A small New Jersey company is again making big law in the Third Circuit on confirmation of chapter 11 plans.
In an appeal last year involving the debtor One2One Communications LLC, the Third Circuit ostensibly held that equitable mootness can be invoked to dismiss a confirmation appeal only in the largest and most complex chapter 11 reorganizations. See In re One2One Communications LLC, 805 F.3d 428 (3d Cir. July 21, 2015).
The new decision, by District Judge Jose L. Linares of Newark, N.J., deals with so-called third party releases where the plan for the debtor One2One waived avoidance actions and other claims against insiders, creditors and nondebtor third parties generally. The waiver of claims was negotiated with the official creditors’ committee.
In his opinion on June 14, Judge Linares reversed the bankruptcy court for failing to determine whether nondebtor recipients of releases “have made a substantial contribution to the debtor’s reorganization.”
A small company, debtor One2One was in bankruptcy to deal with a $9 million judgment against the company and its chief executive. Otherwise, One2One had one secured claim for $100,000 and $1.3 million owing to 17 unsecured creditors, not including a judgment creditor. The sponsor of the plan agreed to invest $200,000 in return for the equity.
Opposing the releases and confirmation of the plan, the judgment creditor offered to buy the claims for $20,000. The company declined the offer, having taken the position that potential claims against the chief executive had no net value, given the uncertainty of success, the cost of litigation and the difficulty of collection.
The bankruptcy court confirmed the plan and approved the third party releases, saying that suits against management “would significantly impair their ability to devote full-time to the management responsibilities of the debtor.” The bankruptcy judge found that the releases were “necessary for reorganization.” The confirmed plan did not affect the creditor’s judgment against the chief executive.
Invoking equitable mootness, the district court had dismissed the judgment creditor’s appeal from the confirmation order without reaching the merits. Holding that equitable mootness was improperly applied, the Third Circuit remanded the case to the district court to consider the merits of the appeal.
While remand was pending in district court, the judgment creditor agreed not to unwind the consummated plan. Instead, the judgment creditor only attacked the third party releases.
Although there is clearer law governing the ability of a plan to bar a third party’s claims against a nondebtor, Judge Linares said there is no Third Circuit authority with a definitive list of factors to consider in judging the propriety of a debtor’s release of claims against nondebtor third parties. Citing the $20,000 offer for the claims, he held that the bankruptcy court “erred as a matter of law in approving the plan by failing to analyze the contribution made by the non-debtors to the plan in exchange for releases.”
Judge Linares did not say how the bankruptcy judge should rule on remand. Even though the chief executive and his wife waived their own claims, he noted that they were rehired at a combined salary of $300,000.
In the penultimate paragraph in his opinion, Judge Linares remanded the case to the bankruptcy court, “reemphasizing that it is appropriate to analyze each of the released non-debtors.”