SBLI - Third Party Releases. Kristopher M. Hansen, Matthew A. Garofalo and Sharon Choi 1. Introduction

Transcription

1 SBLI - Third Party Releases Kristopher M. Hansen, Matthew A. Garofalo and Sharon Choi 1 Introduction One of the fundamental purposes of reorganization in bankruptcy is the debtor s ability to obtain a fresh start. Accordingly, the Bankruptcy Code provides broad powers to bankruptcy courts to release and discharge the debtor of all claims and causes of action. See, e.g., 11 U.S.C. 524(a); However, non-debtors typically request releases from debtors and often request releases from debtors that release them from claims of other third-parties involved in a chapter 11 proceeding, which are commonly and broadly referred to as third party releases. Third party releases often serve as an important component of the consideration offered between parties in a chapter 11 case to achieve consensus around a plan of reorganization or a major settlement. Typically, such releases are sought by parties (i) who are integral to the operation of the debtors business (i.e. current officers and directors), or (ii) whose cooperation may be necessary to allow the debtors to reorganize (i.e. large claim or equity holders or plan sponsors), but often include individuals no longer involved in a debtor s operations who may still be entitled to coverage under a debtor s insurance policies or indemnification obligations (i.e. former officers and directors). While third party releases are commonly included in chapter 11 plans of reorganization, whether courts approve such releases is factually and jurisdictionally dependent and often depends on whether any party-in-interest in the case objects to the release. 2 The Bankruptcy Code does not provide for nor prohibit third party releases. However, section 524(e) of the 1 Kristopher M. Hansen is a partner at Stroock & Stroock & Lavan LLP and is the Co-Chair of the firm s Financial Restructuring Department. Matthew Garofalo and Sharon Choi are associates at Stroock. 2 Often, even where all parties in interest support the releases, the office of the United States Trustee will object to the grant of a third party release with fairly frequent success.

2 Bankruptcy Code makes clear that the discharge of a debtor s obligations does not, by itself, release and discharge the debts of non-debtors. Based on this language, and as discussed further below, some courts take a bright-line approach, holding that they do not have the power to grant releases to non-debtor parties regardless of the context in which they are sought. Most courts, however, employ a facts and circumstances test to evaluate third party releases. Circuit Split on Third Party Releases Third party releases that garner much of the case discussion can generally be broken down into two categories: (i) releases given by the debtor to third parties that some other party objects to, and (ii) releases given by the debtor to a third party that releases the claims of other third parties that could be asserted against the released party, or a release in a plan by one-third party of another third-party s claims, both over the objection of an impacted party. An example of the former is a release in a plan by a debtor to its senior lenders where another debt class objects. An example of the latter is a release by the debtor of its and any other parties claims against the debtor s current and former directors and officers where a class of creditors objects because they believe that they have claims directly against the directors and officers. A minority of Circuit Courts of Appeal, which include the Fifth, Ninth and Tenth circuits, have flatly rejected the proposition that a third party may be granted a release under the Bankruptcy Code due to the specific language of Section 524(e) of the Bankruptcy Code. 3 See In re Lowenschuss, 67 F.3d 1394, 1401 (9th Cir. 1995) (affirming the district court s decision to vacate a release provision, finding that the bankruptcy court lacked the power to approve a provision which released claims against non-debtors); In re W. Real Estate Fund, 922 F.2d 592, 600 (10th Cir. 1990) (finding that a permanent injunction that relieved a non-debtor from its 3 Section 524(e) provides that the discharge of the debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt. 11 U.S.C. 524(e) - 2 -

