Releasing Non-debtors Through a Chapter 11 Plan of Reorganization

Releasing Non-debtors Through a Chapter 11 Plan of Reorganization

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When formulating a plan of reorganization, the debtor's release from liability is always in issue, and is specifically contemplated by the Bankruptcy Code. Often, releases are also sought for non-debtor parties. Such releases are, of course, attractive to parties such as officers, directors and affiliates of the debtor. Many would argue, however, that the release of non-debtor parties contradicts the intent of the Bankruptcy Code. Indeed, non-debtor parties are not the entities seeking a "fresh start," as they have not filed their own bankruptcy proceedings. Thus, as with many other areas where the Bankruptcy Code neither prohibits nor grants authority for a particular action, advocates of non-debtor releases have turned to 11 U.S.C. §105.

Section 105(a) provides that a court has broad equitable power "to issue any order, process or judgment that is necessary or appropriate" to advance a bankruptcy proceeding and matters related thereto. See S. Rep. No. 989, 95th Cong., 2d Sess. 51 (1978), reprinted in 1978 U.S. Code Cong. & Admin. News 5787, 5837; and H.R. Rep. No. 595, 95th Cong., 1st Sess. 341 (1977), reprinted in 1978 U.S. Code Cong. & Admin. News 5963, 6298; see, also, Monarch Life Insurance Co. v. Ropes & Gray, 65 F.3d 973, 978-79 (1st Cir. 1995).

Authority exists under §105(a) for a non-debtor party to receive a release as long as it advances a successful plan of reorganization. In addition to the interests of advancing a successful plan of reorganization, however, one must also consider the competing interests of creditors and equity interests, as well as §524(e)'s prohibition against non-debtor discharges. To comply with §524(e), the non-debtor release must be distinguishable from a discharge that a debtor would otherwise receive. The issue is this: How does one structure a confirmable plan of reorganization that provides for the release of non-debtor parties, yet does not contradict §524(e)?

In re Continental Airlines

One of the most recent cases addressing the issue of non-debtor releases is In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000). In Continental, the proposed plan of reorganization provided for the release of directors and officers in the form of a permanent injunction against shareholder class-action officer and director suits, to which the shareholders/plaintiffs objected. Id. at 206-07.

In a case of first impression, the Third Circuit sought guidance from other courts and reviewed numerous decisions supporting and prohibiting non-debtor releases. Id. at 212-14. Based on the split in authority, and since the shareholders did not argue for a blanket prohibition against non-debtor releases, the Third Circuit declined to establish its own rule for non-debtor releases. Id. at 213-14. Instead, the Third Circuit held that the proposed injunctions and releases were not appropriate because they did not meet even the most flexible test of fairness and necessity by supporting factual findings. Id. at 214. With no factual findings supporting fairness and necessity, the Third Circuit held that the releases "cannot stand on their own merits under any standards set forth in the case law of other circuits." Id. at 214.

While Continental provides authority for non-debtor releases that are fair and necessary, it does not provide specific guidance for structuring such releases. Accordingly, as in Continental, practitioners must consider the decisions of courts that both prohibit and allow non-debtor releases.

Courts Prohibiting Non-debtor Releases

As opposed to the Third Circuit's unwillingness to establish a blanket prohibition against non-debtor releases, both the Ninth and Tenth Circuits have held that non-debtor releases and injunctions are simply impermissible regardless of the circumstance. Resorts International v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1402 (9th Cir. 1995); Landsing Diversified Properties II v. First National Bank & Trust Co. of Tulsa (In re Western Real Estate Fund Inc.), 922 F.2d 592, 601 (10th Cir. 1990). Specifically, both the Ninth and the Tenth Circuits held that any non-debtor release is indistinguishable from a discharge under §524 and, therefore, impermissible. Id.

Similarly, the bankruptcy court for the Eastern District of Michigan recently refused to allow non-consensual releases and permanent injunctions in the Dow Corning case. In re Dow Corning Corp., 244 B.R. 721 (Bankr. E.D. Mich. 1999). In Dow Corning, a key component of the proposed plan was a resolution of product liability claims against the debtor's parent corporations and other third parties through a fund estimated to be sufficient to pay all claims.

The proposed plan further provided for the waiver and release of all claims against numerous third parties and a separate provision enjoining product liability claimants from proceeding against those third parties. Although the court found that §524(e) does not prevent entry of a non-debtor injunction, it determined "that a bankruptcy court has no authority, statutory or otherwise, to issue a non-consensual permanent injunction in favor of non-debtor parties." Dow Corning, 244 B.R. at 739-40. Thus, the absence of legitimate grounds for inferring that a creditor has consented to the entry of such an order cannot be dismissed as "harmless error." Id. at 745. Consequently, the court held that such provisions "must be limited to accepting creditors if these provisions are to be given 'reasonable, lawful, and effective meaning.'" Id., 244 B.R. at 738. Consequently, the court held that the proposed plan's non-debtor releases did not apply to non-accepting claimants.

