Doing the Splits
In re American Hardwoods—a very different Chapter 11 case involving a dispute between a plywood manufacturer and its lender—held that the bankruptcy court lacked the power to enjoin the lender from enforcing its claim against third party guarantors. In both cases, as the injunction proposed was permanent, the circuit courts analyzed the injunctions as tantamount to non-consensual third party releases.
At the center of this circuit split is the reach of the bankruptcy court’s equitable powers under Section 105(a) as the same may be limited by Section 524(e). Section 105(a) gives the bankruptcy court the power to issue “any order, process or judgment that is necessary or appropriate to carry out the provisions of this title.” Section 524(e) states that a “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” Thus, the crux of the split is whether Section 524(e) prevents the bankruptcy court from using its equitable powers under Section 105(a) to discharge the liability of a third party who may also be liable for the debtor’s debt.
The facts of the Robins case were compelling, as the Ninth Circuit acknowledged in the American Hardwoods case. The funds contributed by the debtor’s insurer and the debtor itself were substantial. The plan was accepted by 94% of the claimants voting for the Plan, which included the injunction. The plan provided for payment in full of all claimants, and the injunction only affected about 1.5% of the claimants. The evidence that was presented demonstrated that the injunction was essential for the success of the reorganization because that reorganization depended on the settling insurer and the debtor being free of indirect claims on either the insurance policies or as a result of indemnity or contribution claims. The Fourth Circuit characterized the permanent injunction in Robins as tantamount to a “channel[ing]” order which enforced a “marshaling of assets.” Section 524(e) is distinguished as not precluding the release and discharge of a third party when that release has been accepted and confirmed as part of a plan of reorganization.
Recognizing Robins as presenting “unusual facts” which were not present in American Hardwoods, the Ninth Circuit took a more literal reading of the two apparently conflicting statutory provisions. It determined that “[w]hile endowing the court with general equitable powers, Section 105 does not authorize relief inconsistent with more specific law.” In re Am. Hardwoods, 885 F.2d 621, 625 (9th Cir. 1989). The Ninth Circuit then interpreted Section 524(e) to specifically proscribe non-consensual third party releases as a limitation on the bankruptcy court’s equitable powers, finding that the permanent injunction requested fell “squarely within the definition of a discharge in Section 524(a)(2)” and therefore could not be authorized. Id. at 626.
The circuit courts lining up with Robins are all “unusual” cases. Further, the circuits aligned with Robins only allow non-consensual third party releases after very specific and extensive factual findings in what they describe as “rare” cases. The Eleventh Circuit in Seaside Eng'g & Surveying allowed third party releases where the technical expertise of the principals was an irreplaceable part of the future success of the reorganized company, the complaining parties were paid in full under the plan, and in a situation in which “such an order [was] fair and equitable under all the facts and circumstances.” SE Prop. Holdings, LLC v. Seaside Eng'g & Surveying (In re Seaside Eng'g & Surveying), 780 F.3d 1070, 1078 (11th Cir. 2015). It noted that the “inquiry is fact intensive to the extreme.” Id. at 1079.
The Sixth Circuit in Dow Corning, a mass tort case like Robins, quantified factors to define if “unusual circumstances” exist that would allow third party releases: (1) identity of interests between debtor and third party; (2) non-debtor contribution of substantial assets to the reorganization; (3) a finding that the injunction is essential to the reorganization; (4) overwhelming creditor support for the plan; (5) payment in full of creditors affected by the injunction under the plan; (6) an opportunity for non-settling claimants to recover in full; and
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