Except for the debtor, a trustee, the creditors’ committee and committee members, the Fifth Circuit reiterated its categorial preclusion of nondebtor third-party releases.
However, and it’s a mammoth however, the New Orleans-based appeals court sanctified a workaround to accomplish the same function as third-party nondebtor releases: A chapter 11 plan may give the bankruptcy court a gating function to approve or disapprove the commencement of lawsuits against those who would be protected by exculpations in other circuits.
The Fifth Circuit justified the gating function by relying on the venerable Barton doctrine, announced by the Supreme Court in 1881. Barton v. Barbour, 104 U.S. 126 (1881).
The August 19 opinion by Circuit Judge Stuart Kyle Duncan puts the Fifth Circuit firmly on par with Delaware and New York in terms of hospitality toward large chapter 11 cases, although Houston’s recent popularity indicates that the Southern District of Texas already achieved preeminence.
The Obstreperous CEO
The debtor was a Dallas-based investment firm that managed billion-dollar publicly traded investment portfolios. The company filed a chapter 11 case in Delaware that was transferred to Dallas.
Short of appointing a chapter 11 trustee, the chief executive officer stepped down as a director and officer. In his place, the creditors’ committee tapped three independent directors to act as a “quasi-trustee,” Judge Duncan said. One of independent directors was a retired bankruptcy judge.
To say that the debtor’s founder and former CEO was litigious is perhaps an understatement. After the former CEO filed several chapter 11 plans that failed, Judge Duncan said that “he and other creditors began to frustrate the proceedings by objecting to settlements, appealing orders, seeking writs of mandamus, interfering with [the debtor’s] management, threatening employees, and canceling trades between [the debtor] and its clients.”
An independent director was quoted by Judge Duncan as saying that the former CEO wanted to “burn the place down.” Later, one of the independent directors was named CEO by order of the bankruptcy court.
Well before confirmation, the bankruptcy court entered an order barring any claims against the independent directors and the new CEO “without the bankruptcy court’s authorizing the claim as a ‘colorable claim[] of willful misconduct or gross negligence,’” Judge Duncan said. The order became final without appeal.
By way of cramdown, the bankruptcy court confirmed a chapter 11 plan proposed by the independent directors.
The Exculpations and Gatekeeper Function
“Anticipating [the former’s CEO’s] continued litigiousness,” Judge Duncan said, “the Plan shields [the debtor] and bankruptcy participants from lawsuits through an exculpation provision, which is enforced by an injunction and a gatekeeper provision.”
According to Judge Duncan, the beneficiaries of the gatekeeper provision and the third-party nondebtor exculpations were “nearly all bankruptcy participants: [the debtor] and its employees and [the new] CEO; [the debtor’s sole general partner]; the Independent Directors; the Committee; the successor entities and Oversight Board; professionals retained in this case; and all ‘Related Persons.’” The oversight board was created by the plan to monitor implementation of the plan after confirmation.
Judge Duncan said that the exculpation covered any claims “in connection with or arising out of” the chapter 11 case, excluding, of course, bad faith, fraud, gross misconduct, and the like.
Judge Duncan said that the gatekeeper function barred “bankruptcy participants” from “‘taking any actions to interfere with the implementation or consummation of the Plan’ or filing any claim related to the Plan or proceeding.”
Should someone intend to assert a claim against “protected parties, it must go to the bankruptcy court to ‘first determin[e], after notice and a hearing, that such claim or cause of action represents a colorable claim of any kind,’” Judge Duncan said. “Only then,” he went on to say, “may the bankruptcy court ‘specifically authoriz[e]’ the party to bring the claim.”
Judge Duncan said that the “Plan reserves for the bankruptcy court the ‘sole and exclusive jurisdiction to determine whether a claim or cause of action is colorable’ and then to adjudicate the claim if the court has jurisdiction over the merits.”
Equitable Mootness
The former CEO and others appealed. Because the plan had been consummated, the debtor moved to dismiss the appeal as equitably moot.
After laying out the elements of equitable mootness recognized by circuits arounds the country, Judge Duncan said that the invocation of the doctrine “turns on whether the court can craft relief for that claim that would not have significant adverse consequences to the reorganization.”
Citing In re Pacific Lumber Co. (Pacific Lumber), 584 F.3d 229, 252 (5th Cir. 2009), Judge Duncan said that equitable mootness “does not bar our review” of third-party releases. Again citing Pacific Lumber, he said that equitable mootness does not prevent an appellate court from examining application of the absolute priority rule.
