United States: SDNY Bankruptcy Court Rejects Non-Consensual Third-Party Releases

The Bottom Line

Third-party releases attract significant attention and debate in Chapter 11 cases.  A Southern District of New York bankruptcy court recently weighed in on this hot topic and issued a decision in In re SunEdison, Inc., et al., Case No. 16-10992 (SMB) (Bankr. S.D.N.Y. Nov. 8, 2017), Docket No. 4253, that deals a blow to debtors seeking confirmation of a plan of reorganization that includes broad non-consensual third-party releases.  In his decision, Judge Stuart Bernstein denied the Debtors' request to force non-voting creditors to release non-debtor third parties under their plan of reorganization (the "Plan") because the Debtors had failed to demonstrate that: (a) non-voting creditors had impliedly consented to the releases set forth in the Plan, (b) the bankruptcy court had jurisdiction to release the non-voting creditors' third-party claims, or (c) approval of the requested non-consensual third-party releases were appropriate under governing Second Circuit law – Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136 (2d Cir. 2005) ("Metromedia"). 

What Happened?

Background

In Sun Edison, the Debtors filed a Chapter 11 Plan that included broad third-party releases in favor of numerous non-debtor parties, including the various persons related to those non-debtors (affiliates, subsidiaries, advisors, officers, directors, etc.).  Under the Plan, these parties were to be released by "all Holders of Claims entitled to vote for or against the Plan that do not vote to reject the Plan."  Although no non-voting creditor objected to the Plan's non-consensual third-party release provisions, the bankruptcy court sua sponte questioned whether it can and should approve such releases.  Specifically, Judge Bernstein was concerned with the release of a "largely unidentifiable group of non-debtors from liability based on pre-petition, post-petition and post-confirmation (i.e., future) conduct occurring through the Plan's future [e]ffective [d]ate that related in any way to their claims or these bankruptcy cases subject to the usual exceptions for fraud, willful misconduct, or gross negligence." Slip Op. at 4. 

The bankruptcy court ultimately confirmed the Plan in July 2017, but reserved decision on the propriety of the Plan's  release provisions.  (The parties agreed that this reservation would not hold up confirmation of the balance of the Plan).  The Debtors thereafter filed a supplemental memorandum of law in support of the requested releases. 

Consent

Judge Bernstein first addressed whether the non-voting creditors should be deemed to have consented to the Plan's release provisions.  Recognizing that courts generally apply contract principles in deciding this question, it was clear to the bankruptcy court that an affirmative vote to accept a plan containing third-party releases constituted express consent for the release provisions.  The court was troubled by the notion of consent being implied or deemed to have occurred.  For "deemed" consent to apply, the bankruptcy court observed that, generally, a party must have a duty to speak to translate silence into acceptance; however, assent by silence can also be recognized where (1) it is supported by the parties' ongoing course of conduct, (2) the offeree (a) accepts the benefits of the offer despite a reasonable opportunity to reject them and (b) understands that the offeror expects compensation, or (3) the offeror has given the offeree reason to understand that silence will constitute acceptance and the offeree in remaining silent intends to accept the offer.

The Debtors relied on exception (3), and argued that their disclosure statement and voting ballots warned of the imposition of a third-party release if the Plan was not timely accepted or rejected because the non-voting creditor would be deemed to consent to the release.  This argument was supported, according to the Debtors, by bankruptcy cases in both the Southern District of New York and Delaware. 

Ultimately, the bankruptcy court rejected this argument, and Judge Bernstein held that the Debtors had failed to show that non-voting creditors' silence was misleading or that it signified consent to the Plan's release provisions.  The court noted that there were various reasons that creditors did not object or respond to the Plan; for example, unsecured creditors were receiving a minor 3% recovery under the Plan which didn't warrant their participating in the solicitation and objection process. 

Jurisdiction

Next, Judge Bernstein addressed whether the bankruptcy court had jurisdiction to enjoin creditors' claims against third parties.  The court noted that a released party's financial contribution to the estate, without more, does not confer subject matter jurisdiction to enjoin claims against this party and thus third-party releases are proper only in rare and unique circumstances.  Nevertheless, Judge Bernstein cited Metromedia  for certain situations in which a court may approve third-party releases, including whether the estate has received a substantial contribution, whether the enjoined claims are channeled to a settlement fund rather than being extinguished, whether the enjoined claims would indirectly impact the debtors' reorganization through claims of indemnity and contribution, whether the plan otherwise provides for payment in full of the enjoined claims, and whether the creditor has consented. 

Arguing in support of the releases, the Debtors attempted to invoke subject matter jurisdiction by arguing that the Debtors' had provided indemnification to certain non-debtor parties, including their directors and officers, and pre-petition secured creditors who participated in the Debtors' DIP financing facility. 

Judge Bernstein was not persuaded.  The bankruptcy court found that the Plan's release provisions would benefit a litany of non-debtor parties who were not entitled to indemnification and therefore the mere reference to indemnification owed to a few parties did not establish that the universe of claims the Debtors sought to enjoin would have a conceivable effect on the bankruptcy estate.  This, together with the fact that non-voting creditors did not

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