New York Judge Gives Reasons for Nixing Nonconsensual, Third-Party Releases

Bankruptcy Judge Michael E. Wiles of Manhattan refused to approve broadly worded, nonconsensual, third-party releases in the chapter 11 plan for Aegean Marine Petroleum Network Inc.

Judge Wiles said that “third-party releases are not a merit badge that somebody gets in return for making a positive contribution to a restructuring. They are not a participation trophy, and they are not a gold star for doing a good job.”

Instead, Judge Wiles said, third-party releases are appropriate “only when they are actually important and necessary to the accomplishment of the transaction before the court.” They “are not supposed to be imposed involuntarily just to make people feel better.”

Explaining the limited circumstances when non-consensual, third-party releases are proper in the Second Circuit, Judge Wiles drew together statutory, constitutional and caselaw authorities in his published bench opinion on March 8.

Approved Releases in the Aegean Plan

In plain English, Judge Wiles laid out the release and exculpation provisions in the Aegean plan.

There being no objections, Judge Wiles explained why he was approving consensual releases and broad releases of the debtor’s own claims. Releasing the debtor’s claims, he said, would result in barring derivative claims. He also approved exculpation provisions, which he restricted in scope.

As written, Judge Wiles said the broadly worded exculpation would bar enforcement of contracts approved by the court. He said that an “appropriate exculpation” would protect “people from claims based on their negotiation, execution and implementation of transactions that I approved.”

However, the Securities and Exchange Commission and the U.S. Trustee objected to broadly worded, third-party, nonconsensual releases.

The Circuit Split

Judge Wiles explained how the Fifth, Ninth, and Tenth Circuits have held that bankruptcy courts lack power to grant nonconsensual, third-party releases of the type he was being asked to approve.

On the other hand, he said, the Second, Fourth, Sixth and Eleventh Circuits permit nonconsensual, third-party releases in “rare” or “unusual” cases. In the Second Circuit, he said, releases of this type are proper only when “a particular release is essential and integral to the reorganization itself,” citing In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141-43 (2d Cir. 2005).

The Proposed Nonconsensual Releases

Judge Wiles explained that he was also being asked to approve releases “even if the releasing parties did not agree to provide such releases. These proposed releases do not involve claims against the Debtors [nor] are they limited to claims that are derivative in nature . . . . They are also not limited to transactions that occurred during the bankruptcy case.”

Instead, Judge Wiles said, the involuntary releases would immunize “certain parties” from claims by creditors, stockholders or parties in interest that relate “in any way” to the debtors, “with no exceptions for claims alleging fraud or willful misconduct.”

The parties intended to receive nonconsensual releases fell into two categories: (1) The prepetition lender who was also the DIP lender and will be the acquiring party under the plan; and (2) three individuals on the debtor’s audit committee.

Jurisdictional Limitations on Releases

Judge Wiles disagreed with the idea that the contested releases were “no big deal.” Rather, he said, they were “an extraordinary thing [that is different] from what courts ordinarily do.”

The claims to be released belonged to third parties in circumstances where the bankruptcy court lacks in rem jurisdiction, Judge Wiles said.

Even though the claims might fall under “related to” jurisdiction, Judge Wiles said he was being “asked to exercise power over a potential claim for which no actual proceeding exists.” Even if there were a proceeding, he said the court needed personal jurisdiction over the parties to be bound by the releases.

To obtain personal jurisdiction, there must be formal service of process. Although the Supreme Court has recognized several exceptions, Judge Wiles said none applied.

Limitations on the Court’s Power

Even if there were subject matter and personal jurisdiction, Judge Wiles said, “that would not mean that I would have the power to impose an involuntary release.” For example, he said, the Supreme Court has “held that a court has no power to dictate settlement terms or to force parties to release their claims.”

Rather, Judge Wiles said, a claim belonging to a third party “may only be resolved through litigation on the merits, or on terms to which the third party agrees,” again citing the Supreme Court.

In addition, there are constitutional limitations, because the court cannot “take a third party’s property without any hearing on the merits and without any of the discovery or other rights that a litigant usually would have.”

Typically, Judge Wiles said, the releases are granted in return for contributions to the reorganization, “rather than the benefits to be provided directly to the persons whose claims are being released.”

Finally, Judge Wiles said that the third-party releases are also improper because they would be broader than the released parties could obtain in their own bankruptcies, citing securities law claims as an example.

Second Circuit Restrictions

Judge Wiles said that involuntary releases are “often” justified by “the contention that anybody who makes a contribution to the case has earned a third-party release.” If this were enough, he said, “releases would never be limited to the ‘rare’ and ‘unusual’ circumstances that the [Second Circuit] required in Metromedia.”

The teaching of Metromedia, Judge Wiles said, “is that releases should be given only when they are an important part of a reorganization.” In the case at bar, he said he was “at a loss to understand what claim is left as to which [the lender-buyer] needs protection,” given the scope of the consensual leases he was approving.

To approve a third-party release, Judge Wiles said he should consider “not only” the contribution by the released parties, “but also the particular claims that are to be released, whether the releasing parties are otherwise getting recoveries on the released claims, and the fairness of the releases from the point of view of the people upon whom the releases are to be imposed.”

Judge Wiles could not approve the nonconsensual releases because he was given none of the factual predicate, outlined above, that he interpreted the Second Circuit to require.

Indemnification of Directors

Having declined to approve nonconsensual releases in favor of the lender-buyer, Judge Wiles also disapproved releases designed to protect members of the audit committee.

The possibility that directors on the audit committee might assert indemnification claims against the reorganized debtor was given as a reason for the nonconsensual releases. In that respect, Judge Wiles said that some courts justify releases “to protect the debtor from indemnification claims.”

“I fail to see how the possibility of an indemnification claim is a proper justification to take away the rights that claimants may have to pursue claims that they own directly against the officers and directors,” Judge Wiles said.

N.B.: If anyone suspects that Judge Wiles slipped his opinion through because the debtor was not well represented, think again. The debtor, the creditors’ committee, and the lender-buyer were represented by some of the country’s most renowned bankruptcy counsel.