The Third Circuit Court of Appeals recently affirmed the decisions of the District and Bankruptcy Court denying, for reasons of inadequate disclosure, the approval of a third-party release provision in the Chapter 11 plan of In re Lower Bucks Hospital, et al., Case No. 10-10239(ELF)(“Lower Bucks”). The offending release purported to prohibit a class of creditors that held corporate bonds in the Debtor, Lower Bucks Hospital, from bringing claims against their Indenture Trustee, The Bank of New York Mellon Trust Company, N.A. The permissibility of third-party releases, where a non-debtor receives a release of the claims of creditors, continues to be a controversial issue in the Third Circuit. While the Third Circuit has yet to issue a definitive opinion on when such third-party releases may be granted, the Court emphatically stated that they may not be granted in the absence of clear and conspicuous disclosure to affected parties.
An understanding of the underlying facts is essential to an appreciation of the Third Circuit’s ruling. In the early 1990’s, Lower Bucks issued bonds to refinance some of its debt and to fund certain capital projects. The bonds were secured by interests in the gross revenues of the hospital. The Bank of New York Mellon Trust Company, N.A. (“BNYM”) was appointed as Indenture Trustee and was responsible for maintaining effective financing statements for the Bondholders’ security interests. Lower Bucks underwent some name changes in 1997 and 2006, but BNYM did not file any amended financing statements to reflect the correct name of the hospital until October of 2009. Lower Bucks filed for bankruptcy within 90 days of these amended financing statements.
The Bond Litigation.
An adversary proceeding (“Bond Litigation”) was filed by Lower Bucks against BNYM seeking to reduce the status of the Bondholders from secured to general unsecured creditors, alleging that the security interests in Lower Bucks’ assets were not perfected at the time of its bankruptcy because BNYM failed to timely file amended financing statements after Lower Bucks’ earlier name change. The financing statements that were subsequently filed in October 2009 were filed within 90 days of Lower Bucks’ bankruptcy petition date, exposing the lien created by that filing to a claim for avoidance as a preference under 11 U.S.C. § 547.
The Settlement of the Bond Litigation.
After litigating the Bond Litigation for more than a year, BNYM and Lower Bucks reached a settlement. The settlement stipulation (“Stipulation”) provided that the Bondholders’ asserted secured claim would be reduced from approximately $26 million to $8.15 million. In addition to the customary mutual releases between parties to the settlement, the Stipulation went further and also contained a provision, without any highlighting or emphasis, stating that the eventual plan would provide for a release of all claims against the Bond Trustee by all parties, including the Bondholders, to the extent permitted by applicable law. Lower Bucks then filed a motion seeking approval of the Stipulation pursuant to Fed. R. Bankr. P. 9019 (“9019 Motion”). The 9019 Motion consisted of seventeen pages of mostly single-spaced text that, in similar fashion to the Stipulation, made reference to the purported Third-Party Release by including, without highlighting or reference, the words “and the Bond Trustee” among the parties to be released. Bankruptcy Judge Frank approved the 9019 Motion and Settlement without being aware of the purported third-party release provisions. During the hearing on the 9019 Motion, Judge Frank questioned the litigants about unusual language in the proposed order approving the Stipulation that should have prompted the candor of counsel to fully apprise the Court of the existence of the Third-Party Release.
The Class Action.
In October 2011, Leonard Becker (“Becker”) commenced a class action on behalf of the Bondholders against BNYM, asserting claims for breaches of fiduciary and contractual duties and for negligence for allowing the lien on Lower Bucks’ assets to become unperfected, which resulted in the Bondholders recovering less than the full value of their claims in the bankruptcy case.
The Plan and Disclosure Statement.
Following the approval of the 9019 Motion, the Debtor then filed a proposed plan of reorganization (“Plan”) and disclosure statement (“Disclosure Statement”) where reference to the Third-Party Release was embedded without emphasis in the fine print at the back of each lengthy document. Because of the obscurity of the Third-Party Release in the Disclosure Statement and Plan, as well as the failure of counsel to highlight the issue during hearings before the Court, the Bankruptcy Court was unaware of the presence of the Third-Party Release provision in the Plan when it approved the Disclosure Statement.
Objections to the Third-party Releases.
At this point, Becker’s class action counsel hired special bankruptcy counsel to preserve the claims of the Bondholders against BNYM. A motion for reconsideration of the 9019 approval of the Stipulation was immediately filed. Because delay in the finality of the Settlement threatened the ability of Lower Bucks to obtain the financing necessary for the implementation of its Plan, Becker’s counsel agreed to withdraw the motion for reconsideration with the agreement from Lower Bucks that his right to object to the inclusion of the Third-Party Release in the Plan would be preserved.
