What’s Fraud Got to Do With It? Permitting Confirmation Orders to Control Over Plan Language

Contributed by Aliza Reicher
Often, the days leading up to confirmation of a plan are a whir of negotiating activity, involving last-minute compromises and modifications to the plan and confirmation order.  In the rush to confirm a plan of reorganization, it is important to ensure that changes made to accommodate one objection do not inadvertently create another problem.  Moreover, a plan proponent is not required to include the proposed confirmation order in its solicitation materials, and the proposed confirmation order may only be filed with the bankruptcy court days before a confirmation hearing (and after the deadline for objecting to the plan has passed).  What happens when, following the debtor’s emergence from chapter 11, key provisions of the plan and confirmation order conflict?  In a recent decision by the Fifth Circuit Court of Appeals in In re Davis Offshore, L.P., the bankruptcy community learned the lesson of careful drafting and the need to pay attention to the terms of the confirmation order when the court ruled that exculpatory language in an overbroad confirmation order can supersede the exculpatory language in a plan and absolve a party from personal liability – even fraud – when deferring to the confirmation order would lend finality and closure to the bankruptcy process.
To address the financial and legal troubles it was encountering, family owned business, Davis Offshore, L.P., negotiated a prepackaged chapter 11 plan, pursuant to which the family agreed to sell Davis Offshore to a group of investors.  One of the investors was Gregg Davis, the son of the recently deceased patriarch and owner of Davis Offshore.  In exchange for $31 million, Davis Offshore sold its assets through an expedited bankruptcy process, and its chapter 11 plan was confirmed in less than a week.  The plan included releases for all “Debtor Parties” and “Buyer Parties” involved in the transaction.
Half a year after the confirmation of the plan, the Nancy Sue Davis Trust, a Debtor Party, filed a motion to revoke the confirmation order, alleging that Gregg Davis and certain Buyer Parties had perpetrated fraud by, among other things, undervaluing the company in connection with the bankruptcy sale.  Although the bankruptcy court ruled on the merits and concluded that no fraud had occurred, the district court vacated the bankruptcy court’s holding and held that the Trust’s appeal was moot because the plan had been substantially consummated.
Rather than appeal, the Trust filed a new motion to pursue damage claims against certain of the Buyer Parties.  After the motion was found to be an impermissible “collateral attack” on the plan and confirmation order, the Trust appealed, and the appeal was certified for direct review by the Fifth Circuit Court of Appeals.
The Fifth Circuit analyzed two issues on appeal.  First, the Court looked to whether Davis Offshore’s plan or confirmation order barred the assertion of fraud claims against the Buyer Parties and Gregg Davis.  Second, and more importantly, the Court examined whether, if the two documents were inconsistent, which document would prevail.
The Plan’s Release and Exculpation
The plan contained two provisions pertaining to the liabilities of the purchasing parties:  the mutual release language and the exculpation and limitation of liability language.  The mutual release contained in the plan stated that “[u]pon the Effective Date, except for Causes of Action arising under the Purchase Agreement or the Plan,” each of the Buyer Parties released all causes of action against the Debtor Parties, and in exchange for the release and the funding of the Plan, the Debtor Parties released all causes of action against the Buyer Parties.  The exculpatory language further stated that “except for their willful misconduct or gross negligence,” no party would have a cause of action against “the Debtors, the Estate(s), the Reorganized Debtors, [or the] Buyer Parties . . .”  By the terms of the plan itself, the Trust was defined as a “Debtor Party,” but Gregg Davis was not defined as a “Buyer Party” or otherwise within the scope of the plan releases.
The Court noted that not only did the allegedly fraudulent acts occur before the effective date of the plan, but also that the causes of action being asserted did not arise under the plan but rather from “fiduciary, common law and statutory duties.”  In addition, the Trust’s reliance on the willful misconduct exclusion from the exculpatory language was inappropriate because the specific language of the mutual release controlled over the general exculpatory language.  For these reasons, the Court determined that the Trust was barred by the plan from pursuing causes of action against all Buyer Parties, but was not barred from pursuing a claim against Gregg Davis.
The Confirmation Order’s Release
But the Trust still faced an obstacle in pursuing its claims against Gregg Davis – the significantly broader release language contained in the confirmation order.  The confirmation order stated that “[n]one of the Debtors, the Debtors’ directors, officers, employees, equity holders . . . shall have or incur any liability to any holder of a claim or equity interest that arose before the Effective Date of the Plan for any act, event or omission in connection with or arising out of, these Chapter 11 Cases, or in connection with the confirmation of the Plan . . .”
By the plain language of the confirmation order, all officers, including Gregg Davis, were released from claims arising prior to the effective date of the plan.  Therefore, even though not exonerated pursuant to the terms of the plan, Gregg Davis would be exonerated pursuant to the terms of the confirmation order.
Resolving the Ambiguity
Because the interpretation of the plan and the confirmation order separately would return different results, the Court needed to determine which document would control.  The Court held that, though the release and exculpation in the plan were clear-cut, the confirmation order was ambiguous with respect to the scope of Davis’s release or exculpation.  In order to resolve the ambiguity, the Court chose to give credence to the confirmation order because doing so aligned with the overall goal of bringing finality to the sale and the bankruptcy case.
The Fifth Circuit rejected the proposition that, in the event of a conflict between the plan and the confirmation order, the order should control as a rule, even though the bankruptcy court had cited slim legal authority for this holding.  Such a rule, the Court determined, would encourage “errors and abuse.”  Rather, the primary consideration should always be to interpret the documents in such a way that furthers the intent of the agreement between the parties.  Making the ultimate practice point, the court further stated,

In the flurry of activity that normally precedes plan confirmation, the parties have more likely negotiated and studied the terms of the plan itself than the often boilerplate language embodied in the court’s order of confirmation.  It is also not unusual for a plan to be modified before the confirmation hearing, yet the confirmation order, whether drafted by the parties or the court alone, might not reflect last-minute changes.  An error in the confirmation order should not overcome the parties’ negotiated deal.

Moreover, allowing the order of confirmation to stand alone, separate and apart from the plan, in the interpretive process, would tempt parties to insert other provisions in the confirmation order that might not coincide with a plan and, on occasion, might not even comport with the Bankruptcy Code.

The Court of Appeals thus held that, under the circumstances, the confirmation order controlled, and the Trust’s claims were barred against all Buyer Parties and Gregg Davis.  The result should not have a significant impact on most cases because the general practice is to include a provision specifically addressing the issue of conflicts between a plan and a confirmation order, typically with the confirmation order controlling.  In the absence of a specific provision, however, no solid rule exists in the Fifth Circuit for whether the plan or the confirmation order should control.  Davis Offshore certainly alerts parties that they should not assume that either the plan or the confirmation order controls and that they need to pay close attention to both documents.  When the documents are silent, if a conflict arises between a plan and confirmation order, courts in the Fifth Circuit will now implement a reasoned interpretation of the interplay of the two documents, rather than the enforcement of one document over the other.