peace.  It’s easy enough for a lender to negotiate a settlement with the debtor, but getting relief from potential third party claims can be trickier.  Third party releases built into a plan of reorganization or liquidation can be an Achilles’ heel, as was the case in Bank of N.Y., Mellon Trust Co., NA v. Becker (In re Lower Bucks Hosp.), No. 12-3399, 12-3752 (E.D. Pa. Jan. 2, 2013), which affirmed a bankruptcy court opinion discussed here last year.

Looking Back

In 1992, the debtor, a community hospital, entered into a multi-party municipal bond financing transaction.  The Borough of Langhorne Manor Higher Education and Health Authority issued the bonds and loaned the bond proceeds to the debtor.  The agreements governing the transaction obligated the debtor to indemnify the Authority against “any and all claims” arising out of the transaction and to indemnify the indenture trustee against “any liabilities” arising out of its powers and duties.  At the time of the debtor’s chapter 11 filing in January 2010, the debtor owed approximately $26 million to the bondholders.  Three months later, the debtor commenced an adversary proceeding against the trustee, arguing that the security interest was not perfected at the time of its bankruptcy filing.  Ultimately, the indenture trustee and the debtor reached a settlement, which granted the bondholders secured status and, in exchange, reduced the debt from $26 million to $8.15 million.  Central to the appeal is a provision in the settlement stipulation releasing the trustee from all claims and causes of action arising from or related to the bond documents by all parties.

No one called the court’s attention to the third party release at the settlement hearing and the court subsequently entered the proposed order.  When the debtor filed its disclosure statement and proposed plan of reorganization in September 2011, both documents contained the third party release.  A bondholder, Leonard Becker, later initiated a class action against the trustee and its predecessor in the district court, asserting, among other things, claims for breach of fiduciary and contractual duties for failing to perfect the security interest.  The same bondholder also objected to the proposed plan of reorganization, arguing that the release was an impermissible third party release.  In addition, Becker argued that the third party release was not “clearly and conspicuously” identified in the disclosure statement, an argument with which the bankruptcy court agreed.

Looking Forward

On appeal, the district court focused on whether (i) the bankruptcy court had subject matter jurisdiction to approve the third party release as part of the debtor’s plan of reorganization, (ii) the notice provided to the bondholders regarding the release was adequate, (iii) the bondholders consented to the release through the settlement motion process, and (iv) the third party release was an impermissible non-consensual release.

The district court ruled that the bankruptcy court had “related to” jurisdiction over the third party release, although the court was careful to note that an “inchoate claim of indemnity” is insufficient to establish related to jurisdiction.  In determining the existence of related to jurisdiction in cases involving indemnification agreements, the court queried whether (i) the filing of the class action against the trustee automatically triggered the debtor’s indemnification liability and (ii) a subsequent successful lawsuit against the debtor was required for a finding of indemnification in favor of the indenture trustee.  If the indemnification liability is not automatically triggered or if a subsequent successful lawsuit is required, then related to jurisdiction would not exist.  After reviewing the financing documents, the court concluded that the debtor’s indemnification obligation was, at least in part, “triggered upon the filing of the class action . . . and [was] not contingent upon a finding of liability.”  Id. at 18.

Having affirmed that the bankruptcy court had subject matter jurisdiction to approve the third party release, the district court then considered the adequacy of the notice provided to the bondholders and agreed with the bankruptcy court that the disclosure statement did not adequately inform the bondholders of the settlement details and the significance of the third party release.  The district court disagreed with the trustee’s argument that Bankruptcy Rule 3016(c), which requires conspicuous disclosure of injunctions in a plan in “bold, italic, or underlined text,” merely provided examples of conspicuous language and should not be read as a requirement that the identified typography be used.  In addition, the district court reviewed the content of each of the nine notices sent to the bondholders prior to the disclosure statement.  The notices contained, among other things, information on the debtor’s bankruptcy filing and the status of the adversary proceeding.  None of the notices contained sufficient information on the bondholders’ potential claims against the trustee and the third party release.

As to whether the bondholders consented to the third party release because of their failure to object timely during the settlement motion process, the district court agreed with the bankruptcy court that the bondholders’ omission did not constitute acceptance of the release.  The stipulation was not self-executing upon court approval.  Rather, the settlement was conditioned on plan confirmation and the plan going into effect.  The district court observed that the provisional settlement stipulation never survived as part of the plan because the bankruptcy court had stricken the release in a May 2012 order.  In this context, ruling failure to object amounted to acceptance would, according to the district court, render the notice requirements superfluous.

Finally, the district court affirmed that the third party release was an impermissible non-consensual release.  In reaching its conclusion, the district court determined that the “Continental hallmarks” for permissible non-consensual releases were absent.  (In Continental Airlines, the Third Circuit identified the “hallmarks of permissible non-consensual releases . . . [as] fairness, necessity to the reorganization, and specific factual findings to support these conclusions[,]”  id. at 214 (internal quotation marks omitted), as well as whether reasonable consideration had been given.  Id. at 215.)

Rule 3016. Filing of Plan and Disclosure Statement in a Chapter 9 Municipality or Chapter 11 Reorganization Case
    . . . (c) INJUNCTION UNDER A PLAN. If a plan provides for an injunction against conduct not otherwise enjoined under the Code, the plan and disclosure statement shall describe in specific and conspicuous language (bold, italic, or underlined text) all acts to be enjoined and identify the entities that would be subject to the injunction
203 F.3d 203 (3d Cir. 2000).

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