18 JBKRLP 4 ART. 6 Page 1 18 J. Bankr. L. & Prac. 4 Art. 6. Norton Journal of Bankruptcy Law and Practice August 2009

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1 18 JBKRLP 4 ART. 6 Page 1 Norton Journal of Bankruptcy Law and Practice August 2009 Revisiting the Propriety of Third-Party Releases of Nondebtors Kyung S. Lee, Maria M. Patterson, Jason M. Rudd, and Brian A. Abramson [FNa1] The controversy over the propriety of third-party releases of nondebtors is well documented in modern bankruptcy jurisprudence and practice. The issue of whether the debtor alone should have the benefits of invoking Chapter 11 is ubiquitous in modern practice and arises at some point in most Chapter 11 cases. Why are parties who did not invoke Chapter 11 entitled to a discharge? What is the rationale for giving parties the benefits of injunctions or releases (extraordinary legal and equitable remedies) when the debtor confirms a Chapter 11 case? Why release parties, especially officers and directors, whose very conduct, ineptitude, or avarice caused the company to seek Chapter 11 in the first place? Why are creditors confronted with releasing claims that, if pursued, may lead to a bigger pot for the estate or, depending on the facts, for their class? In this article, we first examine the development of the jurisprudence relating to nondebtor third-party releases and analyze arguments for and against nondebtor releases. In the second part of the article, we then discuss the Travelers case and the decision issued by the Supreme Court on June 18, [FN1] Many thought that the Supreme Court would use the Travelers case to provide guidance on the viability of nondebtor third-party releases in Chapter 11 cases. As discussed in the third part of this article, however, the majority opinion in Travelers did not resolve the question of the propriety of third-party releases under the Bankruptcy Code. A Chapter 11 plan may contain two different types of releases: (1) a release by the estate of claims against parties, and (2) a third-party release. An estate release is a release by the debtor of claims that the debtor itself possesses. In contrast, a third-party release prevents a nondebtor (primarily creditors) from prosecuting claims against another nondebtor. Voluntary third-party releases are those to which a creditor has consented, for example, by agreeing to the release on its plan ballot. Most courts do not find voluntary third-party releases controversial since they represent an agreement between the creditor and the released nondebtor party. In comparison, involuntary thirdparty releases compel a creditor or nondebtor to release another nondebtor without consent. This type of release, sometimes described as a coercive release of third parties, [FN2] is the focus of this article. I. The History of Third-Party Nondebtor Plan Releases and Injunctions Over the last 25 years, the majority of federal circuits have upheld bankruptcy courts' equitable power to release and enjoin claims against nondebtors in order to deal with extraordinary and complex cases. [FN3] The majority view maintains that such releases should be used rarely and granted only in exceptional circumstances but are nevertheless valuable tools for debtors dealing with complex multiparty disputes. [FN4] In contrast, several circuits adhere to the minority view that third-party nondebtor releases violate a strict reading of the Bankruptcy Code and are per se prohibited. [FN5] In this article, we trace the history of nondebtor releases, discuss the current split in the circuits as to the propriety of such releases, and examine the policy arguments advanced in support of nondebtor plan releases as a means for bankruptcy courts to resolve the increasingly complex cases that they face.

2 18 JBKRLP 4 ART. 6 Page 2 A. The Origins of Third-Party Nondebtor Plan Releases and Injunctions Most of the case law regarding nondebtor releases and injunctions has developed since the passage of the Bankruptcy Code in 1978 (Bankruptcy Code). Nevertheless, the origins of third-party nondebtor releases and injunctions date back to the Bankruptcy Act of 1898 (Bankruptcy Act) and the Supreme Court's decision in Stoll v. Gottlieb. [FN6] Ever since Congress vested bankruptcy courts with injunctive powers to discharge debtors, Congress and the courts have been leery of providing a discharge to anyone other than the debtor. This fear was codified in 16 of the Bankruptcy Act, which provided that the liability of a person who is co-debtor with, or guarantor or in any matter a surety for, a bankrupt shall not be altered by the discharge of such bankrupt. [FN7] Courts consistently interpreted 16 to prevent bankruptcy courts from releasing or enjoining claims by a debtor's creditors against nondebtors with liability on the claims. [FN8] Notwithstanding 16's prohibition on nondebtor discharges, parties affiliated with or connected with a debtor-- including but not limited to officers and directors, insurers, employees, creditors, family members, guarantors, and equity holders--sought ways to expand the discharge to the greatest extent possible to release nondebtors from liability. [FN9] Specifically, nondebtor guarantors often tried to sneak in a third-party discharge through negotiated-for plan provisions that released nondebtors from liability on their guarantee of claims against the debtor. If no creditor objected to or appealed the nondebtor releases, the guarantor then used the confirmation order to defeat creditor efforts to collect on the guarantee in other courts. In 1938, the Supreme Court in Stoll emboldened these crafty guarantors. [FN10] In Stoll, the Supreme Court enforced a confirmed plan's discharge of nondebtor guarantors as res judicata to a creditor's postconfirmation state court suit against the guarantors. The Supreme Court specifically stated that it was not holding that bankruptcy courts had jurisdiction and authority to grant such third-party nondebtor releases and even cited to cases holding that 16 prohibits them. [FN11] The Stoll court then found that if creditors did not appeal the bankruptcy court's confirmation of the plan containing a nondebtor release, then the creditors could not collaterally attack the release in separate courts by asserting claims against