Are Non-debtor ReleasesPermanent Injunctions Authorized Under the Bankruptcy Code

Journal Issue

May 2003

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Reorganization
plans are negotiated and drafted with the intent of resolving all matters
affecting the debtor. It goes without saying that if the debtor is to
successfully reorganize, the plan must provide for the resolution of all claims
and causes of action that have been or that may be brought against the bankrupt
individual or entity. One of the strategies used with increasing frequency to
ensure that the reorganized debtor truly has a fresh start is to expand the
scope of the plan discharge to include a release of claims against non-debtor
third parties with an ongoing affiliation or relationship with the debtor. In
the alternative, the plan may include provisions to permanently enjoin claims
or causes of action against these third parties. These strategies have been
especially popular and, it is argued, necessary in plans proposed by so-called
"mega" debtors, who may continue to face post-confirmation
indemnification claims arising from officer and director liability<a href="#1" name="1a">1</a> and from
payments made by the debtor's insurance carriers. As a result, the
non-debtor release and/or permanent injunction provisions are being litigated
with increasing frequency at confirmation. This litigation focuses on the
interplay between <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §§105(a)</a> and 524(e).

Under
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §524(e)</a>, "the discharge of a debt of a debtor does not
affect the liability of any other entity on, or the property of any other
entity for, such debt." On its face, it would appear that §524(e)
precludes bankruptcy courts from discharging the liabilities of non-debtors.
However, under <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §105(a)</a>, bankruptcy courts are given broad equitable powers
"to issue any order, process or judgment that is necessary or appropriate
to carry out the provisions of [the Bankruptcy Code]." Does this mean
that bankruptcy courts can resort to the §105(a) powers to validate a
non-debtor release or permanent injunction? Not necessarily. The powers under
§105(a) are not unfettered. As a general rule, the equitable powers under
§105(a) cannot be used by the courts to authorize relief inconsistent with
a more specific provision of the <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=4….
Northwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988)</a>. Thus, the question becomes one of whether
a court can utilize its equitable powers of §105(a) in light of the
apparent prohibition on non-debtor releases and/or permanent injunctions
contained in §524(e).

The case of <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Transit Group Inc., 286 BR 811 (Bankr. M.D.
Fla. 2002)</a>, is the latest decision to examine this interplay.
In Transit Group, the reorganization
plan proposed to release all claims and causes of action against the debtor,
the debtor's children, the debtor's professional corporation and
the pension plan for debtor's professional corporation; to release all
liens against certain trusts, custodian accounts and the pension plan for the
debtor's professional corporation; and to satisfy all outstanding
judgments, executions and levies against the released persons, entities and
their affiliates. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
Group, 286 B.R. 814-15</a>. After
conducting a thorough analysis of existing law, the court ruled that
§524(e) does not bar non-debtor releases or permanent injunctions in
appropriate circumstances where substantial contributions have been made by the
released parties to the debtor's reorganization. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
Group, 286 B.R. at 817-18</a>.

In
so ruling, the Florida district court aligned itself with the majority view
held by the Second,
Third, Fourth, Sixth and Seventh Circuits. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Continental Airlines, 203 F.3d 203 (3rd Cir.
2000)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
re Specialty Equipment Co. Inc., 3 F.3d 1043
(7th Cir. 1993)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
re Drexel Burnham Lambert Group Inc., 960 F.2d
285 (2nd Cir. 1992)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
re A.H. Robins Co. Inc., 880 F.2d 694 (4th Cir.
1989)</a>. In these circuits, courts have held that bankruptcy
courts have the power under §105(a) to issue permanent injunctions or
third-party releases under appropriate factual circumstances.

Of
the cases supporting non-debtor releases and permanent injunctions, A.H.
Robins and Drexel Burnham offer the best sets of facts to justify the
inclusion of a non-debtor release and/or permanent injunction in the
debtor's plan provisions. A central focus of these reorganizations was
the global settlement of massive tort liabilities asserted against the debtors
and co-liable third parties. The co-liable third parties contributed hundreds
of millions of dollars to the debtors' reorganization plans to compensate
claimants and make the debtors' plans feasible. As a result, the
co-liable third parties appropriately expected and demanded releases in
consideration for the payments to the debtors. The courts granted the requested
relief, dispelling of the arguments made by creditors that §524(e)
precludes third-party releases and permanent injunctions.

More
to the point, the A.H. Robins court
determined that §524(e) should not be applied literally in every case as a
prohibition on the court's equitable power to approve the injunction
where the facts justify its inclusion. The court relied on facts evidencing
that the plan had been overwhelmingly approved by creditors, that the Plan B
opt-out members chose not to take part in the settlement that would have paid
them in full, and that the reorganization hinged on the debtor being free from
indirect claims against parties who would have indemnity or contribution claims
against the debtor. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8….
Robins, 880 F.2d at 701-02</a>.

