Disagreeing with some of her colleagues in Delaware, a newly appointed bankruptcy judge refused to approve third-party releases binding creditors and equity holders who receive no distribution in a chapter 11 plan but had been given the option of opting out from the releases.
In her December 5 opinion, Bankruptcy Judge Karen B. Owens could not conclude that the failure to opt out represented consent to granting the releases, under the circumstances of the case. Judge Owens was appointed to the bankruptcy bench in Delaware in June.
The debtor mined and produced sand used for hydraulic fracturing in the oil and gas industry. The case was a typical prepackaged chapter 11 reorganization.
The plan called for refinancing the pre-bankruptcy revolving credit and secured loans incurred by the debtor in possession. In return for their debt, secured noteholders were to receive all of the equity in the reorganized debtor.
The plan presumed that the reorganized business was worth less than the approximately $320 million owed to secured creditors. Therefore, unsecured creditors and equity holders were out of the money and entitled to no distribution.
As an incentive for unsecured creditors to vote in favor of the reorganization, the plan contained a so-called deathtrap. If the unsecured creditor class were to vote in favor of the plan by the requisite majorities, they would receive 5% of the new equity and warrants for 10% more. Existing equity holders would be given warrants for 5% of the new equity if the unsecured creditor class were to approve the plan.
The plan contained broad third-party releases barring everyone – creditors and equity holders included – from bringing claims against non-debtor participants in the reorganization, such as the secured noteholders and revolving credit lenders.
In the ballots they were given, unsecured creditors had the option of opting out from the releases. Equity holders were given a form for them to sign and return if they did wish to grant releases.
The unsecured creditor class voted against the plan, meaning neither they nor equity holders would receive any distribution. The unsecured creditors’ committee, the U.S. Trustee, and the Securities and Exchange Commission objected to confirmation of the plan on a variety of grounds.
Judge Owens devoted most of her decision to placing a value on the debtor’s business and assets. Analyzing valuation opinions given by experts for the debtor and the unsecured creditors’ committee, Judge Owens concluded that unsecured creditors were entitled to no distribution. She also concluded that the plan satisfied the best interests and fair and equitable tests.
Having failed to win the war on valuation, the unsecured committee argued that the deathtrap meant the plan was not filed in good faith.
Although the deathtrap “may have seemed unsavory,” Judge Owens said it “was intended to encourage consensus.” Given the circumstances, she ruled that the deathtrap was neither “impermissible [nor] indicative of a lack of good faith.” Thus, she concluded that the plan was proposed in good faith.
With regard to the third-party releases, the debtor did not fare so well.
The debtor argued that the releases were consensual because creditors and equity holders were given the opportunity of opting out. Judge Owens disagreed, holding that “consent cannot be inferred by the failure of a creditor or equity holder to return a ballot or Opt-Out Form.”
Judge Owens could not say “with certainty” that a creditor or equity holder who failed to opt out “did so intentionally to give the third-party release.”
To evaluate the significance of failing to opt out, Judge Owens employed what she called “basic contract principles.” She concluded that failing to opt out did not “manifest [an] intent to provide a release.” She believed that “[c]arelesness, inattentiveness, or mistake are three reasonable alternative explanations.”
Judge Owens conceded that the conclusion put her in “a minority amongst the judges in this District.” She cited bankruptcy judges in New York and Bankruptcy Judge Mary F. Walrath in Delaware who take the same position as she.
Nonetheless, Judge Owens did not proscribe third-party releases altogether. First, she said that “silence or inaction” may be indicative of consent if “special circumstances are present.” She did not give examples of special circumstances.
Second, nonconsensual releases, she said, can be permissible in the Third Circuit under Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 212-14 (3d Cir. 2000), when there is an appropriate bankruptcy justification.
The debtor had not proffered a bankruptcy justification, so Judge Owens declined to confirm the plan, while suggesting that the debtor may confirm the plan by omitting the third-party releases.
Judge Owens had been a law clerk for a Delaware bankruptcy judge and was a partner at a prominent Delaware firm before ascending to the bench.
Disagreeing with some of her colleagues in Delaware, a newly appointed bankruptcy judge refused to approve third-party releases binding creditors and equity holders who receive no distribution in a chapter 11 plan but had been given the option of opting out from the releases.
In her December 5 opinion, Bankruptcy Judge Karen B. Owens could not conclude that the failure to opt out represented consent to granting the releases, under the circumstances of the case. Judge Owens was appointed to the bankruptcy bench in Delaware in June.
The debtor mined and produced sand used for hydraulic fracturing in the oil and gas industry. The case was a typical prepackaged chapter 11 reorganization.
The plan called for refinancing the pre-bankruptcy revolving credit and secured loans incurred by the debtor in possession. In return for their debt, secured noteholders were to receive all of the equity in the reorganized debtor.
The plan presumed that the reorganized business was worth less than the approximately $320 million owed to secured creditors. Therefore, unsecured creditors and equity holders were out of the money and entitled to no distribution.