3 liability to a creditor was inappropriate); In re Zale Corp., 62 F.3d 746 (5th Cir. 1995) (finding that since a permanent injunction improperly discharged a potential debt of a non-debtor, the bankruptcy court exceeded its powers under Section 105); In re Pac. Lumber Co., 584 F.3d 229 (5th Cir. 2009). 4 Courts following this minority view hold that they are powerless to approve third party releases in any context (other than as provided in Section 524(g) described below). The majority of Circuit Courts, however, have held that third party releases may be permitted under special circumstances and that the language of Section 524(e) merely explains the effect of a debtor s discharge and does not prohibit the release of a non-debtor. See In re Specialty Equip. Co., 3 F.3d 1043, 1047 (7th Cir. 1993) ( [The language of Section 524(e)] does not purport to limit or restrict the power of the bankruptcy court to otherwise grant a release to a third party. ). Together with the broad powers provided to the bankruptcy court under Section 105(a) to issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title, a majority of courts have found it to be within their authority to grant third party releases of both consenting and non-consenting creditors. 11 U.S.C. 105(a). Even though courts recognize the possibility of a third party release, actually obtaining one can be a difficult task. As described more fully below, third party releases are only available in rare or unusual circumstances. See In re Dow Corning Corp., 280 F.3d 648, (6th Cir. 2002) ( [S]uch an injunction is a dramatic measure to be used cautiously.... ); In re Continental Airlines, 203 F.3d 203, 214 (3d Cir. 2000); In re Metromedia Fiber Network, In Pacific Lumber, the court went so far as to find that the exculpation clauses contained in the debtor s plan of reorganization that released the non-debtor plan proponents for acts taken during the course of the bankruptcy proceeding were inappropriate. The plan proponents argued that the release was part of their bargain and without it the proponents would not have financed the plan. Regardless, the court stated that that it saw little equitable about protecting the released non-debtors from negligence suits arising out of the reorganization. The court held that such exculpation was not within the scope or intent of section 524(e) and concluded that the release was inappropriate. Exculpation clauses like these that release only the conduct of parties in connection with a chapter 11 proceeding, as opposed to actions occurring prior to a company s bankruptcy filing, are generally acceptable in other courts

4 F.3d 136, 141 (2d Cir. 2005) ( [I]t is clear that such a release is proper only in rare cases. ); In re Airadigm Commc ns, 519 F.3d 640 (7th Cir. 2008). In 2009, the United States Supreme Court had an opportunity to resolve the issue of whether third party releases can be granted, but chose not to do so. In Travelers Indemnity Co. v. Bailey, 129 S. Ct 2195 (2009), the U.S. Supreme Court was asked to interpret a plan of reorganization and settlement approved by the Bankruptcy Court for the Southern District of New York in the Johns-Manville case in 1986 (the 1986 Orders ), which included a discharge of Johns-Manville Corporation, an asbestos supplier and manufacturer of asbestos-containing products, and a release of its insurers from future tort liabilities. As part of the terms of the settlement, the insurers, which included Travelers Indemnity Company, were required to contribute to a settlement trust. Such settlement would release the insurers from Policy Claims which were then channeled to the trust. However, over a decade after the settlement was established, certain claimants brought actions directly against Travelers (the Direct Actions ), arguing that Travelers was obligated to pay claims independent of Manville s wrongdoing. Travelers sought protection under the 1986 Orders and argued that the previously issued injunction disallowed such actions. Travelers asked the Bankruptcy Court to enjoin the Direct Actions and eventually the Bankruptcy Court approved a settlement in which Travelers would compensate the claimants in the Direct Actions and an order would be entered clarifying that the Direct Actions were in fact barred by the 1986 Orders. The settlement and order were appealed and the District Court affirmed, but the Second Circuit reversed, finding that the Bankruptcy Court lacked subject matter jurisdiction to enjoin the Direct Actions since those actions sought to - 4 -

5 recover directly from Travelers for its own wrongdoing. 5 This case was presented to the United States Supreme Court, which had the opportunity to determine whether the Bankruptcy Court had the power to grant the injunctions essentially a third party release contained in the 1986 Orders. The Supreme Court, however, held on procedural grounds that the 1986 Orders were final orders that were not themselves timely appealed and thus prevented the injunction from being challenged on the basis of res judicata and therefore did not decide the issue of the underlying validity of a third party release. 6 Requirements for Third Party Releases While the majority of courts have held that third party releases may be permissible under certain circumstances, courts are not in agreement as to the requirements necessary to approve such releases. Courts have generally agreed, however, that the releases must be important (or necessary) and that the party seeking a release must provide some form of consideration in return. Releases by the Debtor Claims held by the debtor are generally property of the estate. As such, certain courts will grant debtor releases of third parties upon a showing that the releases are in the best interest of the estate. See, e.g., In re Charter Commc ns, 419 B.R. 221 (Bankr. S.D.N.Y. 2009) ( When reviewing releases in a debtor's plan, courts consider whether such releases are in the best interest of the estate. ). This is particularly true to the extent the parties receiving the releases would have indemnification rights back against the Debtors. Id. 5 See Travelers Indemnity Co. v. Bailey, 129 S. Ct 2195, 2202 (2009) (stating that the bankruptcy court mistook its jurisdiction when it enjoined claims brought against a third party non-debtor solely on the basis of that third party s financial contribution to a debtor s estate, because a bankruptcy court only has jurisdiction to enjoin third party non-debtor claims that directly affect the res of the bankruptcy estate ). 6 Id. at 2203 ( [W]hether the bankruptcy court had jurisdiction and authority to enter the injunction in 1986 was not properly before the Second Circuit in 2008 and is not properly before this Court. )