the released nondebtors. [FN12] The plan at issue in Stoll discharged the debtor's secured bond debt, including nondebtor guarantees of these bonds. Gottlieb held one of the secured bonds discharged by the plan. The bankruptcy court denied Gottlieb's request to modify the confirmation order and remove the nondebtor release. Gottlieb did not appeal the confirmation order, filed a state court action against the guarantor of the discharged debt, and thereafter secured a judgment against the guarantor from the state court. The Supreme Court reversed Gottlieb's state court judgment against the guarantor, holding that the confirmation order's discharge of the guarantor was res judicata against Gottlieb's judgment. The Supreme Court explained that Gottlieb could not use a state court proceeding to challenge the bankruptcy court's jurisdiction to enter the confirmation order. [FN13] Although the Supreme Court specifically refused to rule on whether the bankruptcy court had jurisdiction to release a nondebtor guarantor, the court enforced a confirmed plan with a third-party nondebtor release. The Stoll decision encouraged nondebtors to negotiate for plan provisions with similar releases and injunctions, hoping that inattentive creditors like Gottlieb would not object to the provision until the confirmation order became final. After Stoll, other courts reached similar results where creditors sought to challenge release and injunction provisions in confirmation orders through state court actions against the released nondebtor parties. In Levy v. Cohen, the California Supreme Court, citing Stoll, held that when the creditor failed to appeal the confirmation order, it was res

3 18 JBKRLP 4 ART. 6 Page 3 judicata to the creditors' action against the released nondebtor parties. [FN14] Again, the court ruled on res judicata grounds and did not address whether the bankruptcy court held sufficient jurisdiction or authority to grant such releases in a confirmation order. Under the Bankruptcy Act, courts agreed that bankruptcy courts lacked jurisdiction to release or enjoin thirdparty nondebtors. Nevertheless, as a result of Stoll and similar rulings, third-party nondebtors could still obtain enforceable releases and injunctions in plans if the affected creditors were not careful in opposing such relief in confirmation orders. It was not until the passage of the Bankruptcy Code in 1978 that bankruptcy courts found expanded jurisdiction and equitable powers in support of broader third-party nondebtor releases and injunctions. B. Nondebtor Third-Party Releases Under the Bankruptcy Code Bankruptcy courts' narrow jurisdictional authority under the Bankruptcy Act not only limited the courts' ability to exercise power over third-party nondebtors but also caused the bankruptcy system significant other impediments. [FN15] In 1978, in an effort to cure the Bankruptcy Act's jurisdictional constraints, Congress repealed the Bankruptcy Act and passed the Bankruptcy Code, greatly expanding bankruptcy courts' jurisdiction. [FN16] This expanded jurisdiction granted bankruptcy courts greater power over nondebtors in matters related to bankruptcy cases. [FN17] Bankruptcy Code 524(e) continued Bankruptcy Act 16's prohibition on nondebtor discharges. However, the expanded bankruptcy court jurisdiction and the filing of increasingly complex bankruptcy cases encouraged some bankruptcy courts to exercise equitable powers over third-party nondebtors through Bankruptcy Code 105(a). Specifically, many courts interpreted Bankruptcy Code 105(a) to authorize nondebtor releases and related injunctions when such relief was necessary to deal with extraordinary cases. [FN18] Other courts continued to adhere to a strict interpretation of Bankruptcy Code 524(e), applying it as an absolute bar on all nondebtor releases and injunctions. [FN19] The divergent interpretation of the equitable powers found in Bankruptcy Code 105(a) and 524(e)'s discharge restriction created a split in the federal appeal circuits on the question of whether a bankruptcy court could issue an injunction that relieved third-party nondebtors from postconfirmation liability. 1. The majority view--circuit courts allowing plans to release nondebtors in certain circumstances Since the enactment of the Bankruptcy Code in 1978, the majority of federal circuits have found authority for bankruptcy courts to use third-party nondebtor releases and injunctions to deal with unusual and complex cases. The First, Second, Third, Fourth, Sixth, Seventh, Eleventh, and D.C. Circuits have all ruled, in varying degrees, that Bankruptcy Code 105(a) authorizes a bankruptcy court to issue injunctions or releases benefiting third-party nondebtors. [FN20] The Fourth Circuit's decision in In re A.H. Robins Co., Inc. is a key opinion explaining the justification for using third-party nondebtor releases in resolving certain complex cases and litigation. [FN21] A.H. Robins filed bankruptcy upon being overwhelmed with an avalanche of mass tort product liability suits from consumers injured by the Dalkon Shield, which the debtor manufactured. [FN22] In an effort to resolve these claims and reorganize its business, A.H. Robins' plan of reorganization contained nondebtor releases that permanently enjoined tort claimants from suing the debtor's directors and officers, its insurers, and their attorneys. [FN23] Those claimants would instead recover from trusts funded by some of the released parties. The plan allowed Dalkon Shield claimants to opt out of the nondebtor release, preserving their right to assert direct claims against the debtor's insurers but none of the other released parties. An overwhelming majority of claimants voted to confirm the plan. Those claimants opposing the plan appealed the confirmation order, asserting,