Further review of case law addressing non-debtor releases demonstrates that the Ninth and Tenth Circuits, as well as the court in Dow Corning, are in the majority in their prohibition against non-debtor releases.

Courts Allowing Non-debtor Releases

In addition to holding that non-debtor releases are appropriate, certain courts have provided specific guidance for structuring a non-debtor release in a plan of reorganization. The Second Circuit, for example, affirmed a plan confirmation, despite the inclusion of non-debtor releases, based on the plan's provisions for compensation to the enjoined parties that satisfied their claims. Securities and Exchange Commission v. Drexel Burnham Lambert Group Inc. (In re Drexel Burnham Lambert Group Inc.), 960 F.2d 285, 293 (2d Cir. 1992). Similarly, and in direct contradiction to Dow Corning, the Fourth Circuit held that non-debtor releases in mass tort cases were appropriate when the releases were necessary for reorganization and were accompanied by consideration for claimants whose claims were released. Menard-Sanford v. Mabey (In re A.H. Robins Co.), 880 F.2d 694, 702 (4th Cir. 1989).

Based on Drexel Burnham and A.H. Robbins, practitioners can structure a non-debtor release by providing settlement funds and/or other compensation to the enjoined parties. When non-debtor third parties provide substantial consideration that makes reorganization feasible, the chances of confirmation, and subsequent affirmation, increases. See Monarch Life Ins. Co. v. Ropes & Gray, 65 F.3d 973, 980-81 (1st Cir. 1995).

In Monarch, the First Circuit stated that "in extraordinary circumstances it has been held that a bankruptcy court can grant permanent injunctive relief essential to enable the formulation and confirmation of a plan of reorganization if, for example, non-debtors who would otherwise contribute to funding the plan will not settle their mutual claims absent protection from potential post-confirmation lawsuits arising from their pre-petition relationship with the chapter 11 debtor." Monarch, 65 F.3d at 980-81.

The Eleventh Circuit, on the other hand, addressed non-debtor releases in the context of a settlement reached in a related adversary proceeding. Matter of Munford Inc., 97 F.3d 449, 455 (11th Cir. 1996). In Munford, the Eleventh Circuit affirmed permanent injunctions against non-settling defendants, when the injunction was an integral part of the debtor's settlement and the injunction was fair and equitable. Munford, 97 F.3d at 455. In Munford, the court based its decision on 11 U.S.C. §105(a) and Federal Rule of Bankruptcy Procedure 7016, which grants a court authority to take certain actions in aid of settlement. Id. at 454-55; see, also, In re Labrum & Doak LLP, 237 B.R. 275 (Bankr. E.D. Pa. 1999) (which held that permanent injunctions were warranted to preserve settlements with settling parties, even though such injunctions had the effect of extending relief to non-debtors).

Indeed, numerous other courts have held that non-debtor releases are appropriate when the circumstances make such releases necessary for an effective reorganization. See, e.g., In re United Health Care Organization, 210 B.R. 228, 232-33 (S.D.N.Y. 1997); In re Heron, Burchette, Ruckert & Rothwell, 148 B.R. 660, 685 (Bankr. D. D.C. 1992); In re Eagle-Picher Industries Inc., 963 F.2d 855, 858 (6th Cir. 1992); In re Energy Co-op. Inc., 886 F.2d 921, 929-30 (7th Cir. 1989); In re Codfish Corp., 97 B.R. 132, 135 (Bankr. D. P.R. 1988); In re MacDonald Associates Inc., 54 B.R. 865, 867 (Bankr. D. R.I. 1985).

Consequently, when a non-debtor release is necessary for an effective reorganization, one may be obtained. Typically, however, one of two things must be present: (1) significant compensation to the enjoined parties or (preferably and) (2) substantial contribution from the non-debtor party that makes reorganization feasible.


Despite case law allowing for non-debtor releases, such releases are difficult to obtain and implement in a confirmable plan of reorganization. Even when allowed by courts, the hurdles and standards are often placed extremely high. For certain debtors and related parties, non-debtor releases are of such importance that it may be worth the confirmation fight.

It is further important to recognize that such releases are not free. Indeed, the parties receiving the benefits of the releases and/or injunctions must contribute substantial value to the estate, or some alternative fund must be established to channel claims against the released parties. Above all, it is important to note that non-debtor parties are receiving releases, not a discharge, and the differences therein.

Journal Date: 
Friday, December 1, 2000