Another Judge Clamps Down on Third-Party Releases in a Major Reorganization

Saying that he agrees with an opinion handed down three months ago by Bankruptcy Judge Michael E. Wiles of Manhattan, Bankruptcy Judge Alan M. Koschik of Akron, Ohio, refused to approve broadly worded, nondebtor, third-party releases in a reorganization plan proposed by FirstEnergy Solutions Corp., the owner of two fossil-fuel electric generating plants and three nuclear power generating facilities.

In his August 29 opinion, Judge Koschik described the “broad and nearly even circuit split on the issue of whether bankruptcy courts can, under any circumstances, release nondebtors from claims held by nonconsenting parties in connection with a debtor’s reorganization plan.”

In the case before him, Judge Koschik explained that the “most substantial class” of claims to be extinguished by the nonconsensual releases would have been “environmental cleanup and maintenance claims held by the Governments.”

Judge Koschik’s opinion explained why he had signed an order in April rejecting the debtors’ disclosure statement. Since then, the debtors revised the plan several times and held a confirmation hearing in August. Judge Koschik sustained one of the objections to the plan, and the confirmation hearing was adjourned.

Judge Wiles had similarly refused to approve broadly worded, nonconsensual, third-party releases in a chapter 11 plan. In re Aegean Marine Petroleum Network Inc., 599 B.R. 717 (Bankr. S.D.N.Y. April 8, 2019). To read ABI’s report on Aegean Marine, click here.

The FirstEnergy Plan

The FirstEnergy debtors are part of a family of companies, but not all were in chapter 11. Judge Koschik said that the “intent” of the plan was for the debtors and their nondebtor affiliates to “wash [their] hands of any liability flowing from [their] historical ownership of the properties and operation of the businesses and facilities now or at any time owned and operated by the Debtors.”

The proposed third-party releases emanated from a settlement earlier in the case where nondebtors committed substantial assets to the plan. The settlement called for the releases to be incorporated into a chapter 11 plan, but ultimate approval of the releases was not a condition to the settlement. Consequently, Judge Koschik’s prior approval of the settlement did not tie his hands when the disclosure statement came to court for approval.

The releases, Judge Koschik said, made the plan “patently unconfirmable.” He therefore declined to approve the debtors’ disclosure statement.

The Circuit Split

Judge Koschik went beyond the Sixth Circuit to survey law throughout the country. “The circuit split occupies the spectrum between ‘impossible’ and ‘very rare,’” he said.

In the Fifth, Ninth and Tenth Circuits, he said, nondebtor releases “are categorically outside the power of the bankruptcy courts.” “Other circuits are not so strict,” he said.

Adopting standards laid down by the Sixth Circuit in Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648, 658 (6th Cir. 2002), Judge Koschik said that the Fourth Circuit allows releases “when the affected creditors of the nondebtor approved of and accepted the terms of the plan.”

The Second and Seventh Circuits, according to Judge Koschik, “allow for the possibility of nonconsensual third-party releases . . . , but always in rare and exceptional circumstances.” The Third Circuit, he said, “may be willing to allow for such releases as well.”

Although the rules vary, Judge Koschik found it “striking that each circuit that has considered nondebtor releases either rejects them absolutely or approves them only reluctantly.” He described the leading cases of Detroit, A.H. Robbins and Johns-Manville as “essentially class action settlements releasing a debtor and its co-obligors, ensuring that no claims of contribution or indemnity against the debtor survive plan confirmation, and directing substantial compensation to the class of claimants voting to accept the settlement incorporated into the plan of reorganization.”

The Dow Corning Standard Applied to FirstEnergy Plan

Naturally, Judge Koschik applied the Dow Corning standard to the FirstEnergy plan. While “possible within the Sixth Circuit,” he said that “the nonconsensual release of third-party claims against nondebtors remains an exception, not the rule.”

Judge Koschik analyzed how the seven Dow Corning factors applied to the FirstEnergy plan. The factors include an identity of interest between the debtor and the nondebtor (usually an indemnity relationship), the contribution of substantial assets by the nondebtor, an overwhelming vote in favor of the plan by affected classes, and the opportunity for a full recovery by those who elect not to settle.

FirstEnergy failed the Dow Corning test, in Judge Koschik’s opinion. The releases were “extraordinarily broad or at least potentially so.” The debtors, he said, would “impose [the releases] upon all of its creditors, including those who do not consent.” The releases would bar “a wide array of potential claims, including all claims that have anything to do with the historic operation of the business.”

Judge Koschik heard “impassioned pleas” by governmental authorities. He noted that most of their claims for environmental cleanup and other damages would “lie solely against the [nondebtors], and not at all against the Debtors.” [Emphasis in original.] Furthermore, he said, the plan had no recovery for holders of claims against nondebtors that “would nevertheless be released.”

Judge Koschik declined to approve the disclosure statement because the releases in the plan were “not justified by unusual circumstances as required by Dow Corning.”