6 Many courts, particularly those in the Third Circuit, have looked to specific factors in determining whether a debtor s release of a non-debtor is appropriate. See In re Washington Mutual, Inc., 2001 WL 57111, at *24 (Bankr. D. Del. 2011); In re Zenith Electronics Corp., 241 B.R. 92, 110 (Bankr. D. Del. 1999). These courts generally look to the 1994 decision by Judge Koger in In re Master Mortgage, who noted that third party debtor releases can create some knotty problems and that courts consider the following factors: (1) if there is an identity of interest between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete assets of the estate; (2) if the non-debtor has contributed substantial assets to the reorganization; (3) if the injunction is essential to reorganization and there is little likelihood of success without it; (4) if a substantial majority of the creditors agree to such injunction, specifically, whether the class, or classes, impacted by the release has overwhelmingly voted to accept the proposed plan treatment; and (5) if the plan provides a mechanism for the payment of all, or substantially all, of the claims of the class or classes affected by the injunction. In re Master Mortgage Inv. Fund, Inc., 168 B.R. 930, 937 (Bankr. W.D. Mo. 1994). Courts recognize that these factors are neither exclusive nor conjunctive requirements, but provide guidance in the assessment by a Court of the fairness of a third party release. Releases by Non-Debtors Releases of non-debtors by other non-debtors may be based on consent or ordered by the court. Notwithstanding the hesitation of courts to grant releases to non-debtors, certain courts will permit such releases to the extent agreed to by the parties. In particular, the First, Eleventh, and D.C. Circuits recognize the ability of the bankruptcy court to approve consensual third party non-debtor releases in the context of settlement agreements. See Monarch Life Ins. Co. v. Ropes - 6 -

7 & Gray, 65 F.3d 973 (1st Cir. 1995) (involving a confirmed plan that included a settlement by creditors of the debtor who, in consideration of their agreement to release claims and contribute to the plan, wanted a permanent injunction to protect them from future lawsuits arising from such settled claims); In re Munford, Inc., 97 F.3d 449, 455 (11th Cir. 1996) (holding that Section 105(a) and the Fed. R. Civ. P. 16 authorize bankruptcy courts to enter bar orders 7 where such orders are integral to settlement in an adversary proceeding. In further support, the court stated that Section 105(a) clearly provides that the bankruptcy court can enter any order necessary or appropriate to carry out the provisions of the Bankruptcy Code, while rule 16 authorizes the use of special procedures to assist the parties in reaching a settlement. ); In re AOV Indus., 792 F.2d 1140 (D.C. Cir. 1986) (stating that the bankruptcy court had jurisdiction to approve a plan even if contained a third party release, which was included as a result of a settlement. ). Because the releases are based on consent, courts are more willing to grant such releases on the theory of contract law, as opposed to the equitable powers of the bankruptcy court. The most controversial of the third party releases are releases between two non-debtor parties sought by a debtor and/or one of the non-debtor parties to facilitate a plan or settlement without the consent of all the parties impacted by the release. While such non-consensual releases are generally disfavored, certain courts, such as the Third and Sixth Circuits, have enumerated several factors to consider that may lead to the approval of the release that flow are similar to those found in Master Mortgage. These courts, as well as courts with less formal tests, all agree that such releases should be the exception and not the rule. 7 In this case, bar orders meant an order barring nonsettling defendants from asserting contribution and indemnification claims against settling defendants

