James M. Lawniczak on Third-Party Releases in Chapter 11 Plans

James M. Lawniczak on Third-Party Releases in Chapter 11 Plans

James M. Lawniczak addresses the circuit split on whether a chapter 11 plan can include a nonconsensual nondebtor release. Of the five circuits allowing such releases under appropriate circumstances, the Seventh Circuit has gone the furthest, requiring only that the release be necessary to the reorganization and appropriately tailored. The Ninth and Tenth Circuits permit them under no circumstances; the Fifth Circuit likely does not permit them.

EXCERPT (note-links to statutes below are accessible by lexis.com subscribers): The Circuits Are Split on Whether Chapter 11 Plans Can Include Nonconsensual Nondebtor Releases

Certain nondebtor parties often make major contributions to chapter 11 plans of reorganization. In those cases when creditors and other parties in interest do not specifically consent to the release or the plan, does the bankruptcy court have authority to grant such a third-party release? If yes, under what circumstances? The courts of appeals are in conflict as to the answers to those two questions. For a general discussion of third-party releases in chapter 11 plans, see 12 Business Organizations with Tax Planning § 157.02 [i] (Lexis 2011).

The Split in the Circuits

The majority of circuit courts of appeals allow nonconsensual third-party releases in chapter 11 plans under appropriate circumstances. These are the Seventh, Second, Sixth, D.C. and Fourth Circuits. Two circuits certainly never permit them, the Ninth and the Tenth Circuits. And the Fifth Circuit almost certainly does not permit them, as shown by the court's comments in the Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229, 252-53 (5th Cir. 2009) case. The issue remains open in the Third Circuit where the Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 213-14 (3d Cir. 2000) case did not actually decide the issue, although the Seventh Circuit in Airadigm Communications, Inc. v. F.C.C. (In re Airadigm Communications, Inc.),519 F.3d 640 (7th Cir. 2008) incorrectly placed the Third Circuit in the majority group. The ways in which the courts of appeals disagree as to nonconsensual third-party releases will be examined in detail below, with focus on the Airadigm case from the Seventh Circuit.

Practice Pointers

Based on the approaches in those circuits that allow third-party releases, a third party seeking a release in a plan of reorganization must make an important, perhaps even vital, contribution to the reorganization. In addition, the release cannot be overbroad; instead, it must be narrowly tailored and probably limited to matters related to the reorganization. Excluding "willful misconduct" from the release will be important. Finally, as discussed above, the third party receiving the release should carefully consider the circumstances under which it will be able to enforce the release going forward.

Consensual third-party releases are generally allowed. However, as a matter of due process, they should be highlighted in the materials, probably in the ballot itself right next to the vote, and certainly in the initial executive summary of the plan in the disclosure statement. If the information on the release is buried on page 88 of the plan and page 156 of the disclosure statement, a creditor might have a due process argument with which to collaterally attack the release.

Conclusion

The Seventh Circuit has joined the majority of circuits holding that third-party releases can be included in a chapter 11 plan of reorganization under appropriate circumstances. At the same time, it is the only case to approve a third-party nonconsensual release without noting that such releases should be given only in extraordinary, rare circumstances. The Seventh Circuit merely required that the release be necessary for the reorganization and appropriately tailored for the situation.

Access the full versions of Bank of New York Trust Co., NA v. Official Unsecured Creditors' Comm. (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. Tex. 2009), Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203 (3d Cir. 2000) and Airadigm Communications, Inc. v. F.C.C. (In re Airadigm Communications, Inc.), 519 F.3d 640 (7th Cir. 2008) with your lexis.com ID. Additional fees may be incurred.

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