4 18 JBKRLP 4 ART. 6 Page 4 among other arguments, that the plan's third-party nondebtor releases and injunctions violated Bankruptcy Code 524(e). The Fourth Circuit upheld the plan injunctions and releases citing Bankruptcy Code 105(a): Given the impact of the proposed suits on the bankruptcy reorganization and the fact that the [Dalkon Shield claimants] who chose to opt-out could have had their claims fully satisfied by staying within the settlement, the bankruptcy court's equitable powers support the questioned injunction... Permitting a suit by them in violation of the Plan is a defeat of the Plan and a resulting defeat of the other creditors. Particularly since the insurance settlement/injunction arrangement was essential in this case to a workable reorganization, it falls within the bankruptcy court's equitable powers which traditionally have been invoked to the end that... substance will not give way to form, that technical considerations will not prevent substantial justice. [FN24] The Fourth Circuit found that Bankruptcy Code 524(e) did not prohibit bankruptcy courts from exercising their equitable powers to grant nondebtor third-party releases and injunctions through a plan of reorganization when the entire reorganization hinges on release and injunction of the claims. Of particular importance to the A.H. Robins court was that if not enjoined and released, the third-party nondebtor claims would result in indemnity and contribution claims against the debtor, jeopardizing the debtor's reorganization. The court explained: In this situation where the Plan was overwhelmingly approved, where the Plan in conjunction with insurance policies provided as a part of a plan of reorganization gives a second chance for even late claimants to recover where, nevertheless, some have chosen not to take part in the settlement in order to retain rights to sue certain other parties, and where the entire reorganization hinges on the debtor being free from indirect claims such as suits against parties who would have indemnity or contribution claims against the debtor, we do not construe 524(e) so that it limits the equitable power of the bankruptcy court to enjoin the questioned suits. [FN25] Courts following the majority view agree with the Fourth Circuit that Bankruptcy Code 524(e) does not expressly prohibit nondebtor injunctions or releases. [FN26] These courts point to 105(a), which authorizes the bankruptcy court to issue any order, process or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code] as authority to issue nondebtor releases to facilitate a debtor's reorganization and consummation of a plan. [FN27] Following the reasoning in A.H. Robins, other circuits have allowed third-party nondebtor injunctions and releases benefiting a debtor's insurers, shareholders, and directors under Bankruptcy Code 105(a) where the released parties provided a large fund to satisfy the released claims. [FN28] Citing A.H. Robins, the Dow Corning court set out the most widely accepted factors for determining whether a case warranted granting a nondebtor release or injunction. The factors include: [FN29] (1) The identity of interests between debtor and third-party, such as an indemnity relationship, such that a suit against the third-party is in essence a suit against the debtor or will deplete the assets of the estate; (2) The nondebtor has contributed substantial assets to the reorganization; (3) The injunction is essential to reorganization to permit the debtor to be free from indirect suits that would cause indemnitor contribution claims against the debtor; (4) The impacted creditors overwhelmingly voted to accept the plan; (5) The plan provides a method to pay creditors affected by the injunction;

5 18 JBKRLP 4 ART. 6 Page 5 (6) The plan provides payment in full to those creditors who choose not to settle; and (7) The bankruptcy court's records support the injunction or release. In analyzing whether to permit third-party nondebtor releases and injunctions, courts following the majority view have not universally adopted the Dow Corning factors in their analysis. The Second Circuit, for example, in In re Metromedia Fiber Network, Inc., warned that such a standardized test may oversimplify the decision to allow third-party nondebtor releases and injunctions because such expansive equitable powers are not a matter of factors and prongs and proper only in rare cases. [FN30] Courts following the majority view also have not developed a consensus on how far third-party nondebtor releases and injunctions may stretch. For example, some courts allow nondebtor releases and injunctions to stop all future claims, whether or not the creditor asserting the claim consented to the plan and the release. [FN31] Other courts limit third-party nondebtor releases and injunctions to apply only against creditors who have consented by voting in favor of the plan containing the release provisions. [FN32] Although the circuits authorizing third-party nondebtor releases have not adopted a standard analysis for when these releases are proper or how far they may reach, there is consensus in the majority of circuits that such releases have a proper role in resolving complex disputes through plans of reorganization but only in exceptional cases. The court in In re Transit Group, Inc. summarized the generally accepted approach as follows: [I]n order for a debtor to confirm a plan of reorganization containing a non-debtor release, the debtor must demonstrate that unusual circumstances exist, and that the non-debtor release is fair and necessary, utilizing those [Dow Corning] factors listed above that are applicable. A case by case analysis is required. Moreover, allowing non-debtor releases is the exception, not the norm. Debtors should not automatically expect to release officers, directors, insurers, or creditors from future liability, unless some extraordinary reason is proven. [FN33] The majority of circuits allow debtors and nondebtors to provide for third-party nondebtor plan releases and injunctions in a negotiated plan; however, these courts place a high burden on parties to justify the releases and injunctions with a showing of exceptional circumstances. Did the released parties contribute significant value in exchange for the release? Will the released claims receive a substantial recovery? What relief does the plan provide affected parties that oppose the release? Parties seeking such releases should be prepared to answer these questions and establish that the requested releases and injunctions are fair and necessary given the facts of their case. 2. The minority view--federal circuits prohibiting injunctions for nondebtors The Fifth, Ninth, and Tenth Circuits have adopted a minority view that Bankruptcy Code 524(e)'s language