Restructuring

Contributed by Frank Grese
One topic we regularly write about on the Bankruptcy Blog is releases – especially third-party releases. In fact, as recently as Thursday, we wrote about third-party releases. The topic of third-party releases is often controversial, and circuits disagree about the extent to which they are permissible, if at all. In a recent memorandum opinion confirming the chapter 11 plan of drybulk shipper Genco Shipping and its debtor affiliates, the Honorable Sean Lane of the United States Bankruptcy Court for the Southern District of New York in In re Genco Shipping & Trading Limited, et. al. waded into the controversy by considering the appropriateness of third-party releases – and non-consensual ones at that.
Background
The Genco plan provided for certain standard releases and exculpations, including releases granted by the debtors and exculpation for released parties, which were not opposed by any party in interest. In addition, the plan included non-debtor releases granted by certain non-debtor third parties, including, among other parties, parties holding unimpaired claims and equity interests, who were deemed to accept the plan and, thus, not entitled to vote on the plan. Among the non-debtor parties to be released under the plan were the prepetition agent and lenders under the debtors’ three credit facilities, convertible noteholders and their indenture trustee, and parties agreeing to backstop the debtors’ rights offering. The U.S. Trustee and the official committee for equity holders objected to such third-party releases. The U.S. Trustee objected to the extent holders of claims did not affirmatively consent to these releases and argued that a release granted solely because a party was deemed unimpaired under a plan violated section 1124(1) of the Bankruptcy Code (which sets forth the conditions under which a class of claims is impaired) because by requiring that an unimpaired holder of a claim or interest grant a release, the holder is, in effect, relinquishing certain legal rights and, therefore, is not in fact “impaired.” The equity committee objected on the grounds that equity holders were not given the opportunity to vote, the releases were non-consensual, and otherwise failed to satisfy the requirements under Second Circuit law. In particular, the equity committee argued that no mechanism was established to allow an equity holder to exercise a right to opt-out of the releases.
In support of the releases, the debtors noted that no party, including the equity committee or the U.S. Trustee, identified any actual third-party claim that was being released by the parties that were not entitled to vote. With respect to unimpaired creditors, the debtors said that it would be difficult to imagine what possible remaining claims they could have when they were being paid in full under the plan. As to equity holders, the debtors hypothesized that the only claim an equity holder might have would be against directors and officers or certain creditors, but, they noted, such claims were almost certain to be estate causes of action being released by the debtors, without regard to third-party releases. In addition, the debtors noted that the third-party releases under the plan were being granted “to the fullest extent permissible under applicable law” and that courts in the S.D.N.Y. have found this qualification acceptable and have held that a plan is confirmable with such a qualification even if it provides for impermissible, non-consensual third-party releases. The debtors also characterized the binding of unimpaired creditors who did not vote on the plan as an unremarkable feature of any non-consensual third-party release and cited certain S.D.N.Y. cases approving similar treatment. Finally, the debtors dismissed the U.S. Trustee’s “novel” section 1124 argument as irrelevant arguing that section 1124 applies to a class of claims or interests against the debtor as opposed to claims against third parties.
Analysis
After considering the arguments, the court concluded that the non-consensual third-party releases were permissible so long as the Second Circuit standard set forth in Metromedia was satisfied. The Metromedia standard looks to (i) whether the releases are important to a debtor’s plan; (ii) the claims are channeled to a settlement fund rather than extinguished; (iii) the enjoined claims would indirectly impact the debtor’s reorganization by way of indemnity or contribution; (iv) the released party provides substantial contribution; or (v) whether the plan otherwise provides for full payment of the enjoined claims. The Second Circuit has stated that the Metromedia standard is not a matter of factors or prongs, but, instead, requires a finding of unique circumstances. The court agreed in part with the U.S. Trustee that just because a party’s claim or interest is classified under a plan as unimpaired does not mean that the party should automatically be deemed to have granted a release when the Metromedia standard is not met. The court then proceeded to analyze the releases under the Metromedia standard.
First, the court approved all consensual releases under the plan – i.e., by parties that expressly consented to grant the releases or were deemed to have done so through their ability to “check the box” on the plan’s voting ballots. The court noted that this includes those who voted in favor of the plan and those who voted to reject the plan but failed to opt out from granting the release provisions. Second, the court approved all third-party releases for claims that would trigger indemnification or contribution claims against the debtors, explaining that the purpose of such releases is to align with indemnification obligations of the debtors that existed before the filing of the bankruptcy such as indemnification obligations under employment agreements, bylaws, or loan agreements. The court, however, refused to extend its ruling to indemnification obligations that arose out of plan negotiations or negotiations surrounding the restructuring support agreement executed by the debtors, the vast majority of their secured creditors, and holders of unsecured convertible notes. The court reasoned that granting such releases would allow parties to create indemnification obligations simply to gain the protection of a third-party release and quoted case law reaching a similar conclusion on the grounds that the law would be turned on its head if parties could require a third-party release as a condition to a restructuring agreement or plan and circumvent the general rule that non-debtor third-party releases are proper only in rare cases. Third, the court approved third-party releases as to those parties who provided substantial consideration to the reorganization by (i) agreeing to forego consideration to which they would otherwise be entitled and providing a distribution of warrants to existing equity holders; (ii) providing new value to the debtors by agreeing to backstop a rights offering; or (iii) agreeing to receive equity in exchange for debt. The court found that these concessions are “precisely the types of circumstances and ‘give-ups’ that meet the requirements of Metromedia, in return for which it is appropriate to grant the [third-party releases],” and are important to implementation of the plan.
Conclusion
Genco’s ruling – that a plan can require holders of unimpaired claims or equity interests to grant a release to non-debtors even when such parties were not entitled to vote on the plan and did not otherwise consent to, or have an opportunity to opt-out of, granting such a release – is noteworthy because it was presented to the court as a novel issue that no prior case law had addressed. Another noteworthy aspect of the ruling is the court’s refusal to approve third party-releases that arose only out of a restructuring support agreement or plan negotiations.
The court’s ruling on third-party releases is not the only significant aspect of the Genco confirmation opinion – there were also noteworthy conclusions on valuation, including the court’s conclusion that the discounted cash flow methodology is not appropriate in the drybulk shipping context. Stay tuned for more on Genco in the future.