8 Legal Requirements for Non-Consensual Third Party Releases In In re Continental Airlines, the Third Circuit Court of Appeals delineated requirements that must be met in order for releases to be granted to a third party over the objection of a party impacted by the release. The court stated that (1) the releases must be fair, which would require sufficient compensation to the party granting the release, (2) the releases must be necessary to the reorganization, and (3) the bankruptcy court must make specific factual findings to support these conclusions. In re Continental Airlines, 203 F.3d 203, 214 (3d Cir. 2000). The Sixth Circuit Court of Appeals in In re Dow Corning Corp. set forth what is probably the most extensive set of factors for considering such third party releases: We hold that when the following seven factors are present, the bankruptcy court may enjoin a non-consenting creditor's claims against a non-debtor: (1) There is an identity of interests between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate; (2) The non-debtor has contributed substantial assets to the reorganization; (3) The injunction is essential to reorganization, namely, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor; (4) The impacted class, or classes, has overwhelmingly voted to accept the plan; (5) The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction; (6) The plan provides an opportunity for those claimants who choose not to settle to recover in full and; (7) The bankruptcy court made a record of specific factual findings that support its conclusions

9 In re Dow Corning Corp., 280 F.3d 648, 658 (6th Cir. 2002). Clearly, satisfying all seven requirements is very difficult. While looking at similar factors, the Second Circuit has stated that third party releases should only be approved in rare circumstances and that such an inquiry was not a factors-based test. See In re Metromedia Fiber Network, 416 F.3d 136 (2d Cir. 2005). Recently, the Second Circuit stated that it could only approve a third party release if such release affected the bankruptcy estate. See In re Johns-Manville Corp., 600 F.3d 135 (2d Cir. 2010). 8 In In re Johns- Manville Corp., the court, on remand, stated that previous orders issued by the bankruptcy court in 1986 exceeded the bounds of the bankruptcy court s in rem jurisdiction. Id. at 153. While the Dow and Continental courts set forth the broad standards for approving nonconsensual third party releases, the releases in such cases were not approved. Courts in the Fourth and Seventh Circuits, however, have actually upheld third party releases on appeal where, among other things, compensation was provided to the parties who would be enjoined from suing non-debtors, and substantial consideration was provided to the debtors in those cases by the released parties. See In re A.H. Robins Co., 880 F.2d 694 (4th Cir. 1989).; In re Airadigm Commc ns, 517 F.3d 640 (7th Cir. 2008). In In re A.H. Robins Co. Inc., 880 F.2d 694 (4th Cir. 1989), certain personal injury claimants appealed plan confirmation, challenging, among other things, an injunction of suits brought against certain non-debtor entities. The bankruptcy court approved a two class structure (the Settlement ), which included (i) a mandatory non-opt-out class for members of Class A 8 As noted earlier, the Bankruptcy Court previously found that the injunctions in the 1986 Orders applied to not only claims directed at Travelers, an insurer of the debtor, but also to non-derivative claims against the insurer individually. The Second Circuit previously concluded that a bankruptcy court only has jurisdiction to enjoin third party non-debtor claims that directly affect the res of the bankruptcy estate. Id. at 146 (citing to previous opinion, In re Johns-Manville Corp. (Manville III), 517 F.3d 52, 66 (2d Cir. 2008)). Here, the court adhered to its previous holding in Manville III, that the bankruptcy court exceeded its authority in Id. at

