The Third Circuit held that the releases in a reorganization plan can insulate a company from claims for having made a distribution violating the regulatory regime under the Financial Industry Regulatory Authority, or FINRA.
Unlike the district court, the Third Circuit did not rule on whether FINRA rules must or should govern distributions to shareholders under a chapter 11 plan.
A Canadian company filed a petition in Canada for an arrangement under the Companies’ Creditors Arrangement Act. Simultaneously, the company filed a chapter 15 petition in Delaware, where the bankruptcy court recognized the Canadian proceeding as the foreign main proceeding.
The Canadian court approved the company’s plan, which was recognized by the Delaware bankruptcy court in an order that gave the plan full force and effect in the U.S. The plan provided for distributions to shareholders once all creditors were paid in full. The company’s shares were traded in the over-the-counter market in the U.S., thus presumptively making them subject to FINRA rules.
The Canadian plan contained a release in favor of the debtor and its officers and directors, insulating them from claims “in any way related to” the bankruptcy. The only exceptions were for claims to enforce the plan, gross negligence or willful misconduct, or releases not “permitted by applicable law.”
After creditors were paid in full, the company announced that it would make a distribution to shareholders of record on a specified date. Given the large size of the distribution, the record date and the distribution date were not in accord with the FINRA rules.
The plaintiff purchased shares on dates that entitled the purchaser to receive the distribution under FINRA rules. However, the company did not make the distribution to the purchaser because the plaintiff had purchased the shares after the record date established under the plan.
The purchaser sued the company in bankruptcy court on claims including negligence and securities fraud based on alleged violations of FINRA rules. The bankruptcy court dismissed the suit.
District Judge Sue L. Robinson of Delaware upheld the bankruptcy court in June 2017 by ruling that the record date pursuant to a plan exclusively determined which shareholders were entitled to receive distributions, even if U.S. securities regulations might call for distributions to holders who purchased securities after the record date. Zardinovsky v. Arctic Glacier Income Fund (In re Arctic Glacier International Inc.), 255 F. Supp. 3d 534 (D. Del. June 14, 2017). To read ABI’s discussion of the district court opinion, click here.
The purchaser appealed, but the Third Circuit upheld dismissal, albeit on a different ground, in an August 20 opinion by Circuit Judge Stephanos Bibas, who was appointed to the appeals court in November 2017.
Judge Bibas held that the releases in the Canadian plan were res judicata and barred the plaintiff’s claims. The purchaser contended, unsuccessfully, that the releases were inapplicable, relying on Holywell Corp. v. Smith, 503 U.S. 47 (1992), where the Supreme Court said it could “not see how [a confirmed plan] can bind the United States or any other creditor with respect to post confirmation claims.” Id. at 58.
Holywell involved a liquidating trust under a confirmed chapter 11 plan where the trustee did not pay capital gains taxes on a post-bankruptcy sale. The Supreme Court held that the trust was liable for the taxes, rejecting the trustee’s argument that the government should have objected to confirmation because the plan said nothing about paying post-confirmation taxes.
Judge Bibas cited the Collier treatise and decisional law for the proposition that that an “entire plan . . . including its releases” is res judicata.
Referring to Holywell, Judge Bibas said, “Its facts, its language, and its logic do not apply to post-confirmation acts to carry out a bankruptcy plan.” He said that the purchaser’s “overreading” of a single sentence in Holywell “would nullify the res judicata effect of confirmed plans and, with it, much of chapter 11. We do not read Holywell that broadly. It casts no doubt on the rule that confirmed plans can bar liability for post-confirmation acts.”
Judge Bibas therefore held that “Holywell does not bar plan terms authorizing or limiting liability for post-confirmation acts that implement the plan.”
With brief discussion, Judge Bibas held that the purchaser was bound by the releases in the plan by having purchased the shares from holders who participated in the bankruptcy.
Judge Bibas did not reach the issue relied on by the district court: that distributions were governed by the plan, not by FINRA rules. The closest he came was in saying that the purchaser did not argue in the lower courts that FINRA rules fell within the definition of “applicable law” and thus survived the releases in the plan. He therefore said that “we need not address how broadly a plan can sweep when it purports to preempt otherwise applicable laws.”
Superficially, the opinion by District Judge Robinson — holding that a plan need not follow FINRA rules — could be cited as “affirmed on other grounds.” However, that’s not so clear, because Judge Bibas specifically declined to rule on how broadly a plan could “sweep . . . to preempt otherwise applicable laws.”
The door therefore seems to be open in the Third Circuit for arguing than a plan must make distributions to shareholders in accordance with FINRA rules.