expressly limits the scope of any discharge to apply only to claims against the debtor and that courts cannot use 105(a) to circumvent this provision of the Bankruptcy Code by granting relief to nondebtors. [FN34] These courts follow a per se rule that prohibits all nondebtor releases and injunctions based on a strict reading of Bankruptcy Code 524(e). The Ninth Circuit has handed down several opinions consistently denying efforts to grant nondebtor releases or injunctions as violations of Bankruptcy Code 524(e). [FN35] In Lowenschuss, the Ninth Circuit set out a detailed discussion to support the denial of a plan's release of nondebtor parties. [FN36] The debtor in Lowenschuss sought broad releases of his relatives, affiliated companies, and other third parties. The court reiterated its prior holdings that such releases violate Code 524(e)'s prohibition on nondebtor discharges. [FN37] In contrast to the majority view, the Ninth Circuit expressly rejected the application of Code 105(a)'s equitable powers as a means to grant nondebtor releases. The Lowenschuss court also cited Congress's addition of 524(g) to the Bankruptcy Code in

6 18 JBKRLP 4 ART. 6 Page as an argument for why such releases are prohibited. The court explained that Congress expressly limited 524(g)'s scope to only a narrow set of facts, expressing Congress's intent to prohibit such injunctions outside of asbestos cases. [FN38] In Zale, the Fifth Circuit also adopted a strict interpretation of Code 524(e). The Zale court held that bankruptcy courts have no jurisdiction to enjoin litigation against nondebtors, including the debtor's former officers, directors, and insurer, because such actions do not sufficiently relate to the bankruptcy proceeding. [FN39] The Zale court explained that such third-party injunctions may be granted temporarily to aid the debtor's reorganization during the bankruptcy case; however, imposing such injunctions permanently would result in a discharge of nondebtors in violation of 524(e). [FN40] Similarly, the Tenth Circuit in Western Real Estate Fund ruled that a bankruptcy court could enjoin actions against nondebtor parties but only temporarily during the pendency of the bankruptcy case and only to the extent that the defendant party had an indemnification claim against the debtor. [FN41] The court explained that imposing broader or permanent injunctions in favor of nondebtors would violate the Bankruptcy Code by improperly discharging nondebtors. The courts adopting the minority view prohibiting nondebtor releases and injunctions employ a consistent and predictable analysis--third-party releases and injunctions are per se prohibited. Without question, the minority view does not provide bankruptcy courts any flexibility to address the unique facts of increasingly complex bankruptcy cases. Such an approach removes one arrow from a bankruptcy court's quiver in achieving a successful reorganization in some cases. C. The Role that Third-Party Nondebtor Releases Play in the Chapter 11 Process Bankruptcy courts are facing more complex cases, including related litigation and disputes that embroil numerous nondebtor parties. As a result, bankruptcy courts and debtors must fashion creative solutions to achieve a successful reorganization. For plans of reorganization to resolve all claims that affect the debtor, bankruptcy courts and debtors must have the tools to achieve consensus and bring peace to multiparty disputes. Even courts allowing nondebtor releases do so only in exceptional cases when, as exhibited in the Dow Corning factors, the nondebtor parties have provided valuable consideration to the plan process, the plan has provided a means to compensate those affected by the release, the affected creditors overwhelmingly support the plan, and the injunction is truly necessary to the debtor's reorganization. The courts that take the minority view and impose a per se prohibition against nondebtor releases and injunctions rely on strict statutory construction arguments and fail to address the practicalities and equities at work in exceptionally complex and unusual cases. Parties in interest such as the debtor's officers and directors, equity holders, and insurers often have much to offer a debtor and its creditors. The success and failure of many plans of reorganization often balance on designing creative nonmonetary consideration to gain support from a wide array of competing interests. By crafting proper releases and injunctions to protect these parties, the debtor and bankruptcy court can encourage them to participate in the plan reorganization process, contribute value to the creditors, and reach global resolution of expansive litigation. The current split in the circuit case law and the state of uncertainly created by the changing nature of nondebtor plan releases and injunctions create pitfalls for plan negotiators. Even in the federal circuits that uphold third-party nondebtor releases, inconsistent rulings on the permissible scope of such releases may prevent the level of predictability necessary to provide comfort to parties negotiating plan releases. For example, a nondebtor could provide valuable consideration in exchange for a release or injunction only to have that release later deemed unenforceable. The

7 18 JBKRLP 4 ART. 6 Page 7 split in the caselaw and inconsistent application of nondebtor releases and injunctions must be resolved to ensure the proper use of these valuable tools. II. Travelers While the dissent addresses the issue of nondebtor third-party releases in Chapter 11 cases, the Supreme Court's majority opinion in Travelers did not declare a winner of the debate regarding the viability of such releases. The question that seemingly faced the Supreme Court in Travelers was whether the bankruptcy court had jurisdiction to enjoin so-called direct claims against nondebtors. Such claims were asserted in lawsuits based upon allegations that Travelers, [FN42] the primary insurance carrier for debtor Johns-Manville from 1947 through 1976, improperly failed to disclose accurate information about the risks of asbestos, influenced the debtor's failure to make such disclosure, or conspired to assert fraudulent defenses to asbestos plaintiffs' tort claims. [FN43] A. The Johns-Manville Injunctions In 1986, the