10 and a class which allows an opt-out for compensatory damages for Class B members. 9 The Settlement gave the Class B claimants the opportunity to remain in their class and apply to a claims resolution facility or opt out and relinquish the benefits of the Settlement (but retain their right to bring claims against insurers and other medical providers for malpractice). Those who chose to remain in their classes were barred from prosecuting their claims. Those who opted out of the Settlement argued that they had direct causes of action against the debtors directors, an insurer, and their respective law firms. However, such a suit would affect the reorganization process, which was why the claims resolution facility was established to pay the claims of Class B members in full. The court, after considering the impact of the potential suits on the reorganization and the opportunity of Class B members to opt-in to the Settlement and have their claims paid in full, held that it was within its equitable powers (pursuant to Section 105(a)) to support the injunction. 10 In this case, the court stated that it was essential to the reorganization that the Class B claimants who had opted out of the settlement seek satisfaction of their claim from either of the funds provided to them in the plan and the Settlement or not be allowed to interfere with the reorganization at all. In other words, since the claimants had a choice, they could not protest the injunction. The court briefly addressed the conflict regarding the power of bankruptcy courts to discharge liabilities of a non-debtor. The court agreed with the Fifth Circuit and stated that Section 524(e) does not have to be literally applied in every case here, the plan was overwhelmingly approved, Class B claimants were given a second chance to recover in full, those who opted-out of the settlement still retained rights to sue certain other parties, and the 9 Both classes were made up of Dalkon Shield claimants, however, Class B claimants missed the filing deadlines and did not qualify for a non-subordinated recovery from the trust fund established for the claimants in the reorganization. 10 The court analogized the situation to the doctrine of marshalling assets, and provided an example of such situation if a creditor has the ability to choose between two funds to pay its claim, the court has the authority to order the creditor to choose the fund that will not defeat other creditors

11 entire reorganization depended on the debtor being free from indirect claims. Thus, the court held that the injunction was appropriate. Similarly, in In re Airadigm Comms., Inc., 519 F.3d 640 (7th Cir. 2008), the court upheld a release contained in a plan of reorganization. Here, the plan provided a release for a third party financier from liability for any acts arising out of or in connection with the confirmation of the plan (except for willful misconduct). The FCC, a creditor, appealed and stated that such a release was in violation of the Bankruptcy Code. Pursuant to the plan, two payment options were presented: (i) the FCC could take an immediate payout of $33 million and lose its lien in the debtors licenses or (ii) treat its entire $64.2 million claim as secured and receive deferred payments (Section 1111(b) election). In its opinion, the court stated that Section 524(e) did not limit the bankruptcy court s authority to approve third party releases. Instead, the court stated that if Congress had intended such a restriction, it would have used mandatory terms shall or will rather than the definitional term does. The court also held that Congress would have omitted the prepositional phrase on, or... for, such debt, ensuring that the discharge of a debt of the debtor shall not affect the liability of another entity whether related to a debt or not. Id. at 656. Further, the court stated that where Congress intended to limit the powers of the bankruptcy court, it has clearly stated it. See, e.g., 11 U.S.C. 105(b); see, e.g., 11 U.S.C. 1129(a). In addition, the court found that the facts of this case demonstrated that the release was necessary for the reorganization because (i) the limitation was narrow and only applied to claims arising out of or in connection with the reorganization and excluded willful misconduct, (ii) the limitation was subject to other provisions of the plan, and (iii) there was adequate evidence to show that the released financier required such a release before agreeing to provide financing for the reorganization, making the injunction essential to the plan

12 To grant a non-consensual third party release, courts also need to make factual findings that the release is necessary to the reorganization and fair to the party granting the release, and need evidence to so find. In In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005), the Second Circuit made this clear and found that absent sufficient evidence to show that the release provided for in the plan of reorganization was in itself necessary for the facilitation of the plan, the release should not be approved. In Metromedia, the appellants asserted that the releases included in the plan were not authorized by the bankruptcy court, particularly based upon the findings made by the court. The court stated that approval of non-debtor releases is not a matter of factors and prongs. Id. at 142. In fact, the court noted that there are no cases that have allowed non-debtor releases without a finding of circumstances that are portrayed as unique. Id. In this case, the only finding to justify the non-debtor release was that the non-debtor made a material contribution to the estate. However, there was no finding that the non-debtor release itself was important to the plan, and no inquiry was made as to whether such release, which covered a broad scope of third parties and claims, was a necessary component of the plan (this is a minimum requirement, as stated in the Drexel Burnham case). Id Thus, the court concluded that the bankruptcy court s findings were insufficient. The court emphasized the importance of finding that truly unusual circumstances render the terms important to success of the plan focusing on considerations such as when the estate receives substantial consideration for the release, when the enjoined claims are channeled to a settlement fund instead of being extinguished, when the enjoined claims would indirectly impact the debtors reorganization by way of indemnity or contribution and the plan otherwise provided for the full payment of the enjoined claims, if the creditor consents, and when substantial financial contributions from nondebtor co-liable parties provided compensation to claimants in exchange for releases. Id

