Fifth Circuit Bars Creditors’ Own Claims Against Settling Defendants

In a 2/1 opinion arising from the R. Allen Stanford Ponzi scheme, the Fifth Circuit held that third parties who paid a receiver more than $130 million to settle claims are entitled to an order barring creditors from suing on the creditors’ own claims. 

This week’s opinion stands in contrast to the Fifth Circuit’s long-held ruling that bankruptcy courts lack power to grant nonconsensual, third-party releases in chapter 11 plans. See, e.g., Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.), 584 F.3d 229, 251 (5th Cir. 2009).

Is it therefore fair to say that bar orders are proper in settlements in the Fifth Circuit but not in chapter 11 plans? And if that is a correct statement of the law in the Fifth Circuit, why is it true?

The dissenter in the Fifth Circuit would have held that the receivership court lacked subject matter jurisdiction to bar creditors from suing.

The Stanford Ponzi Scheme and the Settlement

The Securities and Exchange Commission put Stanford International Bank into a federal receivership in Dallas after discovering that the enterprise was a Ponzi scheme where hundreds of defrauded investors lost some $5 billion. The receiver brought lawsuits generating recoveries for distribution to all creditors pro rata. Stanford himself is serving a 110-year prison sentence.

The receiver sued two insurance brokers who provided policies that were advertised as providing investors with complete protection against loss. As it turned out, the policies were almost as illusory as the Stanford business.

After years of litigation and discovery, the two brokers agreed to settle and pay the receiver more than $130 million. At the time, the brokers were also defendants in lawsuits in state court brought by Stanford creditors. The brokers therefore insisted that the receivership court enter a bar order precluding creditors from pursuing their own claims.

The district court approved the settlement and the bar order. Objecting creditors appealed. For himself and Circuit Judge James E. Graves, Jr., Circuit Judge Patrick E. Higginbotham upheld the settlement and the bar order in a July 22 opinion.

Jurisdiction and Power

The objecting creditors principally argued that the district court lacked subject matter jurisdiction to bar claims that were not before the court. 

The 30-page opinion by Judge Higginbotham is largely an explanation of the practical necessity for a bar order. As he said several times, the objecting creditors otherwise would “jump the queue” and potentially recover in full from their lawsuits, while other defrauded investors would only recover a fraction of their losses through the receiver.

Initially, it seemed as though Judge Higginbotham would approve the bar order by invoking federal securities laws, because he said the “district court’s power to determine appropriate relief for a receivership is broad.” He could not go far in that direction, because another panel of the Fifth Circuit had held on June 17 in a different Stanford appeal that receivers do not have greater powers than bankruptcy trustees to settle claims and enter bar orders based on the receivership court’s in rem jurisdiction. Becker v. Certain Underwriters at Lloyd’s of London (In re Stanford International Bank Ltd.), 17-10663, 2019 WL 2496901 (5th Cir. June 17, 2019). To read ABI’s discussion of Becker, click here.

Judge Higginbotham reasoned that the district court was not exercising jurisdiction over the objecting creditors or their claims. Rather, the district court was protecting the receivership and its assets. Without a bar order, there may not have been a settlement and $130 million for distribution to creditors, he said.

For authority, Judge Higginbotham relied on a nonprecedential Fifth Circuit opinion from 2013, SEC v. Kaleta, 530 F. App’x 360 (5th Cir. 2013). He described Kaleta as meaning that the “powers to fashion relief in a receivership context included the power to enjoin other proceedings by non-parties.” He said that Kaleta was “based on principles so commonplace that [the opinion] was not published.”

Judge Higginbotham said his decision was consistent with Becker. He described the opinion in June as approving a bar order where the enjoined creditors were receiving distributions as a result of the settlement.

Judge Higginbotham upheld the bar order in light of the “broad jurisdiction of the district court to protect the receivership res.” The court’s jurisdiction, he said, allows the court to bar “proceedings where they would undermine the receivership’s operation.”

The Dissent

Circuit Judge Don R. Willett dissented, although he said he appreciated the “settlement’s practical value.” In his view, the district court “lacked jurisdiction to grant the bar orders.”

Judge Willett believed that the receiver only had standing to assert the receiver’s claims and could not release the creditors’ claims. He saw Becker as supporting his conclusion.

He interpreted Becker to mean that the court could not settle creditors’ claims without their consent “and without the procedural protections of a class action.” In his estimation, the right of the objectors “to participate in the receivership claims process does not change this.”

Finally, he said that the district court “lacked in rem jurisdiction over these claims, as in rem jurisdiction extends only to receivership property. And receivership property consists of Stanford’s assets, not its victim’s claims.”

A former justice of the Texas Supreme Court, Judge Willett was appointed to the circuit bench by President Trump. He was confirmed in the Senate on a party-line vote.

Observations

When it comes to the power to issue releases to nondebtors, the law is all over the map. Unlike the Fifth, Ninth and Tenth Circuits, the Second, Fourth, Sixth and Eleventh Circuits permit plans to have nonconsensual, third-party releases in “rare” or “unusual” cases. Even within more permissive jurisdictions, there is resistance to the notion of nondebtor releases. See, e.g., In re Aegean Marine Petroleum Network Inc., 599 B.R. 717 (Bankr. S.D.N.Y. April 8, 2019). For ABI’s discussion of Aegean Marine, click here.

Beyond the practical justification, what is the underlying legal rationale to support a finding of jurisdiction and power?

Granted, there are factual differences between a nondebtor release in a chapter 11 plan and one issued in the wake of a settlement. Are bar orders and releases justified when the third party is paying so much money that it hurts? 

Perhaps there is a distinction between potential claims as opposed to existing claims. In a chapter 11 plan, the plan proponents want to ensure that creditors do not sue after confirmation by contending that someone sold them short. In the Fifth Circuit case, by contrast, there were existing claims that might double the defendants’ exposure, not merely the hypothetical possibility of a claim in the future brought by a disgruntled creditor following plan confirmation.

One of these days, the issue of nondebtor releases may reach the Supreme Court. Will there be different rules for chapter 11 plans and for settlements? And if so, why?