Restructuring

Contributed by Adam Lavine
As a result of the sheer number of legal and factual issues involved in many chapter 11 cases, bankruptcy judges can sometimes find themselves as captives of the parties; they may not appreciate the significance of an issue or a provision buried in a longer document unless it is properly presented. Thus, it is imperative that counsel flag the key issues for the court. Failure to do so risks severe consequences for parties in interest, as exemplified by In re Lower Bucks Hospital.
In Lower Bucks, the Third Circuit (in an opinion by Judge Ambro) denied approval of a third-party release contained in a chapter 11 plan, in large part because such release was not properly disclosed to creditors or the court at the appropriate time. As we previously reported, the lower courts in this case, the District Court for the Eastern District of Pennsylvania and the Bankruptcy Court for the Eastern District of Pennsylvania, likewise relied on the parties’ failure to disclose properly the third-party release as a basis for denying their approval. See our previous posts here and here.
Background
In Lower Bucks, an indenture trustee filed a $26 million secured claim on behalf of certain bondholders. The debtor disputed the priority of the claim, arguing that the indenture trustee had failed to properly perfect its security interest. Ultimately, the indenture trustee and the debtor reached a settlement that granted the bondholders secured status in exchange for a reduction of the claim from $26 million to $8.15 million.
The settlement agreement included releases between the signatories (the debtor and the indenture trustee) as well as a release of all bondholder claims against the indenture trustee – i.e., a non-consensual third-party release. The settlement agreement was approved by the bankruptcy court at a hearing pursuant to Rule 9019 of the Federal Rules of Bankruptcy Procedure.
The third-party release was also built into the debtor’s plan of reorganization. Critically, however, the third-party release was referenced only once in the plan (on page 42 of 47) and only once in the disclosure statement (on page 55 of 62). The release was not emphasized in any way, whether through bold-face type, italics, or underlining. Further, neither counsel for the debtor nor counsel for the indenture trustee referenced the third-party release at the Rule 9019 hearing or at the disclosure statement hearing. Accordingly, the court was unaware of the third-party release when it approved of the settlement agreement and later the disclosure statement.
After the disclosure statement was approved, a bondholder objected to the proposed plan, arguing that the third-party release was impermissible and not properly disclosed. At the confirmation hearing, the parties agreed to sever provisionally the third-party release from the plan and hold a separate hearing on the propriety of such release after confirmation. The bankruptcy court confirmed the plan but subsequently denied approval of the third-party release.
The Third Circuit’s Decision
In Lower Bucks, the Third Circuit decision addressed three issues: (1) was the third-party release adequately disclosed in the disclosure statement, (2) could the bankruptcy court revisit its initial approval of the disclosure statement, and (3) was the denial of the third-party release appropriate?
With respect to the first issue, the Third Circuit held that the bankruptcy court did not abuse its discretion in finding that the disclosure statement did not contain “adequate information” with respect to the third-party release as required by section 1125 of the Bankruptcy Code. In support of this holding, the Third Circuit noted that the debtor had violated Rule 3016(c) of the Federal Rules of Bankruptcy Procedure, which requires that “[i]f a plan provides for an injunction . . . , the plan and disclosure statement shall describe in specific and conspicuous language (bold, italic, or underlined texts) all acts to be enjoined . . . .” In addition, the Third Circuit observed that the release was “omitted from numerous sections of the disclosure statement where it was arguably relevant” and that “in both presentation and placement, the documents sent to the Bondholders did not differentiate the Third-Party Release from any of the other information provided. . . .”
With respect to whether the bankruptcy court could revisit its initial approval of the disclosure statement, the Third Circuit held that it could under Rule 9024 of the Federal Rules of Bankruptcy Procedure, which incorporates Rule 60(b) of the Federal Rules of Civil Procedure. Rule 60(b) allows courts to reconsider earlier orders in the case of “mistake, inadvertence, surprise, . . . excusable neglect,” or “any other reason that justifies relief.” According to the Third Circuit, once the bankruptcy court learned of the third-party release after its approval of the disclosure statement, Rule 60(b) permitted the bankruptcy court to revisit that decision. The Third Circuit reasoned that “any other rule would encourage debtors to obscure information in their disclosure statement.”
Finally, when considering whether the bankruptcy court was correct to withhold approval of the third-party release, the Third Circuit applied the standard it had crafted in In re Continental Airlines. Under this standard, some small subset of non-consensual third-party releases might be confirmable where the release is both necessary to the plan of confirmation [sic] and given in exchange for fair consideration. . . . [T]he hallmarks of a permissible non-consensual third-party release [are] fairness, necessity to the reorganization, and specific factual findings to support these conclusions.
Applying the Continental Airlines standard, the Third Circuit held that the third-party release of claims against the indenture trustee could not be approved. In support of this holding, the Third Circuit reasoned that if the bankruptcy judge was not aware of the third-party release, “it seems highly unlikely that a typical Bondholder was.” Thus, absent adequate disclosure of the release to bondholders, it was impossible for the court to conclude that the release was exchanged for adequate consideration or was otherwise fair to the relevant parties.
The Takeaway
The main takeaway from Lower Bucks should be obvious. Just in case it isn’t, the Third Circuit made sure to spell it out in a concluding paragraph seemingly directed at bankruptcy practitioners:
Key terms of a plan of confirmation, particularly those that release a non-debtor from claims by creditors, must be adequately disclosed. Failure to do so in a clear and conspicuous manner risks excision of the release from the plan. That is what occurred here, and thus we affirm.