13 (citing to several cases where the court approved non-debtor releases due to the unusual circumstances surrounding the case). Therefore, the court must make specific factual findings that support its conclusion in order to authorize a non-debtor release. Id. at 143. However, it is important to note that the Second Circuit found this appeal to be equitably moot as the plan of reorganization had already been substantially consummated, and affirmed the district court s decision to grant the release. Id. at 145. The appellants in this case did not seek a stay of the confirmation order. Id. The necessity of sufficient factual findings was also espoused in In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000), where shareholders appealed the release provision in the plan, which enjoined their actions against the debtor s directors and officers. The shareholders questioned the legal and factual basis for the district court s finding that the release was necessary and appropriate to the reorganization. Id. at 211. The Third Circuit held that the release provisions contained in the plan did not pass muster under even the most flexible tests for the validity of non-debtor releases, and found that the hallmarks of permissible nonconsensual releases-fairness, necessity to the reorganization, and specific factual findings to support these conclusions were absent under the facts of this case. Id. In particular, the bankruptcy court did not specifically address the release provision when rendering its order. Therefore, there were no findings to show that the release was fair to the shareholders and necessary to the reorganization. Id. While the district court found the release provisions to be an essential part of the debtors reorganization 11, the Third Circuit stated that the district court assumed facts not of record and drew superficial analogies based on inapposite case law. Id. The district court did not inquire as to whether the release and injunction were fair to the 11 The debtors were obligated to indemnify the directors and officers and would eventually be the ones to bear the burden of the shareholders lawsuits, affecting the property of the estate. In re Continental Airlines, 203 F.3d at

14 shareholders and whether they were given anything in exchange for reasonable consideration. In fact, the shareholders did not receive consideration in exchange for the injunction. In addition, the court found nothing in the record to imply that the success of the debtors reorganization depended even remotely on the injunction of the shareholders action. There was no evidence that the non-debtor directors and officers provided a financial contribution to the debtors plan that was necessary to make the plan feasible in exchange for the release. The court also did not agree with the district court s conclusion that the debtors obligation to indemnify its directors and officers made the release an essential component of the case. Id In conclusion, the court held that the release of the shareholders claims was not supported by sufficient evidentiary and legal basis and thus should not have been approved. Id. at 216. Release Opt-Out and Opt-In Ballot Provisions Certain courts will permit what would otherwise be an impermissible third party release where a creditor has an opportunity to opt-out of such a release and chooses not to. Such an option will typically be provided on a ballot and the releasing party may make its election in connection with voting on the plan of reorganization. See, e.g., In re Washington Mutual, Inc., 2011 WL 81549, at *33 (Bankr. D. Del. 2011). By not opting out of a release, the creditor may be deemed to consent to the release. See In re Conseco, Inc., 301 B.R. 525, 528 (Bankr. N.D. Ill. 2003) (approving releases as consensual where creditors who agreed to be bound, either by voting for the Plan or by choosing not to opt out of the release ); In re Calpine Corp., 2007 WL at *10 (Bankr. S.D.N.Y. 2007) ( [R]elease by Holders of Claims and Interests that vote in favor of the Plan, who abstain from voting and choose not to opt out of the releases, or who have otherwise consented to give a release, and are consensual ). As the releasing party is

15 consenting to the release, some courts view such releases as consensual and appropriate under a contract theory. Some courts, however, have held that consent cannot be implied by inaction. In such cases, the creditor must actually return a ballot affirmatively accepting the plan (but not opting out) to consent to a release. See In re Washington Mutual, Inc., 2011 WL 81549, at *33 (stating that any third party release is effective only with respect to those who affirmatively consent to it by voting in favor of the Plan and not opting out of the third party releases ); In re Zenith, 241 B.R. at 111 (finding that a release provision had to be modified to permit third parties' release of non-debtors only for those creditors who voted in favor of the Plan). But see In re Spansion, Inc. 426 B.R. 114 (Bankr. D. Del. 2010) (permitting releases by classes of creditors who per paid in full and deemed to accept the plan, received adequate consideration for the releases and did not object to the plan). Courts may even require a more affirmative acknowledgement that a creditor actually opt in on its ballot. In any event, to protect against challenges that creditors inadvertently consented to the release, release and opt-out provisions will typically be clearly marked (and often in capitalized and bold type) on the ballot. See, e.g., In re DBSD North America, 419 B.R. 179, 219 (Bankr. S.D.N.Y. 2009) (approving release where ballots set forth in both capitalized and bold text the effect of consenting to the Plan or abstaining without opting out of the release ) (reversed on other grounds). Need to Challenge Third Party Releases at Confirmation Even though third party releases are subject to extremely high legal hurdles, sometimes the releases go unchallenged and unappealed. In such instances, the third party releases may go unnoticed and the releases may become permanent and immune from attack at a later time by the party giving such release. The res judicata doctrine prevents a non-consenting creditor that

