Please Release Me? Colorado Bankruptcy Court Answers "Perhaps" in Midway Gold Case

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This article is  reprinted with the permission of the American Bankruptcy Institute. It originally appeared in Volume 17, Number 1 of the ABI Business Reorganization Committee Newsletter, May 2018.

The permanent release of a nondebtor from a debt owed to a third party in a chapter 11 plan is barred per se in some courts and must meet a high standard to be allowed in others. The U.S. Bankruptcy Court for the District of Colorado in In re Midway Gold US Inc. addressed this issue in connection with confirmation of the joint chapter 11 plan of 14 debtor entities in the gold mining and exploration business.

As a threshold issue, the Midway court looked to whether third-party releases are ever allowed in the Tenth Circuit or whether they are barred per se as had been argued and applied in other cases. The court analyzed the Western Real Estate case and concluded a chapter 11 plan could not 鈥渂ar litigation against nondebtors for the remainder of the discharged debt鈥 and that the court鈥檚 authority under 搂 105(a) could not be used in a manner inconsistent with 搂 524(e). However, such finding did not translate into an absolute bar of all nondebtor releases in all circumstances.

In connection with its analysis of the nondebtor release, the Midway court reviewed the treatment of nondebtor releases in other circuits and found that while the 鈥淔ifth and Ninth Circuits have held a bankruptcy court does not have authority to issue and enforce third-party non-debtor releases in a Chapter 11 plan,鈥 these circuits are in the minority. Rather, the Midway court sided with the majority, represented by the First, Second, Third, Fourth, Sixth, Seventh, Eighth and Eleventh Circuits, permitting third-party releases under certain narrow circumstances.

Section 524(e) of the Bankruptcy Code provides in pertinent part that 鈥渄ischarge 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.鈥 The majority of the circuits view this language as a 鈥渟avings clause鈥 that preserves post-confirmation rights (e.g., the right to pursue a nondebtor for a debt) rather than 鈥渁n absolute bar to third-party releases.鈥

Further, the court observed that, read together, 搂搂 105(a), 1123(b)(3)(A) and 1123(b)(6) indicate that 鈥渆njoining a creditor's claims against a nondebtor may be necessary, and within the bankruptcy court鈥檚 authority, to achieve a successful reorganization.鈥

Before forging its own path, the court examined the standards used by the other circuits in determining whether nondebtor releases are acceptable, some of which overlap. The First and Eighth Circuits look generally to the following nonexclusive list of factors outlined in the case In re Master Mortg. Fund (the 鈥淢aster Mortgage Factors鈥), including whether:

(1) there is an identity of interest between the debtor and the third party, usually an indemnity relationship, such that a suit against the nondebtor is, in essence, a suit against the debtor or will deplete assets of the estate;

(2) the nondebtor has contributed substantial assets to the reorganization;

(3) the injunction is essential to reorganization (i.e., without it, there is little likelihood of success);

(4) a substantial majority of the creditors agree to such injunction; specifically, the impacted class (or classes) has 鈥渙verwhelmingly鈥 voted to accept the proposed plan treatment; and

(5) the plan provides a mechanism for the payment of all, or substantially all, of the claims of the class or classes affected by the injunction.

The Midway court found that courts in the Third Circuit do not have a specific test, although a Delaware bankruptcy court has looked to the Master Mortgage Factors as a foundation along with 鈥渙ther relevant factors.鈥 Third-party nondebtor releases are allowed in the Second and Seventh Circuit only 鈥渨hen truly 鈥榰nusual circumstances鈥 exist.鈥 The Sixth Circuit also restricts allowing such releases to 鈥渦nusual circumstances鈥 and further looks to a set of seven factors, certain of which are identical or substantially similar to the Master Mortgage Factors referred to as the 鈥淒ow Corning Factors.鈥 The Midway court found that the U.S. Courts of Appeals for the Fourth and Eleventh Circuits have also looked to the Dow Corning Factors.

After analyzing Western Real Estate and the other circuits, the Midway court determined that 鈥渨hile 搂 524(e) does not expressly provide for the release of a third party's claims against a nondebtor, 搂 524(e) does not expressly preclude such releases.鈥 However, such releases are not given 鈥渃arte blanche鈥 and are acceptable only 鈥渋n certain, and very limited, circumstances if the release is 鈥渁ppropriate鈥 and not inconsistent with any other provision of the Bankruptcy Code, including 搂 524(e).鈥

For its own approach, the Midway court found that 鈥渢he Court must parse out exactly who is releasing whom from what.鈥 In other words, the court stressed the importance of distinguishing 鈥渂etween the Debtors鈥 release of nondebtors and third parties鈥 release of nondebtors鈥 and to 鈥渇ind the release to be necessary for the reorganization and appropriately tailored to apply only to claims arising out of or in connection with the reorganization itself, and not to matters which would have no effect upon the estate.鈥 If not, there is potential for a jurisdictional issue that would preclude the authority of the bankruptcy court to enter a final order.

The court further warned against the releases providing 鈥渘ondebtors with 鈥榖lanket immunity鈥 for all times, transgressions and omissions and may not include immunity from gross negligence or willful misconduct.鈥 As the Midway court summarized it, 鈥淸i]t is not the intention of the Court to permit nondebtors to purchase immunity from unrelated torts, no matter how substantial their contribution to a debtor鈥檚 reorganization.鈥

In summary, most jurisdictions will allow third party releases of nondebtors 鈥 but only in certain narrow circumstances. Courts will determine the issue based on the facts and dynamics of each case and will require that such releases be fully justified. Plan proponents must walk the tightrope of providing for the releases necessary to have a plan accepted while avoiding overbroad language and staying within the lines of bankruptcy jurisdiction.

 

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