District Judge Finds No Loopholes in Ninth Circuit Aversion to Third-Party Releases

Reversing the bankruptcy court, a district judge in Washington State refused to recognize any loopholes in the Ninth Circuit’s categorical ban on non-debtor, third-party releases. The district court also ruled that a free-and-clear sale under Section 363(f) cannot circumvent the Ninth Circuit’s staunch opposition to third-party releases.

Beyond reflecting the Ninth Circuit’s peculiar aversion to third-party releases, District Judge Ronald B. Leighton of Tacoma, Wash., positioned himself in the mainstream by barring settlements that preclude third parties from making claims against insurers outside of Section 524(g).

The case involved the bankruptcy of a debtor corporation whose only business was settling and paying asbestos claims. The debtor negotiated a settlement where some of its insurers would buy back their policies for $11.7 million. The sale would be free and clear of claims related to the policies.

The free-and-clear provisions in the sale would bar non-settling insurers from asserting claims against the settling insurers for contribution and breach of a cost-sharing agreement among the insurers.

The bankruptcy court approved the free-and-clear sale over objection from the non-settling insurers, who appealed. Judge Leighton overturned the sale, having previously granted a stay pending appeal.

Of no small significance, Judge Leighton ruled in his March 8 opinion that the bankruptcy court only had non-core jurisdiction to enter an injunction against the non-settling insurers. Consequently, the bankruptcy court did not have power to enter a final judgment. However, Judge Leighton went on to rule that there was no statutory power to enter the injunction, whether the injunction came from the bankruptcy court or the district court.

Judge Leighton surveyed Ninth Circuit decisions culminating in In re Lowenschuss, 67 F.3d 1394, 1401-1402 (9th Cir. 1995), where the appeals court held, “without exception, that Section 524(e) precludes bankruptcy courts from discharging the liabilities of nondebtors,” unless the case falls within Section 524(g) pertaining to asbestos claims. He said that the Ninth Circuit prohibits “all third-party releases,” not just global third-party releases.

Judge Leighton criticized several lower court opinions in the Ninth Circuit that, in his view, violated the hard-and-fast rule laid down by Lowenschuss. “The Ninth Circuit has stated that exceptions are not allowed,” he said.

The debtor was not an ongoing business and was therefore not eligible to utilize Section 524(g) to obtain a so-called channeling injunction dealing with asbestos claims. Given the categorical preclusion of third-party injunctions, Judge Leighton held that the bankruptcy court erred by enjoining inter-insurer claims under Section 105(a).

Alternatively, the debtor argued that Section 363(f) authorized the bankruptcy court to bar inter-insurer claims as part of a free-and-clear sale. Judge Leighton rejected the contention, saying that the debtor’s theory “would be inconsistent with existing Ninth Circuit precedent regarding bankruptcy courts’ power over third-party claims.”

Notably, Judge Leighton approvingly cited authorities outside the Ninth Circuit that did not permit settlements barring third parties from suing insurers, such as In re Adelphia Communications Corp., 364 B.R. 518 (Bankr. S.D.N.Y. 2007). He also precluded the use of Section 363(f) because he said the non-settling insurers’ claims did not entail an “interest” in property of the debtor.