On June 27, 2014, the Fourth Circuit issued its second opinion in the National Heritage Foundation, Inc. (“NHF”) case on the issue of nonconsensual non-debtor releases.Although the Fourth Circuit reiterated that nonconsensual non-debtor releases may be approved in appropriate circumstances, in affirming the district court’s opinion, the Fourth Circuit analyzed the six Dow Corningfactors and again held that NHF failed to provide adequate factual evidence to support the nonconsensual non-debtor releases included in its Chapter 11 plan.

Case Background

In October 2009, the bankruptcy court approved NHF’sfourth amended plan, which contained a nonconsensual release of non-debtor entities including the unsecured creditors’ committee and its members, designated representatives of the committee, officers, directors or employees of NHF, and their successors and assigns (the “Released Parties”).4   The release provided that Released Parties:

shall not have or incur, and are hereby released from, any claim, obligation, cause of action, or liability to any party in interest who has filed a claim or who was given notice of the Debtor’s Bankruptcy Case (the “Releasing Parties”) for any act or omission before or after the Petition Date through and including the Effective Date in connection with, relating to, or arising out of the operation of the Debtor's business, except to the extent relating to the Debtor's failure to comply with its obligations under the Plan.5

In NHF I, the Fourth Circuit vacated the portion of the district court’s judgment affirming the non-debtor releases and remanded the case for further factual findings.In NHF I, the Fourth Circuit instructed the bankruptcy court to make specific factual findings on remand — if the record permitted it — supporting its conclusions that the non-debtor release provision contained in the NHF plan was valid.7

The Lower Court Decisions

On remand, the bankruptcy courtgave the parties the option of reopening the record to present more evidence, but they declined to do so.On remand, multiple parties opposed the non-debtor releases in the bankruptcy court, and in the subsequent appeals, including the Behrmanns, who were the appellants in NHF I.  After reviewing the existing record, the bankruptcy court made factual findings with respect to the six Dow Corning factors, which consider whether:

(1) There is an identity of interests between the debtor and the third party . . . ; (2) The non- debtor has contributed substantial assets to the reorganization; (3) The injunction is essential to reorganization . . . ; (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; [and] (6)  The plan provides an opportunity for those claimants who choose not to settle to recover in full.10

The bankruptcy court concluded that only the first Dow Corning factor clearly weighed in favor of the releases and therefore determined that the nonconsensual non-debtor releases were unenforceable.11

The district court affirmed, concluding that the nonconsensual non-debtor releases were not essential to the plan.12 In particular, the district court noted the absence of any evidentiary support on remand for NHF’s position as to the likelihood of lawsuits, the effects of such lawsuits on NHF and the unsupported conclusion that NHF’s reorganization would fail without the release provisions.13

The Fourth Circuit Decision

The Fourth Circuit affirmed, finding the nonconsensual non-debtor releases to be unenforceable. Although the Fourth Circuit agreed that NHF had demonstrated an identity of interests between itself and the Released Parties, thereby satisfying the first Dow Corning factor, the Fourth Circuit also agreed with the conclusions of the bankruptcy court and the district court that only this factor weighed strongly in favor of the releases.14

As to the second Dow Corning factor (whether the party to be released contributed substantial assets to the reorganization) the Fourth Circuit rejected NHF’s argument that the officers and directors satisfied the requirement by promising to continue serving NHF.15 The Fourth Circuit determined that NHF failed to support this argument with evidence that the officers and directors actually promised to continue serving NHF.16 The Fourth Circuit also determined that the officers and directors (all insiders) did not provide meaningful consideration for the releases because they performed their duties as a result of either being paid or having fiduciary obligations.17

Regarding the third Dow Corning factor (whether the injunction is necessary to a successful reorganization), the Fourth Circuit rejected NHF’s claims that the reorganization is doomed without the release provision. In support of this factor, NHF primarily argued that the risk of litigation from its donors renders the release essential.18      The Fourth Circuit found that NHF “provided little to no evidence regarding the number of likely donor claims, the nature of such claims, or their potential merit” or conclusive evidence that the officers and directors would leave without the release provision.19 Further, the Fourth Circuit agreed with the bankruptcy court that “the risk of NHF’s insiders ‘abandon[ing] ship’ is particularly low, given that most of them are members of a single family.”20 The Fourth Circuit also noted that NHF did not suggest that it would be difficult to recruit new officers or directors.21 The Fourth Circuit concluded that NHF failed to carry its burden concerning the third Dow Corning factor.22

With respect to the fourth Dow Corning factor (whether the impacted class overwhelmingly voted to accept the plan), the Fourth Circuit questioned whether deemed acceptance by an unimpaired class is sufficient to satisfy this factor.23 The Fourth Circuit declined to squarely address this issue, however, concluding that even if deemed acceptance satisfied the fourth factor, “[c]reditor support does not make up for the fact that most of the other Dow Corning factors weigh against enforcing the Release Provision.”24

The Fourth Circuit concluded that NHF did not satisfy the fifth and sixth Dow Corning factors (whether the plan provides mechanisms to pay all or substantially all of the claims of the affected class, and for non- settling parties to recover in full) because (i) the plan made no provision for payment of the affected claims, such as a channeling trust, and (ii) NHF provided no evidence that it employed a process to adequately protect the interests of affected claimants.25 In fact, the Fourth Circuit stated that certain provisions of the disclosure statement concerning the affected class “hardly strikes us as a bona fide effort to ensure consideration of nearly all of the donor class’s claims.”26

Having found evidence to clearly support only one of the Dow Corning factors, the Fourth Circuit agreed with the district court and the bankruptcy court that NHF failed to demonstrate that the circumstances justified approving the nonconsensual non-debtor releases.

Implications

NHF II reiterates that in the Fourth Circuit it is imperative that the proponent of a nonconsensual non- debtor release provide appropriate evidence to establish the facts and circumstances that justify approving such a release.  Although the Fourth Circuit analyzed the Dow Corning factors, it did not draw a bright line as to how many of the six factors must be satisfied in order to support a nonconsensual non- debtor release.  In fact, the Fourth Circuit stated that “[a] debtor need not demonstrate that every Dow Corning factor weighs in its favor to obtain approval of a non-debtor release.”27 Further emphasizing the potential availability of nonconsensual non-debtor releases under appropriate facts and circumstances, in NHF II, as it had in NHF I, the Fourth Circuit expressly stated that its decision not to enforce the non- debtor release was rooted in NHF’s failure of proof.28