In recent years, it has become common practice in large chapter 11 cases for debtors to include language in their proposed chapter 11 plan which purports to release certain nondebtors from the claims of third parties. Although some third parties may consent to the release—such as by voting in favor of the plan or otherwise electing to do so during the plan solicitation process—circumstances frequently arise in which the debtors seek approval from the bankruptcy court to release nondebtors from third parties’ claims without the consent of the third parties.

On August 29, 2019, the U.S. Bankruptcy Court for the Northern District of Ohio issued an opinion in the First Energy bankruptcy case denying approval of the debtors’ disclosure statement because the third party release provision included in the corresponding chapter 11 plan, which would have allowed certain nondebtors to wash their hands of all claims and causes of action related to, among other things, the debtors’ historic business operations and assets, was overbroad and rendered the plan patently unconfirmable. In re FirstEnergy Sols. Corp., 2019 Bankr. LEXIS 2742, at *34 (Bankr. N.D. Ohio Aug. 29, 2019). As an initial matter, we note that courts usually make determinations on the appropriateness of releases at the plan confirmation hearing as opposed to disclosure statement stage; here, the court decided to resolve the issue at the disclosure statement stage because it viewed the proposed nonconsensual third party release provision in the plan as so defective that it rendered the plan patently unconfirmable. Id. at *41. The First Energy decision serves as a cautionary reminder that third party release provisions may not be approved unless, at a minimum, their scope is limited to a well-defined universe of claims and essential to the debtors’ reorganization.

The First Energy court began by surveying the case law on the permissibility of nonconsensual third party releases and observed that “each circuit that has considered nondebtor releases either rejects them absolutely or approves them only reluctantly.” Id. at *44. The Fifth, Ninth, and Tenth Circuits fall into the camp that categorically rejects them. See In re Pac. Lumber Co., 584 F.3d 229, 252 (5th Cir. 2009); Matter of Zale Corp., 62 F.3d 746, 760 (5th Cir. 1995); In re Lowenchuss, 67 F.3d 1394, 1401-02 (9th Cir. 1995); In re Western Real Estate Fund, Inc., 922 F.2d 592, 600-02 (10th Cir. 1990). In contrast, the Second, Fourth, Sixth, Seventh, and Eleventh Circuits allow nonconsensual third party releases under certain circumstances. See In re Seaside Engineering & Surveying, Inc., 780 F.3d 1070 (11th Cir. 2015) (applying Dow Corning factors and authorizing nonconsensual third party releases but only in “unusual” cases); In re Airadigm Communications, Inc., 519 F.3d 640, 657 (7th Cir 2008) (approving nonconsensual third party releases where they are necessary for the reorganization and appropriately tailored); In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141-43 (2d Cir. 2005) (permitting approval under “rare” and “unusual” circumstances where the release is important to the plan and its scope is necessary to the plan); In re Dow Corning Corp., 280 F.3d 648, 658 (6th Cir. 2002) (holding that when seven factors are present, a nonconsensual third party release may be upheld); In re A.H. Robins Company, Inc., 880 F.2d 694, 700-02 (4th Cir. 1989) (approving releases where they were important to the reorganization and nearly all holders of released claims were to be fully compensated from the proceeds of a litigation trust). The Third Circuit has not expressly established a specific standard under which nonconsensual third party releases may be approved. See In re Continental Airlines, 203 F.3d 203, 214 (3d Cir. 2000). Nevertheless, bankruptcy courts within the Third Circuit have acknowledged that such releases are permissible in certain instances. See, e.g., In re Millennium Lab Holdings II, LLC, 591 B.R. 559, 573 (D. Del. 2018) (noting that nonconsensual third party releases are not per se impermissible); In re 710 Long Ridge Rd. Operating Co., II, LLC, 2014 Bankr. LEXIS 863 (Bankr. D.N.J. Mar. 5, 2014) (approving some but not all nonconsensual third party releases); In re Wash. Mut., Inc., 442 B.R. 314, 351 (Bankr. D. Del. 2011) (noting that nonconsensual third party releases are not barred in the Third Circuit). Similarly, although the First and Eighth Circuits have not addressed the issue, bankruptcy courts in these circuits have permitted nonconsensual third party releases. See, e.g., In re Chi. Invs., LLC, 470 B.R. 32, 95 (Bankr. D. Mass. 2012) (approving nonconsensual third party releases); In re U.S. Fidelis, Inc., 481 B.R. 503, 519-21 (Bankr. E.D. Mo. 2012) (same).

After surveying the case law, the First Energy court paused to distinguish the circumstances of First Energy from the seminal cases permitting nonconsensual releases. Id. at *47. The court noted that in precedent cases allowing nonconsensual third party releases, many of which were mass tort cases, the debtors were the primary obligor for the claims being resolved under the plan. Id. In First Energy, however, the releases were intended to cover not just claims against the debtors, but independent, standalone claims against nondebtors held by any party that also held a claim against the debtors. Id. at *51. In addition, the precedent cases involved a pool of assets set aside, at least in part, by the parties receiving the releases for the benefit of creditors deemed to be releasing their claims. Id. at *52. As the court explained, “the release granted to nondebtors typically represents consideration for payments made by those nondebtors to the creditors.” Id. On the other hand, in First Energy, the plan contemplated paying only those creditors with liquidated claims despite including nonconsensual releases deemed to have been provided by holders of unliquidated contingent claims (namely, certain claims related to environmental cleanup obligations and other damages held by the U.S. Environmental Protection Agency, the U.S. Nuclear Regulatory Commission, the Ohio Environmental Protection Agency, and the Pennsylvania Department of Environmental Protection) that would receive no value at all under the plan. Id. at *52-53.