Becker’s counsel then filed an Objection to the Plan (“Plan Objection”), asserting that the inclusion of the Third-Party Release was an impermissible, non-consensual release. The Plan Objection brought, for the first time, focus and clarity to the Bankruptcy Court about the existence of the Third-Party Release. Concerned that the resolution of the thorny issues regarding the permissibility such releases might delay confirmation of the Plan beyond the dates of its exit financing commitments, the parties agreed to the unusual procedure of proceeding with Plan confirmation but severing the release issue for later determination, with the express understanding that the confirmation order for the remainder of the Plan would not be affected by the outcome of the Third-Party Release hearing. The Plan, with the Third-Party Release provisions excised, was confirmed.
The Bankruptcy Court and District Court Opinions on the Permissibility of the Third-Party Release.
Several months later, after the conclusion of briefing and argument, Judge Frank issued a thoughtful and comprehensive opinion concluding that the proposed Third-Party Release could not be approved as a non-consensual release absent adequate disclosure. The Bankruptcy Court embarked on a meticulous review of the substance of the various disclosures sent to the Bondholders and concluded that they did not receive adequate disclosure of the Third-Party Release when they voted to accept the Plan. The Court found that there was nothing conspicuous about the Third-Party Release in the any of the disclosures sent to Bondholders and that the Disclosure Statement failed to provide the Bondholders with any information regarding the merits or value of the potential claims against BNYM that would be released in the Plan. The Bankruptcy Court therefore held that the disclosures to the Bondholders were inadequate and that the Third-Party Release could not be approved as a non-consensual release absent adequate disclosure. Judge Frank speculated that this lack of meaningful disclosure was purposeful and intended to avoid opposition by the Bondholders to the confirmation to the Plan. On appeal, the District Court affirmed the Bankruptcy Court decision in all respects.
Third Circuit Analysis
The propriety of non-debtor, third-party releases is controversial, and in previous rulings the Third Circuit left open the possibility that under extraordinary circumstances a small subset of non-consensual third-party releases might be confirmable where the release is “both necessary [to the plan of confirmation] and given in exchange for fair consideration.” See, e.g., Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d. 203, 214 (3d Cir. 2000)( identifying the “hallmarks” of a permissible non-consensual third-party release as “fairness, necessity to the reorganization, and specific factual findings to support these conclusions.”).
The Third Circuit noted the requirements of 11 U.S.C. § 1125 that require disclosure statements to contain adequate information of sufficient detail to enable an informed judgment about the plan. Further, the Court equated the Third-Party Release to an injunction; because by releasing BNYM, the Bondholders are precluded from bringing suit. Federal Rule of Bankruptcy Procedure 3016(c) requires that if a plan provides for an injunction, the plan and disclosure statement “shall describe in specific and conspicuous language (bold, italic, or underlined texts) all acts to be enjoined and identify the entities that would be subject to the injunction.”
Under this statutory backdrop, the Third Circuit embraced the reasoned conclusion of Judge Frank that the Third-Party Release was not adequately disclosed. Reference to the Third-Party Release in the Disclosure Statement was limited to just one paragraph in a 62-page document, and no use of underlined, italicized or boldfaced text was used to emphasize the release provision or to distinguish it from the more ordinary releases between the parties to the settlement. The Third Circuit found the reference to the Third-Party Release in the Plan to be even less direct and similarly obscured by being embedded within more typical releases granted to the Debtor. The release was omitted from numerous sections of the Disclosure Statement where it was arguably relevant. In both presentation and placement, the documents sent to the Bondholders did not differentiate the Third-Party Release from any of the other information provided and no effort was made to bring the existence of the Third-Party Release to the eyes and attention of the Bondholders.
In the absence of adequate disclosure, it was impossible for the Court to conclude that a large majority of the Bondholders supported the Plan and acquiesced to the release of their potential claims against BNYM. As observed by the Third Circuit, if even the Bankruptcy Judge was not initially aware of the existence of the Third-Party Release, it is highly unlikely that a typical Bondholder would be. The Third Circuit therefore was unable to conclude that the Third-Party Release was exchanged for adequate consideration or was otherwise fair to the Bondholders.
This case serves as a cautionary tale of how not to seek approval of third-party releases. Key terms of a plan of confirmation, particularly those that release a non-debtor from claims by creditors, must be adequately disclosed. Failure to do so in a clear and conspicuous manner risks excision of the release from the plan.