16 failed to timely object from challenging the release. As such, it is important for a party opposing the release to raise an objection in the bankruptcy court, and if such objection is overruled, seek a stay of the confirmation order if they plan to appeal. See Travelers Indemnity Co. v. Bailey, 129 S. Ct 2195 (2009). Role of Governmental Entities As noted above, if no party in interest objects to the release, even a release granted in error may sustain a collateral attack. Accordingly, it is often governmental entities, such as the SEC or U.S. Trustee who asserts objections, even where private parties do not. Pursuant to 11 U.S.C. 1109(a), The Securities and Exchange Commission may raise and may appear and be heard on any issue in a case under this chapter, but [they] may not appeal from any judgment, order, or decree entered in the case. Although the SEC may have standing to appear and be heard on the issue of non-debtor releases, the court will not hesitate to approve such an injunction over the SEC s objections. See e.g.. In re Master Mortgage Fund, Inc. 168 B.R. 930 (Bankr. W.D. Mo. 1994) (holding that despite the SEC s objection that the injunction contained in the plan of reorganization violated Section 524(e) of the Bankruptcy Code and therefore did not comply with Section 1129(a)(1), the court found that the issuance of the injunction was appropriate after examination of the facts surrounding this case). The U.S. Trustee is charged with protecting the integrity of the bankruptcy process. As such, the U.S. Trustee may bring an objection for a violation of Section 524(e), and courts will treat such objection as an assertion that the plan does not comply with requirements of Section 1129(a)(2) (The court shall confirm a plan only if the proponent of the plan complies with the applicable provisions of this title ). See e.g., In re Saxby s Coffee Worldwide LLC. (Bankr. E.D. Pa. 2010) (denying confirmation of a plan upon the objection of the U.S. Trustee as the

17 third party release contained in the plan did not satisfy even the most flexible test for non-debtor releases). In fact, even where heavily negotiated plans are otherwise uncontested, it will often be the U.S. Trustee who objects to a third party release and sometimes finds success in doing so. Channeling Injunctions A potential alternative to a blanket third party release is the use of a channeling injunction. A channeling injunction releases a claim against a particular party, but provides the claimant with a separate avenue of redress. See In re Quigley Co., 2010 WL (Bankr. S.D.N.Y. 2010); See also Travelers Indemnity Co. v. Bailey, 129 S. Ct 2195 (2009). Because channeling injunctions provide for some recourse by the claimholders, courts may view them more favorably. Channeling injunctions are specifically authorized in the Bankruptcy Code in cases dealing with asbestos. 11 U.S.C. 524(g). Channeling injunctions have also been used in other mass tort settings. Outside of the mass tort area, however, channeling injections are not typically used. Release of Professionals Notwithstanding the high hurdles associated with third party releases, one exception is the release of negligence claims against persons involved in the debtor s restructuring efforts, including the debtor s officers and directors, the creditors committee members and their respective professionals, for the limited period of time while the debtor is in bankruptcy and limited to the scope of the efforts set forth by the parties in working on the restructuring. See In re PWS Holding Corp., 228 F.3d 224 (3d Cir. 2000). These releases are often deemed important to the reorganization between the debtor and its various constituencies and will be approved if there is a sufficient carve out for gross negligence and willful misconduct. See id; In re Pac. Lumber Co., 584 F.3d 229 (5th Cir. 2009) (approving exculpations of official committee

18 professionals under Section 1103(c), which states that committee members have qualified immunity for actions within the scope of their duties.)