In
Drexel Burnham, the court cited to A.H.
Robins in ruling that a bankruptcy court
"may enjoin a creditor from suing a third party, provided the injunction
plays an important role in the debtor's reorganization plan." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
Burnham, 960 F.2d at 293</a>. The court
concluded the injunction was appropriate because the injunction was an
essential element of the settlement, and thus the reorganization. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…;

A
third case, which is often identified as a seminal holding for the proposition
that third-party releases and injunctions are appropriate, is Dow Corning. Although the Dow Corning court rejected the debtor's request to include
non-debtor releases and a permanent injunction in its plan, the court aligned
itself with the majority in finding that such provisions are appropriate when
"unusual circumstances" are present. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
Corning, 280 F.2d at 658</a>. The
court held that §524(e) does not prohibit the release of a non-debtor, but
rather only explains the effect of the debtor's discharge. The court then
determined that the court's equitable powers under §105(a), when
combined with the provisions of §1123(b)(6),<a href="#2" name="2a">2</a> gives bankruptcy courts the
authority to enjoin non-consenting creditors' claims against third
parties when "unusual circumstances" exist. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
Corning, 280 F.2d at 658</a>, citing
A.H. Robins and Drexel Burnham.

What
makes the Dow Corning decision so
important is that the court took the time to distill and articulate the factors
relied upon by the A.H. Robins
and Drexel Burnham courts in
finding that a non-debtor release or injunction was appropriate under the
circumstances. The factors articulated by the Dow Corning court are:

<ol>
<li>the identity of interests between debtor and third party, such as an indemnity
relationship, are such that a suit against the third party is in essence a suit
against the debtor or will deplete the assets of the estate;

</li><li>the non-debtor has contributed substantial assets to the reorganization;

</li><li>the injunction is essential to reorganization to permit the debtor to be free
from indirect suits that would cause indemnitor contribution claims against the
debtor;

</li><li>the impacted creditors overwhelmingly voted to accept the plan;

</li><li>the plan provides a method to pay creditors affected by the injunction;

</li><li>the plan provides payment in full to those creditors who choose not to settle;
and

</li><li>the bankruptcy
court's records support the injunction or release.
</li></ol>

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
Corning, 280 F.3d at 658</a>.

Many
courts that follow the majority view now rely on these factors and §105 to
conduct their analysis of the appropriateness of a non-debtor release or
injunction. In fact, the Transit Group
court specifically relied on the Dow Corning factors in reaching its holding. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
Group, 286 BR at 817-18</a>.

In
contrast to the reliance on §105(a) found in A.H. Robins, Drexel
Burnham, Dow Corning and their progeny, the
minority view in the Fifth, Ninth and Tenth Circuits hold that §105(a)
cannot be used to authorize relief inconsistent with the provisions of the Code.
See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6… re Lowenschuss, 67 F.3d 1394 (9th Cir. 1995)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
re Zale Corp., 62 F.3d 746 (5th Cir. 1995)</a>;
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
re Western Real Estate Fund Inc., 922 F.2d 592
(10th Cir. 1990)</a>. These courts, which reject non-debtor releases
or permanent injunctions, are best described as courts of strict construction
with respect to this issue. The minority view finds that the plain language of
§524(e) limits the scope of discharge to claims against the debtor.
Accordingly, it is the opinion of these courts that §105(a) cannot be used
by bankruptcy courts to discharge the liabilities of non-debtors because such
relief would be inconsistent with the specific provisions of §524(e). In
other words, the minority concludes that the bankruptcy courts lack the power
to discharge any claims against non-debtors.<a href="#3" name="3a">3</a>

The Zale and Western Real Estate cases are strikingly similar in their holdings in
this vein. In both cases, the courts held that a temporary injunction or stay
prohibiting actions against non-debtors under §105 may be permissible
during the pendency of a bankruptcy to facilitate reorganization. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 62 F.3d at 760</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
Real Estate, 922 F.2d at 601</a>.
However, the stay may not be extended post-confirmation in the form of a
permanent injunction that effectively relieves the non-debtor from its own
liability to third parties. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 62 F.3d at 760</a> citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=9…
Real Estate, 922 F.2d 601</a>

("Not only does such a permanent injunction improperly insulate
non-debtors in violation of §524(e), it does so without any counteracting
justification of debtor protection...").

