Plan solicitation and creditors voting in the early days of the Bankruptcy Code, circa 1985


Officers and directors work hard to shepherd their company through bankruptcy. But, even after all that hard work, creditors can still turn around and sue them individually for alleged acts prior to the bankruptcy.  What kind of thanks is that?  A debtor wishing to protect these hard-working officers and directors may seek to include a third party release in the plan.  However, if all parties do not agree, third party releases over objecting classes are closely analyzed because they are considered a “dramatic measure to be used cautiously, and [] only appropriate in unusual circumstances.”  In re Dow Corning Corp., 280 F.3d 648, 658 (6th Cir. 2002).  Fortunately, this post will discuss the steps officers and directors may take with the debtor to increase the likelihood of plan approval, with third party releases intact, over the objections of some parties.

Initially, the debtor must look to where it may file for bankruptcy. Currently, there is a split in authority concerning whether these releases are even allowed.  The majority of circuits, namely the Second, Third, Fourth, Sixth, Seventh and Eleventh Circuits,  allow these releases under certain circumstances. See In re Seaside Eng’g & Surveying, Inc., 780 F.3d 1070, 1077 n.7 (11th Cir. 2015) (compiling cases).  On the other hand, the Fifth, Ninth, and Tenth Circuits do not allow third party non-consensual releases, or permit them only in the most narrow of circumstances. See In re Pac. Lumber Co., 584 F.3d 229, 253 (5th Cir. 2009); In re Lowenschuss, 67 F.3d 1394, 1401 (9th Cir. 1995); In re Western Real Estate Fund, Inc., 922 F.2d 592, 600 (10th Cir. 1990); Vitro, S.A.B. de C.V. v. ACP Master, Ltd. (In re Vitro, S.A.B. de C.V.), 473 B.R. 117, 131 (Bankr. N.D. Tex. 2012) (describing mass tort situations in which some plan releases may be permissible to parties making large, cash contributions to a plan).  Thus, where the debtor decides to file determines in large part whether a third party release is even available to officers and directors.

Even if a third party release is available in the applicable jurisdiction, courts will engage in a fact-intensive analysis to determine whether a release is appropriate. Generally, when weighing whether the circumstances allow for a third party release, the court will weigh (1) whether the debtor and third parties’ interests are served by release; (2) any assets the non-debtor contributed to the reorganization; (3) if the injunction is essential to reorganization; (4) if the impacted classes overwhelmingly voted to accept the plan; (5) whether the plan provides for payment of substantially all of the class affected by the injunction; (6) does the plan provides claimants who chose not to settle to recover in full; and (7) if the court made a specific record of factual findings to support its conclusions. See e.g. In re Dow Corning, 280 F.3d at 658.  However, courts have flexibility in determining which factors are applicable in a given case. In re Seaside Eng’g, 780 F.3d at 1079.  Here, officers, directors, and the debtor will have the most control over whether the debtor has an interest in the release, the released parties’ participation in the bankruptcy, and the impacted classes’ consent.

First, officers and directors should show how a release serves both the third parties’ and the debtor’s interests. Usually, this involves an indemnity agreement because then the debtor is ultimately liable for any award against the released party. See In re Dow Corning, 280 F.3d at 658.  However, the debtor may also show it is dependent on the released parties’ skilled labor, or that the employees will not be able to perform their duties if they must also defend themselves in litigation. In re Seaside Eng’g, 780 F.3d at 1079.  Thus, a debtor seeking a release should look at the possible lawsuits their employees face, the importance of that employee to reorganization, and the scope of any indemnity agreement involved to show the proposed release is in the debtor’s interest as well as the third party.

Next, the parties must show the third party participated in the bankruptcy process. To fulfill this element, the released parties must contribute more than merely performing their job description or fulfilling their fiduciary obligations. See In re SL Liquidating, Inc., 428 B.R. 799, 804 (Bankr. S.D. Ohio 2010).  For example, merely participating in the plan process and contributing “time and effort” is likely not sufficient. Id. Officers and directors, therefore, must identify areas where they can provide an extra contributions, above and beyond their normal obligations, to earn a release.

Finally, officers and directors must incentivize members of the impacted class to approve the release. For example, a debtor may seek a release in a plan merely to incentivize parties to finish their investigations and allow everyone involved to move forward.  Debtors, officers, and directors may incentivize the class to approve the release by assisting in any investigations they wish to complete prior to plan confirmation.  As with all things in Chapter 11, coalition-building, transparency, and sincerely reaching out to creditors must begin early and continue through the case.  Although this may not be applicable in every case, particularly where the debtor may not be confident the possible claims are meritless; it demonstrates how the parties involved may use releases to incentivize affected classes with cost savings and efficiency to win approval.

No matter what jurisdiction you are in, courts will take a hard look at plan provisions releasing non-debtors over the objections of non-consenting parties. In order to get a plan release, officers and directors should show how the release adds value to the estate, prevents the estate’s assets from being needlessly dissipated, and incentivizes creditors to consent.