U.S. Bankruptcy Court for the Southern District of New York confirmed the Chapter 11 plan in the Johns-Manville Corp. bankruptcy case. [FN44] Johns-Manville was a major asbestos producer and manufacturer of asbestos-containing products, and it was driven into bankruptcy in 1982 by litigation brought by tort claimants. Prior to that time, however, Travelers provided 29 comprehensive general liability policies (one for each year of the relationship) and over 425 other policies, including workers' compensation policies, boiler and machinery policies, employers' liability policies, manufacturer and contractor liability policies, owners and contractors protective liability policies, and landlord/tenant general liability policies. [FN45] Based on these policies, Travelers had to indemnify Manville for its substantial asbestos-related liabilities and also had the obligation to defend lawsuits against Manville in courts around the country for asbestos-related claims. [FN46] Accordingly, early in the reorganization process, the bankruptcy court recognized that Manville's insurance policies were the bankruptcy estate's most valuable assets and were the key to any successful reorganization. [FN47] However, the full value of Manville's insurance rights could be collected and used for the benefit of Manville's creditor only if Travelers and Manville's other insurers receive[d] assurance that any liability arising from or relating to their insurance relationships with Manville would be fully and finally resolved. [FN48] As the bankruptcy court noted in 2004: The ultimate challenge... was the crafting of a plan of reorganization for the Debtors which would provide for payment to holders of present or known asbestos health related claims... and those persons who had not yet manifested an injury... and to do so using only the broken shards of a Fortune 500 company that had been crushed by the weight of a century-long entanglement with asbestos. [FN49] To meet this challenge and maximize the value of the insurance rights for Manville's asbestos creditors, the bankruptcy court and the parties devised a solution under which the estate's insurance rights would be marshaled, liquidated, and equitably distributed via a channeling injunction. [FN50] The injunction contained three interrelated provisions. [FN51] First, the court channeled all claims to the Manville Trust: any and all claims... based upon, arising out of, or related to any or all of the Policies... are transferred, and shall attach, solely to the Settlement Fund. [FN52] Second, the court released Travelers from those claims: [Travelers] shall have no further duties or obligations based upon, arising out of or related to the Policies and shall thereafter be released from any and all Policy Claims. [FN53] Third, the court enjoined all future claims for bad faith or insurer misconduct: All Persons are restrained and enjoined from commencing and/or continuing any suit, arbitration or other proceeding of any type or nature for Policy Claims against any or all members of the Settling Insurer Group, and retained jurisdiction to enforce the terms of the confirmation order. [FN54]

8 18 JBKRLP 4 ART. 6 Page 8 In exchange for these three provisions, which Manville and its insurers expected would immunize them from future liability, Travelers contributed almost $80 million to the debtor's estate. [FN55] Subsequently, both the district court and the Second Circuit upheld the confirmation orders against a jurisdictional challenge from a distributor of the debtor's asbestos products who claimed to be a coinsured under some of Manville's insurance policies pursuant to vendor endorsements' contained in the policies and asserted that the bankruptcy court had no jurisdiction to enjoin its assertion of its rights against Travelers and Manville's other insurers. [FN56] In affirming the confirmation order, the Second Circuit found: We conclude that the Bankruptcy Court had jurisdiction over the insurance policies as property of the debtor's estate. Moreover, the court had authority to issue the injunctive orders pursuant to its power to dispose of a debtor's property free and clear of third-party interests and to channel such interests to the proceeds of the disposition. [FN57] Further, the flaw in [the distributor]'s [de facto discharge argument] is that the injunctive orders do not offer the umbrella protection of a discharge in bankruptcy. Rather, they preclude only those suits against the settling insurers that arise out of or relate to Manville's insurance policies. [FN58] The Second Circuit explained that the protection for settling insurers such as Travelers was a cornerstone of the plan and a critical part of the entire reorganization. [FN59] B. Insurer Goes Back to Bankruptcy Court Subsequent to the confirmation and appeal of the confirmation order, certain asbestos claimants began suing Travelers in state courts around the country seeking to impose liability for acts or omissions by Travelers arising from or relating to [its] insurance relationship with Manville. [FN60] The complaints in these cases were crafted to try and circumvent the bankruptcy court's confirmation order by generally alleging that Travelers withheld information from the public regarding the dangers of asbestos. In 2002, Travelers, facing a number of such suits, went back to bankruptcy court to have an injunction issued against these claimants on the basis that direct action lawsuits violated the 1986 plan confirmation order. Following mediation by former New York Governor Mario Cuomo, Travelers agreed to establish settlement funds of $445 million conditioned upon the entry of an order clarifying that the 1986 confirmation orders enjoined the state court direct claims against Travelers. The settlement funds, however, were not to be paid and distributed in accordance with the Manville personal injury trust but instead were to be paid only to certain parties. The bankruptcy court issued the clarification, holding that it had jurisdiction to enforce the 1986 confirmation order, including the injunction. Further, the bankruptcy court held that the 1986 order, which protected Travelers from claims based upon, arising out of, or related to the policies, did not exceed its jurisdiction because such claims