Are Broad Plan Release and Injunction Provisions Legal?
May 31, 2022
In this post we will discuss the issue of whether a broad release and injunction in a chapter 11 debtor’s plan of reorganization is legally valid. If you have spent any time reviewing a chapter 11 debtor’s typical plan of reorganization, you will no doubt have noted that the plan’s release and injunction provisions tend to be extremely broad and even purport to release claims of a third party (i.e. not the debtor or a creditor) against another third party. We all understand that generally speaking under the Bankruptcy Code the bankruptcy courts have fairly broad powers to deal with claims against debtors. But what is the limit of that power? How about a release of a claim of an obligee for example against the debtor’s CGL policy or builder’s risk policy?
Generally, the Bankruptcy Code notes that a bankruptcy court has jurisdiction over a debtor’s property and the disposition of that property. But third-party claims belong to third parties, not the estate. Thus, as a general rule, a bankruptcy court typically has no power to say what happens to property that belongs to a third party, even if that third party is a creditor or otherwise is a party in interest. See Callaway v. Benton, 336 U.S. 132, 136-41, 69 S.Ct. 435, 93 L.Ed. 553 (1949).
Section 524(e) of the Bankruptcy Code specifically states that “discharge of a debt of the 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). Moreover, the Bankruptcy Code provides that a bankruptcy court lacks the power to confirm plans of reorganization which do not comply with applicable provisions of the Bankruptcy Code. 11 U.S.C. § 1129(a)(1). Given the general law and Code provisions it would seem that broad release and injunction provisions affecting the rights between third parties would not be permissible. However, Section 105 (a) of the Code provides that “[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.” 11 U.S.C.A. § 105. Some courts seize upon Section 105 of the Code as authority to implement such broad release and injunction provisions. Other courts recognize that Section 105 does not provide power to issue orders that are inconsistent with the other provisions of the Code, such as Section 524(e).
Thus, there is a split among the Circuits on the issue of whether bankruptcy courts can release third parties from claims held by other third parties in connection with a debtor’s reorganization plan. Some Circuits, such as the Fifth, Ninth, and Tenth Circuits, have held that third-party releases are categorically beyond the power of a bankruptcy court. See Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pac. Lumber Co.), 584 F.3d 229, 251-53 (5th Cir. 2009);Matter of Zale Corp., 62 F.3d 746, 760 (5th Cir. 1995) (“we must overturn a § 105 injunction if it effectively discharges a nondebtor”); Resorts International, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401 (9th Cir. 1995); Landsing Diversified Properties-II v. The First National Bank and Trust Co. of Tulsa (In re Western Real Estate Fund, Inc.), 922 F.2d 592, 601-02 (10th Cir. 1990) (“while a temporary stay prohibiting a creditor’s suit against a nondebtor … during the bankruptcy proceeding may be permissible to facilitate the reorganization process … the stay may not be extended post-confirmation in the form of a permanent injunction that effectively relieves the nondebtor from its own liability to the creditor.).
Other Circuits, such as the Sixth, Second, Fourth and Eleventh Circuits, have held that such plan releases are permissible under certain circumstances, recognizing that such provisions are only proper in unusual, extraordinary or rare circumstances. See Menard-Sanford, et al. v. Mabey, et al. (In re A.H. Robins Company, Inc.), 880 F.2d 694 (4th Cir. 1989); Stuart, LLC v. First Mount Vernon Industrial Loan Association (In re Peramco International, Inc.), 3 Fed. Appx. 38, 42 (4th Cir. 2001); Behrmann v. National Heritage Foundation, 663 F.3d 704, 712 (4th Cir. 2011); Airadigm Comm., Inc. v. Federal Comm. Commission (In re Airadigm Communications, Inc.), 519 F.3d 640 (7th Cir. 2008) (approving nondebtor release when release was necessary for the reorganization and appropriately tailored … affected only claims arising out of or in connection with the reorganization itself, not blanket immunity); In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005) (warning that “a nondebtor release is a device that lends itself to abuse” and “[n]o case has tolerated nondebtor releases absent the finding of circumstances that may be characterized as unique,” and holding that the bankruptcy court finding that the nondebtor seeking the release made a material contribution to the reorganization was not independently sufficient to justify such a release); Securities and Exchange Commission v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 960 F.2d 285 (2d Cir. 1992); SE Prop. Holdings, LLC v. Seaside Eng’g 7 Surveying (In re Seaside Eng’g & Surveying, Inc.), 780 F.3d 1070, 1078 (11th Cir. 2015) (holding that releases and bar orders are permitted but “ought not to be issued lightly, and should be reserved for those unusual cases in which such an order is necessary for the success of the reorganization, and only in situations in which such an order is fair and equitable under all the facts and circumstances”).
Thus, the split among the Circuits occupies the spectrum between “impossible” and “very rare.” In re Firstenergy Sols. Corp., 606 B.R. 720, 733 (Bankr. N.D. Ohio 2019). The leading decision on this subject permitting the release of third-party claims against nondebtors is the Sixth Circuit’s opinion in Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648, 658 (6th Cir. 2002). In that case, the Court held that while such releases were not categorically prohibited by the Bankruptcy Code, such provisions remain an exception, not the rule. The Court stated such measures are dramatic and should be used cautiously and that “enjoining a non-consenting creditor’s claim is only appropriate in unusual circumstances.” Dow Corning, 280 F.3d at 658 (citing Drexel Burnham Lambert, 960 F.2d at 293; A.H. Robins, 880 F.2d at 702; and Johns-Manville Corp., 837 F.2d at 93-94).
To analyze whether broad release and injunction provisions in plans should be approved, the Dow Corning court held that such nonconsensual provisions may be “appropriate” if seven factors were present. These factors have been adopted by many of the other Circuits that permit such provisions. Generally, the factors look at whether:
(1) There is an identity of interest between the debtor and the third-party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate;
(2) The non-debtor has contributed substantial assets to the reorganization;
(3) The injunction is essential to reorganization, namely the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor;
(4) The impacted class, or classes, have overwhelmingly voted to accept the plan;
(5) The plan provides a mechanism to pay for all or substantially all of the class or classes affected by the injunction;
(6) The plan provides an opportunity for those claimants who choose not to settle to recover in full; and
(7) The bankruptcy court made a record of specific factual findings that support its conclusions.
In performing the research, it becomes clear that the seminal cases where such broad releases have been used are all in the massive tort litigation matters where releases were necessary in exchange for insurers funding huge trusts or other claim mechanisms such as in asbestos cases and Dalkon Shield cases. In all of these types of cases, a plan was negotiated in exchange for significant contributions from third parties and large groups of creditors approved the plan.
Despite the seemingly narrow circumstances under which broad release and injunction provisions are permitted, if permitted at all, it has become common place to find such provisions in reorganization plans. Accordingly, sureties should determine if such release provisions are permissible in the applicable jurisdiction and whether the circumstances warrant such provisions.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the WCS Surety and Fidelity Practice Group.