Restructuring

Article Contributed by Christopher Linden
Having already garnered much attention from the bankruptcy bar, the bankruptcy court in In re Philadelphia Newspapers, LLC, No. 09-11204 SR (Bankr. E.D. Pa. June 15, 2011) recently made more headlines when it enforced an interestingly drafted release provision contained in the debtors’ confirmed chapter 11 plan.  As most plans do, the Philadelphia Newspapers plan appeared, at first glance, to except from the release provisions claims against the debtors and other parties for willful misconduct.  Two individuals asserting willful misconduct claims against the debtors’ purchasers, however, came to learn the hard way that the willful misconduct exception in the plan’s release provision came with an added twist.
On September 30, 2010, the debtors confirmed a plan of reorganization, which contemplated the sale of substantially all of the debtors’ assets to Philadelphia Media Network, Inc (PMN).  Soon after confirmation, on the same day that the plan became effective, the asset purchase agreement between the debtors and PMN closed.  As is common, the plan contained release and injunction provisions, and the asset purchase agreement between the debtors and PMN excluded the assumption by PMN of any pre-closing liabilities of the debtors.  Specifically, the plan and confirmation order enjoined any actions against PMN or its reporters and provided releases to the debtors, the debtors’ employees and PMN.   Except for certain causes of action listed on an exhibit to the plan, the plan released these parties from all pre-effective date liability except “[c]laims or liabilities arising out of or relating to any at or omission that constitutes a failure to perform the duty to act in good faith and where such failure to perform constitutes willful misconduct, gross negligence or fraud.”
The dispute before the Philadelphia Newspapers court arose from two separate lawsuits brought by individuals who asserted that, postpetition, the debtors printed newspaper articles defaming them.  The plaintiffs sued PMN and the reporters who wrote the allegedly defamatory articles.  After dispensing with threshold issues to determine whether the plaintiffs had received notice of the debtors’ bankruptcy proceeding, the court analyzed the scope of the release provision in the plan to determine whether it covered the defamation claims brought by the plaintiffs.  The bankruptcy court interpreted the exclusion contained in the release provision to require the satisfaction of a “two-part conjunctive test.”  Specifically, the willful misconduct carve-out contained in the plan would apply only to claims that arose from a breach of the duty of good faith and constituted willful misconduct, gross negligence or fraud.
Interpreting the provision in this manner required the court to analyze Pennsylvania state law to determine whether PMN had a duty to the plaintiffs to act in good faith.  The court found that, although an independent cause of action for breach of the duty of good faith exists in a limited number of circumstances (e.g., contracts and fiduciary relationships), such a duty was not implicated by the defamation claims brought by the plaintiffs because PMN did not have a fiduciary duty to the plaintiffs.  As a result, the court held that the defamation claims fell within the release provision’s ambit, and the plaintiffs’ claims against PMN were barred.  Ultimately, the court cited to other reasons precluding the plaintiffs’ claims, finding that, in any event, the claims did not satisfy the “demanding level of fault” associated with willful misconduct.
Although it is not unusual for a bankruptcy court to confirm a plan of reorganization containing release provisions, the scope of the releases approved by the bankruptcy court appears to reach further than most.  As drafted, this provision would not only release PMN, but also the debtors, from willful misconduct, fraud and gross negligence, so long as they did not have a duty to act in good faith towards the injured party.  Effectively, the release provision is proportionately as expansive as state law is restrictive.  The duty to act in good faith, as the court notes in its decision, arises in only a limited number of contexts under Pennsylvania law.  Did the debtors recognize the extent of their plan’s release provision when they drafted it?  Or, was it a serendipitous scrivener’s error on their part?  Although the bankruptcy court made it a point to note that the plan’s “release, while broad, is not absolute,” the limited applications of the release’s carve-out in “real life” may suggest otherwise.