Contributed by Victoria Vron
The decision of the United States Court of Appeals for 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 created troubling case law for the future of non-consensual third-party releases and exculpations in chapter 11 cases, at least in the Fifth Circuit.  Although the permissibility of non-debtor releases for prepetition conduct has been the subject of debate among the courts for years (see below), exculpation of non-debtors for postpetition conduct has not been as greatly debated by the courts.  The Pacific Lumber Court has now extended the debate over non-debtor releases for prepetition conduct to non-debtor exculpations for postpetition conduct.  In the year since this decision was issued, courts in the Fifth Circuit have relied on the Pacific Lumber decision to deny third party releases and/or exculpations in chapter 11 plans in cases where parties in interest objected to such third party releases or exculpations.

In Pacific Lumber, a secured creditor joined with a competitor of one of the debtors to propose a chapter 11 plan.  The plan included a provision, not uncommon in chapter 11 plans, that exculpated the plan proponents, the reorganized debtors, and the unsecured creditors’ committee from liability (other than for willfulness and gross negligence) related to proposing, implementing and administering the chapter 11 plan.  As part of the chapter 11 plan, the plan proponents contributed $580 million to fund distributions under the plan and the secured lender agreed to convert its $160 million senior secured claim into equity.  The plan proponents insisted that the exculpation was part of their bargain with the debtors because, without such a provision, neither plan proponent would have provided the financing for the chapter 11 plan.
The chapter 11 plan was rejected by the noteholders and the indenture trustee for the notes and certain noteholders objected to confirmation of the plan.  The bankruptcy court nonetheless confirmed the plan and the indenture trustee appealed to the Court on the ground that the plan was unconfirmable, because among other things, it contained impermissible third party releases.  On appeal, the Court determined, based on its review of the law on third-party releases and exculpations throughout the country, that the exculpation was inappropriate as to anyone other than the unsecured creditors’ committee.  The Court stated that it “[saw] little equitable about protecting the released non-debtors from negligence suits arising out of the reorganization.”  Pacific Lumber, 584 F.3d at 252.  It then relied exclusively on section 524(e) of the Bankruptcy Code for the proposition that non-consensual releases of non-debtors are not allowed.  Section 524(e) of the Bankruptcy Code provides that a “discharge of a debt of a debtor does not affect the liability of any other entity on  . . . such debt.”
When asked to consider the more lenient approaches of other circuits to releases and exculpations, particularly those that relate to the chapter 11 case and the plan, the Court incorrectly concluded that other circuits only allow third-party releases and exculpations in cases involving global settlements of mass claims against the debtor and co-liable parties.  Thus, notwithstanding that the plan proponents made what appears to be a substantial contribution to the chapter 11 plan, the Court found that because the plan proponents were neither jointly liable on any of the debtors’ debts nor guarantors, sureties or insurers, they could not be released from any negligent conduct that occurred during the course of the chapter 11 cases.  The Court determined, however, that the exculpation was appropriate as to the unsecured creditors’ committee and its members because section 1103(c) of the Bankruptcy Code implies that members of the unsecured creditors’ committee have qualified immunity for actions taken within the scope of their duties.
Although Pacific Lumber has not yet been followed outside the Fifth Circuit, at least one lower court in the Fifth Circuit has stricken exculpation and third-party release provisions from a chapter 11 plan as a result of Pacific Lumber.  In Pilgrim’s Pride Corporation, et al., 2010 Bankr. LEXIS 72 (Bankr. N.D. Tex., Jan. 14, 2010), the United States Bankruptcy Court for the Northern District of Texas declined to approve releases and exculpations of debtors’ employees, officers, directors and professionals, as well as other third parties (other than the creditors’ committee and its members and professionals), even though Pilgrim’s Pride’s chapter 11 plan paid creditors in full in cash, and there was no indication of bad conduct by any of the third parties or professionals.  The Pilgrim’s Pride court acknowledged that “a third-party exculpation provision arguably might be defended as justified by the bankruptcy court’s equitable powers given by [section 105 of the Bankruptcy Code],” id. at 9, but felt constrained by Pacific Lumber to follow the Fifth Circuit precedent.  The court allowed exculpations of the creditors’ committee, its members and its professionals, however, because of section 1103 of the Bankruptcy Code.  In addition, potentially recognizing the troubling limitations of Pacific Lumber, the court found that “[t]o the extent [d]ebtors acted in the [c]hapter 11 [c]ases, other than in bad faith, pursuant to the authority granted by the [Bankruptcy] Code or as directed by court order, [d]ebtors’ management and professionals presumptively should not be subject to liability.”  Id. at 11.  Accordingly, the court created a mechanism to provide some protections for the debtors’ management and professionals by channeling to the bankruptcy court claims that may be asserted against the debtors’ management and professionals based on their conduct in pursuit of the chapter 11 cases.
As interpreted by the Pilgrim’s Pride decision, Pacific Lumber appears to have some strange consequences.  For example, it allows full exculpation of the creditors’ committee’s professionals, but only presumptive immunity for a debtor’s professionals.  Moreover, Pacific Lumber further highlights the split among the circuits on the issue of third party releases.  While some circuits have flatly rejected third-party releases as antithetical to the Bankruptcy Code, see, e.g. Resorts Int’l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401-02 (9th Cir. 1995) (finding that third party releases are impermissible); Landsing Diversified Properties-II v. First Nat’l Bank and Trust Co. of Tulsa (In re Western Real Estate Fund, Inc.), 922 F.2d 592, 601-02 (10th Cir. 1990) (holding that permanent injunctions that release non-debtors of their own liability to third parties are impermissible), others circuits are more receptive to third-party releases where unique circumstances arise, see, e.g., In re Specialty Equipment Cos., Inc., 3 F.3d 1043, 1047 (7th Cir. 1993) (holding that third-party releases that apply only to those creditors who vote in favor of the plan are permissible); Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 214 (3d Cir. 2000) (noting that the hallmarks of permissible non-consensual third-parties releases are fairness, necessity to the reorganization, and specific findings to support these conclusions); Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 142-43 (2d Cir. 2005) (noting that third-party releases may be allowed in unique circumstances, but noting that such unique circumstances may exist where, for example, the estate receives substantial consideration for the release, or where the plan provides for payment in full of the enjoined claims).  Courts in the more permissive jurisdictions also commonly approve provisions in chapter 11 plans that exculpate third parties from conduct related to the chapter 11 case.  It will be interesting to see if these courts will become weary of approving such exculpation provisions in light of Pacific Lumber.