Bankruptcy Judge Whitman L. Holt has written a treatise (actually, an opinion) describing the limited circumstances when a general release contained in a settlement can be set aside for fraud. The complaint before him did not measure up, so he enforced the broad release in the settlement.
Judge Holt began his opinion with a prologue, saying that the “need for speed” in bankruptcy “derives . . . more generally from the reality that delay rarely increases stakeholder recoveries. Expedition has some downsides, however . . . . With the benefit of hindsight, some decisions prove regrettable.”
The Release Looked Good at the Time
In the case before him, the corporate debtor was a restaurant chain in chapter 7. The trustee wanted to sell property, but the sale price was less than the debt owing to the secured lender.
The lender refused to allow the sale without a broad, general release. The trustee acceded to the request and filed a motion to approve the release alongside sale approval.
The creditors’ committee objected to the release. Negotiating in the hallway, the lender threw additional consideration in the direction of the committee, which then withdrew the objection. The bankruptcy court approved the sale and the broad, general release in favor of the secured lender.
Five years later, the trustee filed suit in bankruptcy court against the lender, alleging that the lender knew about and participated in a check-kiting scheme by the debtor’s principal. The lender filed a motion to dismiss based on the general release.
No Duty to Volunteer
Analyzing whether the trustee stated a claim, Judge Holt began his January 18 opinion with the proposition that settlements are “particularly valuable in bankruptcy” because they can “preserve[] or create[] value for hundreds of thousands of estates.”
“Quick negotiations,” Judge Holt said, are “another common feature of settlements and other transactions in bankruptcy due to business or other exigencies.” Consequently, he said that “an occasional but inevitable result will be terms that someone regrets in hindsight.”
Presaging his eventual ruling, Judge Holt cited cases for the proposition that “courts rarely allow post hoc recutting of an original, bankruptcy-court-approved deal.”
Judge Holt did not rule on general propositions. Rather, he focused on Montana law and the factual allegations in the trustee’s complaint.
The trustee was alleging that the lender’s failure to disclose information about check-kiting amounted to fraud that would invalidate the release.
Judge Holt characterized the trustee as alleging that the lender did not unilaterally “volunteer” information about the scheme. The allegations, he said, “do not rise to a level sufficient to support a fraud claim or to invalidate the release.” Montana law requires “more affirmative conduct than simple nondisclosure . . . to establish fraudulent concealment.”
Judge Holt summarized some of the shortcomings in the complaint:
[I]t does not allege affirmative acts by [the lender] to mislead, hinder, or otherwise create any misimpressions. It contains no allegations that the Trustee made inquiries or that defendants provided false responses.
In other words, Judge Holt said, “the alleged facts simply tell a story of passive nondisclosure — a failure to volunteer — which is legally insufficient to invalidate the release.” He added, “passive nondisclosure . . . is legally insufficient to invalidate the release.”
Judge Holt rejected the trustee’s entreaty that the lender had a duty to volunteer. He said:
[A] requirement that potentially harmful information be affirmatively disclosed as a condition to an effective settlement or release would hamper and discourage settlement negotiations contrary to public policy. Such a requirement would also create boundless uncertainty subjecting any general release to attack months or years down the road, which again discourages settlement and disrupts the reasonable expectations of parties protected by general releases or, as here, an express release of any “unknown” claims.
Citing a decision by Delaware Bankruptcy Judge Mary F. Walrath, Judge Holt held that creditors “do not have a duty, however, to simply volunteer unsolicited information to a bankruptcy trustee, including when those creditors are negotiating a release with the trustee.”
Judge Holt dismissed the complaint but granted leave to amend the complaint because he could not conclude that “any amendment would necessarily be futile.”
Judge Holt is Chief Bankruptcy Judge for the Eastern District of Washington, sitting in Yakima. He also sits by designation in Montana.
Update: The trustee filed an amended complaint, and the lender filed another motion to dismiss.
Bankruptcy Judge Whitman L. Holt has written a treatise (actually, an opinion) describing the limited circumstances when a general release contained in a settlement can be set aside for fraud. The complaint before him did not measure up, so he enforced the broad release in the settlement.
Judge Holt began his opinion with a prologue, saying that the “need for speed” in bankruptcy “derives . . . more generally from the reality that delay rarely increases stakeholder recoveries. Expedition has some downsides, however . . . . With the benefit of hindsight, some decisions prove regrettable.”