Although
the minority view depends on a strict interpretation of the Code, the holding
in Lowenschuss takes the analysis a step
further. In fact, the Ninth Circuit holding in Lowenschuss provides the strongest support for denying
confirmation of plans that include non-debtor releases and injunctions intended
to protect third parties. In Lowenschuss, the debtor's plan contained a global release for the debtor, the
debtor's children, the debtor's professional corporation and the
pension plan for the debtor's professional corporation, as well as a
release of all liens against certain trusts, custodian accounts and the pension
plan, and a satisfaction of all outstanding judgments, executions and levies
against released persons and their affiliates. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 67 F.3d at 1401</a>.

The
Lowenschuss court rejected the
debtor's argument that the global release was appropriate. The court
first noted that bankruptcy courts lack the power to confirm plans of
reorganization that do not comply with applicable Code provisions as required
by <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
U.S.C. §1129(a)(1)</a>. The court then noted that the plain
language of §524(e) does not provide for the release of third parties from
liability and the inclusion of such releases is inconsistent with the Code.
This interpretation, it stated, was consistent with a long line of Ninth
Circuit law that holds that §524(e) precludes a bankruptcy court from
discharging liabilities of non-debtors. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 67 F.3d at 1401-02</a>, citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
Hardwoods Inc. v. Deutsche Credit Corp. (In re American Hardwoods Inc.), 885 F.2d 621, 626 (9th Cir. 1989)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=7…
v. Roay, 769 F.2d 1426, 1432 (9th Cir. 1985)</a>;

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1…
Wholesalers Inc. v. Investors Commercial Corp.,
172 F.2d 800, 801 (9th Cir. 1949)</a>.

The
court rejected the notion that the general equitable powers bestowed upon a
bankruptcy court under §105(a) permits a court to approve such releases.
The court noted that this argument was specifically rejected in its holding in <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
Hardwoods. See American Hardwoods, 885 F.2d at 625-26</a>. Section 105, the
court held, "does not authorize relief inconsistent with more specific
law...[and] the specific provision of §524 displaces the court's
equitable powers under §105 to order the permanent relief [against the
non-debtor] sought by [the debtor]." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 67 F.3d at 1402</a>, citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8…
Hardwoods, 885 F.2d at 625-26</a>.

The
strong support for the court's decision comes from the court's
inclusion of an analysis of the 1994 amendments to the Bankruptcy Code and the
resulting addition of §524(g). Under this provision, bankruptcy courts are
permitted to issue injunctions against third parties to prevent litigation in
asbestos cases where certain conditions are satisfied. The Lowenschuss court stated that "[t]he numerous conditions
of §524(g) make it clear that this subsection constitutes a narrow rule
specifically designed to apply in asbestos cases only.... That Congress
provided explicit authority to bankruptcy courts to issue injunctions in favor
of third parties in an extremely limited class of cases reinforces the
conclusion that §524(e) denies such authority in other non-asbestos
cases." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…; 67 F.3d 1402, n.6</a>.

Although
the Ninth Circuit's analysis in Lowenschuss has strong appeal, the minority's strict adherence to the
plain-language doctrine may be detrimental to the flexible approach needed in
the large bankruptcy cases being filed today. One only has to look at the news
headlines to realize that bankruptcy courts are facing increasingly complex
issues in increasingly complex cases. As a result, the equitable powers of a
bankruptcy court are often needed to accomplish the goals of the debtor and the
creditors, or to fill in the gaps where the Bankruptcy Code may be silent. The
flexibility of the majority view and their ability to grant relief warranted by
the circumstances of the case is just the kind of approach desired by those
involved in complex cases. For this reason, the majority view appears to be the
appropriate analysis for the current bankruptcy climate.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Indemnification claims would
continue post-petition where the debtor has elected to retain its contractual
obligations to indemnify officers and directors pursuant to the debtor's
bylaws or as contained in contracts with such officers and directors. <a href="#1a">Return to article</a>

<a name="2">2</a> Section 1123(b)(6) permits a plan to
include any appropriate provision not inconsistent with the applicable
provisions of the Code. <a href="#2a">Return to article</a>

<a name="3">3</a> In Zale, the court held that the bankruptcy court had no jurisdiction
to consider the issue because the third-party action sought to be enjoined,
involving the debtor's D&O insurer, a former board member and a
D&O excess policy insurer, was not sufficiently related to the bankruptcy. See

<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=6…
re Zale Corp., 62 F.3d at 756</a>.
The interesting aspect of this holding is that the debtor's D&O
insurer had entered into a global settlement with the debtor regarding the
debtor's claims against its directors and officers, had paid the policy
limits to the debtor and had negotiated a global release as part of the
settlement. The settlement was a fundamental aspect of the debtor's
reorganization. <a href="#3a">Return to article</a>

Journal Authors

Deborah A. Crabbe

Journal Date

Thursday, May 1, 2003 - 12:00

Bankruptcy Rule

2003