would adversely affect the Manville estate. [FN61] In its detailed findings of fact, the bankruptcy court concluded that the extensive and long-lasting relationship between Manville and Travelers demonstrated that Manville was without peer among Travelers insureds and that Travelers learned virtually everything it knew about asbestos from its relationship with Manville. [FN62] It also concluded that the direct claims, whether arising under statutory or common law, turned on allegations as to Travelers' knowledge regarding asbestos. Therefore, the bankruptcy court determined that these claims were inextricably intertwined with Travelers long relationship as Manville's insurer [FN63] and that the bankruptcy court's repeated use [in 1986] of the terms arising out of and related to were not gratuitous or superfluous; they were meant to provide the broadest protection possible to facilitate global finality for Travelers as a necessary condition for it to make a significant contribution to the Manville estate. [FN64]

9 18 JBKRLP 4 ART. 6 Page 9 The bankruptcy court articulated two of the primary justifications for third-party releases of nondebtors--that releases are within the bankruptcy courts' jurisdiction because the released claims would adversely affect the estate and that releases are necessary in order to induce a party or parties to contribute assets to the reorganization plan. An appeal followed this ruling by the bankruptcy court. The district court held that the bankruptcy court indeed had subject matter jurisdiction to interpret and enforce the 1986 Orders and noted that neither the Bankruptcy Court nor the appellees invoke related to jurisdiction in response to the argument that there was no longer a Manville bankruptcy estate for the dispute to relate to. [FN65] It also relied on MacArthur and In re Davis [FN66] for the proposition that the insurance policies were property of the estate, and thus the bankruptcy court could act to protect them from dissipation by direct action claims. [FN67] As to the appellants' arguments that they did not seek to recover against or under the policies but instead sought to hold Travelers liable for its own improper conduct, the district court observed that the Bankruptcy Court found as a fact that the gravamen of these suits is that Travelers learned of asbestos risks from its defense of Manville, and thus the suits were related to Manville and the policies. [FN68] Specifically, the lawsuits were, in fact, creatively pleaded attempts to collect indirectly against the Manville insurance policies. [FN69] An appeal to the Second Circuit soon followed the ruling by the district court. C. The Second Circuit Disagrees with the Lower Courts The Second Circuit disagreed, vacating the district court order and remanding the matter to the bankruptcy court to determine whether the court had jurisdiction to enjoin any of the direct action claims. The opinion framed the question as one of whether the bankruptcy court had jurisdiction to enjoin suits that, as a matter of state law, are predicated upon an independent duty owed by Travelers to the Appellants, that do not claim against the res of the Manville estate, and that seek damages in excess of and unrelated to Manville's insurance policy proceeds. [FN70] The Second Circuit agreed that the bankruptcy court had continuing jurisdiction to interpret and enforce its own 1986 orders but that such a clarification could not be used as a predicate to enjoin claims over which it had no jurisdiction. [FN71] The apparent view of the lower courts that the jurisdictional inquiry [was] a factual one -- that it was sufficient if the claims arose or were related as a matter of fact to the Manville and Travelers relationship- -was too limited, and the inquiry required an analysis of whether the relevant state law imposed an independent duty to plaintiffs on Travelers. The Second Circuit concluded that the direct claims existed independently of the tort claims against Manville that were covered by insurance. Thus reliance upon MacArthur and Davis was misplaced because in both of those cases the claims enjoined were limited to the proceeds of the insurance policies, and thus a recovery by the claimants would reduce the insurance proceeds available to the estate. The appellants' claims in Travelers, according to the Second Circuit, more closely resemble those at issue in Matter of Zale Corp., 62 F.3d 746 (5th Cir. 1995). [FN72] In Zale, the bankruptcy court had approved a settlement by which Zale's directors and officers would accept a judgment in satisfaction of the creditors' committee claims against them, the judgment to be satisfied out of insurance proceeds. The Fifth Circuit also approved an injunction barring the excess D&O carrier from bringing bad faith claims against the primary D&O carrier in connection with the latter's actions in connection with the settlement. The Fifth Circuit had held that the bankruptcy court did not have jurisdiction to enjoin the claim because related to bankruptcy jurisdiction did not extend to claims between nondebtor parties when the claims were not property of the estate. A mere desire to foster and encourage settlement was not enough to give the bankruptcy court jurisdiction. [FN73] The Second Circuit concluded that a bankruptcy court only has jurisdiction to enjoin third-party non-debtor claims that directly affect the res of the bankruptcy estate. [FN74] By so holding, the Second Circuit determined

