The Ninth Circuit had been generally understood as categorically banning nonconsensual, third-party releases in chapter 11 plans.
Narrowing, if not repudiating, three earlier opinions in a published decision on June 11, the Ninth Circuit explicitly aligned itself with the Third Circuit by permitting nonconsensual, third-party releases in chapter 11 plans that exculpate participants in the reorganization from claims based on actions taken during the case.
In her opinion for the appeals court, Ninth Circuit Judge Marsha S. Berzon quoted the Third Circuit for observing that “similar limited exculpatory clauses focused on acts committed as part of the bankruptcy proceedings are ‘apparently a commonplace provision in Chapter 11 plans,’” citing PWS Holding Corp., 228 F.3d 224, 245 (3d Cir. 2000).
The Circuit Split
The Fifth, Ninth and Tenth Circuits were commonly understood as prohibiting nonconsensual, third-party releases in chapter 11 plans, while the Second, Third, Fourth, Sixth and Eleventh Circuits permit exculpations in “rare” or “unusual” cases.
Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pacific Lumber Co.), 584 F.3d 229, 251 (5th Cir. 2009), represents the Fifth Circuit’s prohibition of third-party releases in chapter 11 plans. On the other side of the fence, the Second Circuit has said that releases of the type are proper, but only when “a particular release is essential and integral to the reorganization itself.” In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141-43 (2d Cir. 2005).
There was good reason for believing the ban on third-party releases was categorical in the Ninth Circuit. In In re Lowenschuss, 67 F.3d 1394, 1401-1402 (9th Cir. 1995), the Ninth Circuit 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.
For example, a district judge in Washington State criticized several lower court opinions in the Ninth Circuit that, in his view, violated the hard-and-fast rule laid down by Lowenschuss. The judge refused to recognize any loopholes in the Ninth Circuit’s categorical ban on nondebtor, third-party releases in In re Fraser’s Boiler Service Inc., 18-05637, 2019 BL 80048, 2019 U.S. Dist. Lexis 37840, 2019 WL 1099713 (W.D. Wash. March 8, 2019). To read ABI’s report on Fraser’s, click here.
Tim Blixseth Changes the Law (but Still Loses)
And then came Timothy Blixseth and the seemingly unending litigation in the wake of the chapter 11 reorganization and sale of his Yellowstone Mountain Club LLC. Ultimately, the club was sold to a third party over Blixseth’s objection as part of a chapter 11 plan.
The plan contained a release in favor of specified nondebtor third parties, including the club’s primary bank lender. The provision read as follows:
None of [the exculpated parties, including the bank], shall have or incur any liability to any Person for any act or omission in connection with, relating to or arising out of the Chapter 11 Cases, the formulation, negotiation, implementation, confirmation or consummation of this Plan, the Disclosure Statement, or any contract, instrument, release or other agreement or document entered into during the Chapter 11 Cases or otherwise created in connection with this Plan . . . .
The release did not forgive “willful misconduct or gross negligence.”
Challenging the releases, Blixseth was originally appealing confirmation of the plan as to third parties, as well as to the bank. Because the other third parties settled, Blixseth went forward with his appeal only as to the bank.
Having previously ruled that the appeal was not equitably moot because the court might be able to fashion some form of relief, Judge Berzon tackled the propriety of third-party releases.
The Circuit Narrows Its Precedents
Quoting the bankruptcy court, Judge Berzon said that the releases were “‘narrow both in scope and time’” and were limited to acts and omissions “‘in connection with, relating to or arising out of the Chapter 11 cases.’” She also cited the bankruptcy court’s finding that the releases only covered those who were “‘closely involved’” in formulating the plan.
Judge Berzon noted the bankruptcy court’s finding that the exculpation was “not ‘a broad sweeping provision that seeks to discharge or release nondebtors from any and all claims that belong to others.’”
Recognizing the “long-running circuit split,” Judge Berzon cited the governing statute, Section 524(e), which provides that “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” She held that the section “does not bar a narrow exculpation clause of the kind here at issue — that is, one focused on actions of various participants in the Plan approval process and relating only to that process.”
Focusing on the language of Section 524(e) rather than the court’s previous perception of a larger policy, Judge Berzon quoted the Collier treatise for saying that “‘discharge in no way affects the liability of any other entity . . . for the discharged debt.’” [Emphasis in original.]
After noting the narrow prohibition in Section 524(e), Judge Berzon dealt with Blixseth’s reliance on three Ninth Circuit opinions with seemingly broad rejections of third-party releases. She said those cases “all involved sweeping nondebtor releases from creditors’ claims on the debts discharged in the bankruptcy, not releases of participants in the plan development and approval process for actions taken during those processes.”
Having distinguished prior Ninth Circuit authority, Judge Berzon said that Section 105(a) gave the bankruptcy court “authority to approve an exculpation clause intended to trim subsequent litigation over acts taken during the bankruptcy proceedings and so render the Plan viable.”
Recognizing that the Fifth Circuit in Pacific Lumber “reached a conclusion opposite ours,” Judge Berzon ruled that Section 524(e) did not bar the exculpation, because it “covers only liabilities arising from the bankruptcy proceedings and not the discharged debt.”
Question
Will large companies now consider reorganizing in the Ninth Circuit, given that exculpations are feasible? (I’m not holding my breath.)
The Ninth Circuit had been generally understood as categorically banning nonconsensual, third-party releases in chapter 11 plans.
Narrowing, if not repudiating, three earlier opinions in a published decision on June 11, the Ninth Circuit explicitly aligned itself with the Third Circuit by permitting nonconsensual, third-party releases in chapter 11 plans that exculpate participants in the reorganization from claims based on actions taken during the case.
In her opinion for the appeals court, Ninth Circuit Judge Marsha S. Berzon quoted the Third Circuit for observing that “similar limited exculpatory clauses focused on acts committed as part of the bankruptcy proceedings are ‘apparently a commonplace provision in Chapter 11 plans,’” citing PWS Holding Corp., 228 F.3d 224, 245 (3d Cir. 2000).