Contributed by Victoria Vron
As previously reported, like the Ninth and Tenth Circuits, the Fifth Circuit in Bank of New York Trust Co. v. Official Unsecured Creditors’ Committee (In re Pacific Lumber Co.), 584 F.3d 229 (5th Cir. 2009) has become the latest circuit to disallow non-consensual third party releases under the theory that a discharge of a debtor does not affect the liability of any non-debtors for such debt. In case there was any confusion caused by the Pacific Lumber decision, the bankruptcy court in In re Bigler LP, Case No. 09-38188 (JB) (Nov. 24, 2010), recently attempted to clarify that Pacific Lumber does not prohibit a debtor’s release of estate causes of action against a third party if the release is validly structured as a settlement of claims under section 1123(b)(3)(A) of the Bankruptcy Code. Unfortunately, the attempted clarification may only lead to further confusion of the issue within the Fifth Circuit.
The Bigler court ruled that even under Pacific Lumber, a debtor may release estate causes of actions if section 1123(b)(3)(A) of the Bankruptcy Code is satisfied. Releases of estate causes of action clearly are not the same as forced releases by non-debtor parties of claims they independently are able to assert, and section 1123(b)(3)(A) expressly recognizes that a plan may incorporate compromises and settlements by the debtor. For a release of estate causes of actions to constitute a valid settlement of claims, however, the Bigler court imposed a seemingly new requirement beyond the exercise of the debtor’s reasonable business judgment – the consent and consideration by each participant in the agreement would be required to release an estate cause of action. Thus, in Bigler, the court held that the debtor’s chapter 11 plan could release estate causes of action and derivative claims against a secured creditor because the secured creditor was providing funding for the chapter 11 plan. Interestingly, notwithstanding the court’s ruling that consideration by each participant in the agreement was required, the court did not mention whether any of the other released parties provided any consideration. If the Bigler requirement of having to demonstrate consideration and consent by each party released by the debtor under a plan is followed by other courts, debtors may find it difficult to include broad releases of estate causes of action in plans.
In releasing derivative claims against the estate – claims that clearly belong to the estate, not third parties, and are within the power of the estate of bring and to resolve — the debtor added seemingly innocuous “belt and suspenders” language to the release, which sought to enjoin third parties from pursuing the derivative claims that had been released by the estate. Arguably, such language was not necessary because, if only the estate has the power to bring and release such claims, then the logical consequence of the release under the plan is that no right by any other party to pursue derivative claims should survive. On the other hand, the plan proponent presumably concluded that there was no harm in expressly reminding third parties that the effect of the release was that they would be prohibited from bringing such actions.
Not quite. The inclusion of that additional language only led to confusion. The Bigler court saw “third parties” and jumped to the conclusion that what the debtor was attempting was a non-consensual third party release prohibited by Pacific Lumber. It, therefore, concluded that the release of estate causes of actions and derivative claims could not bind any party that had objected to such release or voted to reject the chapter 11 plan.
While the Bigler court correctly concluded that Pacific Lumber was not intended to affect releases of estate causes of actions by the debtor (as opposed to a non-consenting third party), the remainder of the court’s ruling may unfortunately lead to some unintended consequences. By holding that the debtor’s release of estate causes of actions cannot bind any non-consenting creditors, the Bigler decision incorrectly implies that a creditor may have the right to pursue a derivative claim belonging to the estate even after the estate’s rights to bring a cause of action have been released in a chapter 11 plan. This is contrary to the well established principal that derivative claims are property of the estate, and if the underlying claim is released by the debtor, the derivative claim is released as well – regardless of whether there is consent by the creditors who may otherwise have had standing to bring such derivative claim before the debtor’s bankruptcy filing.
The Bigler decision also contains another statement that may have unintended consequences. In dicta, the court holds that “a discharge in a rehabilitative plan is limited to claims which arose pre-petition or are specifically enumerated post-petition claims.” Section 1141 of the Bankruptcy Code states that a discharge affects all claims against the debtor that arose pre-confirmation and does not require that the plan specifically enumerate postpetition claims for them to be discharged. It is not clear what the Bigler court meant, and its statement was not relevant to its underlying decision, but future reorganized debtors may have to address this language if parties seek to cite to it in the future.
Increasingly, courts have become more focused on the limits of the scope of permissible non-consensual third party releases in a plan. Bigler shows that this heightened sensitivity can sometimes lead to courts protecting “third parties'” rights when such rights do not exist.