10 18 JBKRLP 4 ART. 6 Page 10 that it lacked the requisite jurisdiction to enforce the injunction, notwithstanding that the injunction was a necessary condition to the insurers' agreement to contribute funds to the Manville Trust. [FN75] In fact, the court noted that such a ruling could potentially lead to abuse in the form of a bankruptcy discharge arranged without a filing and without the safeguards of the Code. [FN76] D. The Supreme Court Arguments In the briefs and in oral argument before the Supreme Court, the parties did not dispute that a bankruptcy court could enjoin claims that would have an impact upon the estate of the debtor and that the release of those claims was a proper exercise of related to jurisdiction. [FN77] The amicus brief of the Future Claimants Representatives, for example, stated that Code 1334(b) provides bankruptcy courts with subject matter jurisdiction to issue injunctions to preclude third-party actions against insurers where the outcomes of such actions could have a conceivable effect on the bankruptcy estate or would otherwise affect the administration of the estate. [FN78] The Future Claimants Representatives, [FN79] however, argued for a very broad view of conceivable effect that encompasses third-party claims... that directly affect settlements that the insurers will enter into with debtor policyholders and under which the insurers will contribute to the asbestos compensation trust. [FN80] Thus the Future Claimants Representatives asserted the validity of the second justification for nondebtor releases--i.e., that they are necessary conditions to settlements that will bring money into the estate. Petitioner Travelers also took the position that the bankruptcy jurisdiction is not limited to in rem jurisdiction based on the res of the estate but that it includes broad authority to issue orders critical for the fair and equitable resolution of commercial matters... most evident in the mass tort context. [FN81] Travelers cited Drexel, A.H. Robins, and Dow Corning, all of which, as discussed in section I(B)(1) of this article, include nondebtor releases. Interestingly, Respondent Chubb's brief also cited to those cases but for the proposition that those cases properly and narrowly upheld injunctions against nondebtor claims with the common thread... that a non-debtor injunction is permissible only when it is necessary to the debtor's reorganization because claims against the non-debtor would otherwise burden the debtor or threaten to diminish the debtor's estate. [FN82] The Brief for Respondents Pearlie Bailey, Shirley Melvin, General Lee Cole, Robert Alvin Griffin, Vernon Warnell, Lee Fletcher Anthony, and the Cascino Asbestos Claimants echoes the Second Circuit's concern about abuse of third-party releases given in order to obtain funding and likens them to a sale of indulgences to non-debtors. [FN83] III. Supreme Court Decides on Narrow Grounds A. Travelers Does Not Address Bankruptcy Courts' Ability to Give Third-Party Releases Despite the focus in briefs and oral argument on the broader jurisdictional issue, the Court's majority opinion in Travelers, delivered by Justice Souter, fails to address the viability of nondebtor third-party releases in Chapter 11 cases. Rather, as set forth by the Supreme Court: [o]ur holding is narrow. We do not resolve whether a bankruptcy court, in 1986 or today, could properly enjoin claims against nondebtor insurers that are not derivative of the debtor's wrongdoing. [FN84] Instead, in its seven to two decision, the Court held that the Respondents' [FN85] objections to the bankruptcy court's 2004 decision were impermissible collateral attacks on the bankruptcy court's 1986 orders. [FN86] The Supreme Court remanded the case so that the Second Circuit could address the issue of whether any particular respondent is bound by the 1986 Orders or was not given sufficient notice to satisfy due process requirements. [FN87] B. Exploring the Majority Opinion: Stoll v. Gottlieb Revisited The majority began its analysis by observing that Travelers was right in its assertion that whether the Bankruptcy Court had jurisdiction and authority to enter the injunction in 1986 was not properly before the Court of Appeals in 2009 and is not properly before us. [FN88] The Court reasoned that the 1986 orders covered claims, demands,

11 18 JBKRLP 4 ART. 6 Page 11 allegations, duties, liabilities and obligations' against Travelers... based upon, arising out of or relating to Travelers' insurance coverage of Manville [FN89] and that the allegations of the direct claims certainly related to the coverage. The Court noted that the 1986 bankruptcy court orders excluded from the injunction any claims against insurers for their own misconduct that had previously been brought, and that this exception would have been unnecessary had the enjoined claims already excluded claims made directly against insurers for their misconduct. [FN90] It dismissed Respondents' argument that parties in the bankruptcy case, including Travelers, understood the proposed injunction to bar only claims derivative of Manville's liability because unambiguous terms of a court order, like those of a contract, are given effect regardless of the parties' understanding or intent. [FN91] The majority, having concluded that the bankruptcy court in 2004 correctly ruled that its 1986 orders covered the direct claims, and that the bankruptcy court was simply interpreting and enforcing those orders, gave the easy answer to the only question left... whether the Bankruptcy Court had subject-matter jurisdiction to enter the [2004 order]. That answer was in the affirmative; the bankruptcy court had jurisdiction to interpret its own orders, and it explicitly retained jurisdiction to enforce the 1986 injunctions. With that answer in place, the Court then concluded that the Second Circuit should not have re-evaluate[d] the Bankruptcy Court's exercise of jurisdiction in 1986 because to do was a collateral attack on the 1986 orders. [FN92] So long as respondents or those in privity with them were parties to the Manville bankruptcy proceeding [the question for remand], and were given a fair chance to challenge the Bankruptcy Court's subject-matter jurisdiction, they cannot challenge it now by resisting enforcement of the 1986 Orders. [FN93] The Court went on to observe that the Second Circuit's willingness... to entertain this sort of collateral attack cannot be squared with res judicata and quoted the case where one might say non-debtor releases began, Stoll v. Gottlieb: It is just as important that there should be a place to end as that there should be a place to begin litigation. [FN94] C. The Dissent Attempts to Weigh in on the Third-Party Release Debate The dissent, filed by Justice Stevens and in which Justice Ginsburg joined, offered the view that [t]he Court doth protest too much and observed that the majority opinion quickly concludes that all claims based upon, arising out of or relating to the insurance coverage could not be covered by the injunction since a literal reading of the language would include