Third-Party Releases on the Merits
Summarizing, Judge Duncan said that the plan “exculpates certain non-debtor third parties supporting the Plan from post-petition lawsuits not arising from gross negligence, bad faith, or willful or criminal misconduct.” He described the gatekeeper provisions as requiring “the bankruptcy court’s approval of the claim” before “any lawsuit is filed.”
“Together,” Judge Duncan said, the plan provisions prohibit “bad-faith litigation” that “could disrupt the plan’s effectiveness.”
Both sides agreed that Pacific Lumber controlled and that exculpation for the debtor and the committee were permissible. According to the debtor, the broader exculpations were “a commonplace Chapter 11 term” that “merely provides a heightened standard of care.”
Judge Duncan acknowledged that there is a circuit split, placing the Fifth Circuit at odds with other circuits condoning nondebtor third-party releases. He characterized the Fifth Circuit as being in league with the Tenth Circuit by “categorically bar[ring] third-party exculpations absent express authority in another provision of the Bankruptcy Code.”
Judge Duncan said that other laws permitting exculpations were Section 524(g), applicable to “asbestos” cases, and the qualified immunity conferred on trustees and creditors’ committees. He went on to “reject[] the parsing between limited exculpations and full releases that Highland Capital now requests.”
The bankruptcy court’s findings of fact about the need for insulating the plan and its participants from the predations of the former CEO “do not alter whether it has statutory authority to exculpate a non-debtor,” Judge Duncan said.
The independent directors were playing a unique role in the case. Judge Duncan said they were “appointed to act together as the bankruptcy trustee” for the debtor. As such, he said, they are “entitled to all the rights and powers of a trustee” and “to the limited qualified immunity for any actions short of gross negligence.”
Judge Duncan struck provisions in the plan providing exculpations for anyone other than the debtor, the creditors’ committee and its members for conduct within the scope of their duties, and the independent directors. In other words, he excised exculpations in favor of the debtor’s employees, the new CEO, the general partner, the trust created by the plan, the professionals for the debtor and the committee, the plan’s oversight board and “related persons.”
Gatekeeping Ok’d
Having eviscerated exculpations that are commonplace in other circuits, Judge Duncan said that the “injunction and gatekeeper provisions are, on the other hand, perfectly lawful.” Citing the Barton doctrine, he said that “[c]ourts have long recognized [that] bankruptcy courts can perform a gatekeeping function.”
The appellants argued that the gatekeeping function extended to claims not within the bankruptcy court’s jurisdiction. Judge Duncan saw no need to “evaluate whether the bankruptcy court would have jurisdiction under every conceivable claim falling under the widest interpretation of the gatekeeper provision. We leave that to the bankruptcy court in the first instance.”
Judge Duncan went on to say in a footnote that the opinion should not be interpreted “to hinder the bankruptcy court’s power to enjoin and impose sanctions on [the former CEO] and other entities by following the procedures to designate them vexatious litigants.”
Another Protection Left Standing
Well before confirmation, the bankruptcy court had entered an order barring claims against the independent directors and the new CEO without the court’s approval. The order was not appealed and became final.
The circuit court had no jurisdiction to entertain a collateral attack on that order, Judge Duncan said. To the extent the appellants sought to “roll back the protections [in that order],” he said that “such a collateral attack is precluded.”
The finality of the order was a big deal. Judge Duncan said that it had “the effect of exculpating the Independent Directors and [the new CEO] in his executive capacities.”
The mid-case order was even more expansive. Judge Duncan said that it gave res judicata protection to the independent directors’ agents, advisors and employees.
Chapter 11 Issues on the Merits
Judge Duncan upheld the bankruptcy court on the merits of issues regarding plan confirmation.
The former CEO contended there was a violation of the absolute priority rule by giving out-of-the-money paper to two classes of unsecured creditors. Judge Duncan said that absolute priority “has never required us to bar junior creditors from ever receiving property.”
Judge Duncan also saw no clear error in the bankruptcy court’s voluminous findings of fact to justify confirmation of the plan.
Except for the debtor, a trustee, the creditors’ committee and committee members, the Fifth Circuit reiterated its categorial preclusion of nondebtor third-party releases.
However, and it’s a mammoth however, the New Orleans-based appeals court sanctified a workaround to accomplish the same function as third-party nondebtor releases: A chapter 11 plan may give the bankruptcy court a gating function to approve or disapprove the commencement of lawsuits against those who would be protected by exculpations in other circuits.