The court then turned to the Dow Corning factors relevant to determining whether a nonconsensual third party release provision passes muster in the Sixth Circuit. First, with respect to the factor that the court characterized as the “least negotiable,” the court said that there was not a sufficient identity of interest between the debtors and the nondebtors receiving the releases because, as mentioned above, certain of the released claims were independent, standalone claims against nondebtors that could not also be brought against the debtors. Id. at *57-63. “The Court cannot release and enjoin claims unless they pose some risk of diminishing the bankruptcy estate.” Id. at *59. And, the court explained, it is not “relevant to examine evidence that such inappropriately released claims are merely theoretical and might not actually exist.” Id. at *40. It is enough for objecting parties to “prove that the Plan would release and enjoin such claims if they do exist.” (emphasis in original). Id. at *59. Second, the court determined that the third party release provision was not essential to the reorganization because, in this particular case, the debtor had expressly agreed to assume liability for many of the claims against nondebtors that were being released. Id. at 65. In the First Energy court’s view, the “purpose of a third-party release is to stop a claimant from making an end run around both the plan’s distribution scheme and discharge injunction by recovering against a nondebtor and causing a contribution claim by the nondebtor to arise against the reorganized debtor that is not discharged.” Id. However, in the First Energy case, the debtors’ assumption of liability for certain of the released claims meant that the effect of the releases would not be, as it might be in other cases, to free the debtors from indemnity or contribution claims that could otherwise hamper the reorganized company. Id. Third, the court said that the creditors deemed to be giving the third party releases were not, as Dow Corning requires, voting overwhelmingly in favor of the plan because they were not entitled to vote on the plan at all. Id. at 68-69. Fourth, the court said that the debtors’ assumption and promise to pay the contingent, unliquidated claims of holders deemed to be providing nondebtor releases (i.e., various state and federal agencies) did not satisfy Dow Corning’s requirement that the plan provide a mechanism to pay such claims. Id. at 71-72. The court also reviewed Dow Corning’s requirement that those choosing not to settle be given an opportunity to recover in full and concluded that it had no application to the circumstances in First Energy. Id. at 75.

It is worth mentioning that the court also noted that the assets contributed to the debtors pursuant to the settlement (hundreds of millions of dollars of cash, three times as much in notes, and certain releases) which mandated that the debtors seek the nonconsensual third party releases at issue may have been able to satisfy Dow Corning’s requirement that the debtor contribute substantial assets to the reorganization, though this would have ultimately been a factual issue to be addressed at the confirmation hearing (the court’s decision was rendered at the disclosure statement stage). Id. at *63-65. In any case, even though the court concluded that the debtors may have been able to establish this factor at the confirmation hearing, it was apparently not enough to save the plan.

Finally, we would be remiss if we did not point out some of the parallels between the First Energy decision and the recent decision issued by the U.S. Bankruptcy Court for the Southern District of New York in the Aegean case. See In re Aegean Marine Petroleum Network Inc., 599 B.R. 717 (Bankr. S.D.N.Y. 2019). In Aegean, which the court in First Energy devotes several pages to discussing, the debtors sought nonconsensual releases of certain key directors as well as their postpetition lender and asset purchaser, Mercuria. Id. at 722. The Aegean court expressed the same reservations about granting nonconsensual third party releases of nondebtors on account of claims that do not affect the bankruptcy estate as did the court in First Energy, but framed the issue as a matter of jurisdiction and due process. Id. at 723. “[W]e are not talking here about a disposition of the Debtors’ own assets, or of the resolution of claims over which we have in rem jurisdiction. Instead we are talking about issuing a ruling that extinguishes one non-debtor’s claim against another non-debtor.” Id. In addition, the Aegean court suggested, as did the court in First Energy, that if there are no claims against nondebtors that a plan provision purports to release beyond the theoretical and meritless, then perhaps the provision’s scope should be narrowed or simply eliminated. Id. at 727. “[I]f the claims that are the subject of the proposed releases would be without merit, that begs the question of why they should be released at all . . . by definition, it cannot be said that the release of a meritless or nuisance claim is essential or integral to anything.” Id. Moreover, the court stated that “a suggestion that [a court] should give releases unless [the court] can come up with a good reason not to do so . . . is the opposite of the approach . . . that ordinary due process considerations require [a court] to take.” Id. at 728. Finally, the Aegean court, like the First Energy court, took issue with the proposed releases because, in its view, the releases were not necessary to the accomplishment of the restructuring transactions. Id. at 728-29. The debtors’ directors that were proposed to be released under the plan had done “what they were paid to do, and that does not mean they are entitled to releases of third party claims.” Id. at 729.

The First Energy decision demonstrates that some courts view the imposition of nonconsensual third party releases through a chapter 11 plan as extraordinary relief that should only be granted in rare cases and with respect to a limited number of claims. It also shows that making an important contribution to the reorganization, including by contributing substantial assets or funding critical to the debtors’ reorganization plan may not, alone, be enough to justify the nonconsensual releases. In addition, demonstrating that the specific claims being released are necessary to the reorganization and that the plan provides for a specific recovery that will benefit the third parties whose claims are being involuntarily released may also make it more likely that a court will grant nonconsensual third party releases. In effect, this may require seeking a release of a narrower set of claims than the broad release that was sought in First Energy.