personal injury claims brought by someone injured by a Travelers' employee recklessly driving to court on account of a Manville claim. [FN95] Therefore, once it was clear that a purely literal construction of the orders was not possible, then it was appropriate to construe the order with reference to the limits of the Bankruptcy Court's authority--limits that were well understood by the insurers during the original settlement negotiations--and with reference to the Court of Appeals' interpretation of the Insurance Settlement Order when it upheld it against a jurisdictional challenge in 1988 [FN96] in the MacArthur decision. In his dissent, Justice Stevens, having concluded that the 1986 orders did not unambiguously cover the direct claims and that the best guide to interpretation of those orders was the limits of the Bankruptcy Court's authority, [FN97] went on to engage in a jurisdictional analysis. He observed that [w]hen a bankruptcy proceeding is commenced, the bankruptcy court acquires control of the debtor's assets and the power to discharge its debts. A bankruptcy court has no authority, however, to adjudicate, settle, or enjoin claims against nondebtors that do not affect the debtor's estate. [FN98] Justice Stevens then reviewed statements made by Manville and Travelers in connection with the 1986 orders that acknowledged the limits of the Bankruptcy Court's power. Travelers, for example, had stated that the injunction is intended only to restrain claims against the res (i.e., the Policies) which are or may be asserted, against the Settling Insurers. [FN99] He also looked to the MacArthur decision's understating of the jurisdictional authority of the bankruptcy court, that the order under review precluded only those suits against the settling insurers that arise out of or relate to Manville's insurance policies. [FN100] That interpretation was further supported by section 524(g), modeled on the Travelers injunction, which is limited to claims for a debtor's wrongdoing. [FN101] Finally, echoing Justice Ginsburg at oral argument, [FN102] Justice Stevens asked why Travelers paid more than

12 18 JBKRLP 4 ART. 6 Page 12 $400 million in 2004, observing that [i]f the 1986 injunction were as clear as the Court assumes, surely Travelers would not have paid $445 million--more than five times the amount of its initial contribution to the Manville Trust-- to obtain a redundant piece of paper. [FN103] D. Where Does Travelers Leave Us? Depending on one's perspective in a given Chapter 11 case, the Supreme Court's refusal to decide Travelers on broad jurisdictional grounds may provide continued and welcome freedom to craft plans within those circuits that permit nondebtor releases, especially in certain kinds of cases: 1. Parties (for example, lenders or other institutional investors that often make financial contributions to the estate of a Chapter 11 debtor as part of the debtor's reorganization) are not precluded from doing so although they should be prepared to demonstrate that any protections that they receive from nondebtor releases are justified by the reorganization's need for their financial contribution and that the releases themselves are important to the success of the debtor's reorganization. 2. Professional-service firm partnerships have often funded their Chapter 11 plans with contributions from current and former partners, which (as in Travelers) will make such contributions only if they receive a release in their favor that is binding on all of the partnership's creditors. They should be able to continue to do so with the same kind of showing as referenced in example Debtors wishing to release, under a Chapter 11 plan, their officers and directors from actions that are in some sense derivative of the creditors' claims against the debtor itself but do not have a clear impact on the bankruptcy estate may have the leeway to continue to do so. The Second Circuit, as well as other circuits, has previously found that a bankruptcy court does have jurisdiction to approve a plan of reorganization that causes the involuntary release of such derivative claims, especially where such releases are essential to confirmation of the plan. In re Airadigm Communications, Inc., [FN104] while not falling into one of these categories, illustrates the freedom that some courts will allow to debtors in devising plans of reorganization. Airadigm involved an appeal of a confirmation order in the second Chapter 11 case of a cellular service provider that had bid for C-block licenses from the Federal Communications Commission (the FCC). As a result of Airadigm's failure to pay for the licenses in full, Airadigm's first Chapter 11 case proceeded as if the licenses were no longer an asset of the company. In 2003, however, the Supreme Court concluded in F.C.C. v. NextWave Personal Communications Inc. [FN105] that the FCC could not cancel a C-block license simply because the licensee had filed for bankruptcy prior to payment for the license. Airadigm subsequently refiled for Chapter 11 in 2006 to, among other things, account for the Supreme Court's decision. Airadigm's original Chapter 11 plan was dependent upon financing provided to Airadigm by Telephone and Data Systems (TDS). The subsequent plan, in consideration for this financing, provided TDS with a third-party release for postpetition actions related to the debtor's second bankruptcy filing. The FCC argued that the Bankruptcy Code did not authorize such an involuntary third-party release. However, the Seventh Circuit disagreed, holding that a bankruptcy court may grant an involuntary third-party release under appropriate circumstances. The Court made no mention of the need for any res of the bankruptcy estate to be involved in order for a bankruptcy court to grant such a release. Rather, the Seventh Circuit found that the power of a bankruptcy court to issue such a release is inherent in its broad equity power, as well as authorized by Bankruptcy Code 105(a) and 1123(b)(6). The former section authorizes a bankruptcy court to issue orders necessary or appropriate to carry out the Bankruptcy Code, and the latter section provides that a plan may include any provision not inconsistent with the Bankruptcy Code. Because TDS was providing significant financing to the plan, and