Reorganization plans are negotiated and drafted with the intent of resolving all matters affecting the debtor. It goes without saying that if the debtor is to successfully reorganize, the plan must provide for the resolution of all claims and causes of action that have been or that may be brought against the bankrupt individual or entity. One of the strategies used with increasing frequency to ensure that the reorganized debtor truly has a fresh start is to expand the scope of the plan discharge to include a release of claims against non-debtor third parties with an ongoing affiliation or relationship with the debtor. In the alternative, the plan may include provisions to permanently enjoin claims or causes of action against these third parties. These strategies have been especially popular and, it is argued, necessary in plans proposed by so-called "mega" debtors, who may continue to face post-confirmation indemnification claims arising from officer and director liability¹ and from payments made by the debtor's insurance carriers. As a result, the non-debtor release and/or permanent injunction provisions are being litigated with increasing frequency at confirmation. This litigation focuses on the interplay between 11 U.S.C. §§105(a) and 524(e).

Under 11 U.S.C. §524(e), "the discharge of a debt of a debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt." On its face, it would appear that §524(e) precludes bankruptcy courts from discharging the liabilities of non-debtors. However, under 11 U.S.C. §105(a), bankruptcy courts are given broad equitable powers "to issue any order, process or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]." Does this mean that bankruptcy courts can resort to the §105(a) powers to validate a non-debtor release or permanent injunction? Not necessarily. The powers under §105(a) are not unfettered. As a general rule, the equitable powers under §105(a) cannot be used by the courts to authorize relief inconsistent with a more specific provision of the Code. Northwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988). Thus, the question becomes one of whether a court can utilize its equitable powers of §105(a) in light of the apparent prohibition on non-debtor releases and/or permanent injunctions contained in §524(e).

The case of In re Transit Group Inc., 286 BR 811 (Bankr. M.D. Fla. 2002), is the latest decision to examine this interplay. In Transit Group, the reorganization plan proposed to release all claims and causes of action against the debtor, the debtor's children, the debtor's professional corporation and the pension plan for debtor's professional corporation; to release all liens against certain trusts, custodian accounts and the pension plan for the debtor's professional corporation; and to satisfy all outstanding judgments, executions and levies against the released persons, entities and their affiliates. Transit Group, 286 B.R. 814-15. After conducting a thorough analysis of existing law, the court ruled that §524(e) does not bar non-debtor releases or permanent injunctions in appropriate circumstances where substantial contributions have been made by the released parties to the debtor's reorganization. Transit Group, 286 B.R. at 817-18.

In so ruling, the Florida district court aligned itself with the majority view held by the Second, Third, Fourth, Sixth and Seventh Circuits. See In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002); In re Continental Airlines, 203 F.3d 203 (3rd Cir. 2000); In re Specialty Equipment Co. Inc., 3 F.3d 1043 (7th Cir. 1993); In re Drexel Burnham Lambert Group Inc., 960 F.2d 285 (2nd Cir. 1992); In re A.H. Robins Co. Inc., 880 F.2d 694 (4th Cir. 1989). In these circuits, courts have held that bankruptcy courts have the power under §105(a) to issue permanent injunctions or third-party releases under appropriate factual circumstances.

Of the cases supporting non-debtor releases and permanent injunctions, A.H. Robins and Drexel Burnham offer the best sets of facts to justify the inclusion of a non-debtor release and/or permanent injunction in the debtor's plan provisions. A central focus of these reorganizations was the global settlement of massive tort liabilities asserted against the debtors and co-liable third parties. The co-liable third parties contributed hundreds of millions of dollars to the debtors' reorganization plans to compensate claimants and make the debtors' plans feasible. As a result, the co-liable third parties appropriately expected and demanded releases in consideration for the payments to the debtors. The courts granted the requested relief, dispelling of the arguments made by creditors that §524(e) precludes third-party releases and permanent injunctions.

More to the point, the A.H. Robins court determined that §524(e) should not be applied literally in every case as a prohibition on the court's equitable power to approve the injunction where the facts justify its inclusion. The court relied on facts evidencing that the plan had been overwhelmingly approved by creditors, that the Plan B opt-out members chose not to take part in the settlement that would have paid them in full, and that the reorganization hinged on the debtor being free from indirect claims against parties who would have indemnity or contribution claims against the debtor. A.H. Robins, 880 F.2d at 701-02.

In Drexel Burnham, the court cited to A.H. Robins in ruling that a bankruptcy court "may enjoin a creditor from suing a third party, provided the injunction plays an important role in the debtor's reorganization plan." Drexel Burnham, 960 F.2d at 293. The court concluded the injunction was appropriate because the injunction was an essential element of the settlement, and thus the reorganization. Id.

A third case, which is often identified as a seminal holding for the proposition that third-party releases and injunctions are appropriate, is Dow Corning. Although the Dow Corning court rejected the debtor's request to include non-debtor releases and a permanent injunction in its plan, the court aligned itself with the majority in finding that such provisions are appropriate when "unusual circumstances" are present. Dow Corning, 280 F.2d at 658. The court held that §524(e) does not prohibit the release of a non-debtor, but rather only explains the effect of the debtor's discharge. The court then determined that the court's equitable powers under §105(a), when combined with the provisions of §1123(b)(6),² gives bankruptcy courts the authority to enjoin non-consenting creditors' claims against third parties when "unusual circumstances" exist. Dow Corning, 280 F.2d at 658, citing A.H. Robins and Drexel Burnham.

What makes the Dow Corning decision so important is that the court took the time to distill and articulate the factors relied upon by the A.H. Robins and Drexel Burnham courts in finding that a non-debtor release or injunction was appropriate under the circumstances. The factors articulated by the Dow Corning court are:

1. the identity of interests between debtor and third party, such as an indemnity relationship, are 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 non-debtor 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;
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.

Dow Corning, 280 F.3d at 658.

Many courts that follow the majority view now rely on these factors and §105 to conduct their analysis of the appropriateness of a non-debtor release or injunction. In fact, the Transit Group court specifically relied on the Dow Corning factors in reaching its holding. Transit Group, 286 BR at 817-18.

In contrast to the reliance on §105(a) found in A.H. Robins, Drexel Burnham, Dow Corning and their progeny, the minority view in the Fifth, Ninth and Tenth Circuits hold that §105(a) cannot be used to authorize relief inconsistent with the provisions of the Code. See In re Lowenschuss, 67 F.3d 1394 (9th Cir. 1995); In re Zale Corp., 62 F.3d 746 (5th Cir. 1995); In re Western Real Estate Fund Inc., 922 F.2d 592 (10th Cir. 1990). These courts, which reject non-debtor releases or permanent injunctions, are best described as courts of strict construction with respect to this issue. The minority view finds that the plain language of §524(e) limits the scope of discharge to claims against the debtor. Accordingly, it is the opinion of these courts that §105(a) cannot be used by bankruptcy courts to discharge the liabilities of non-debtors because such relief would be inconsistent with the specific provisions of §524(e). In other words, the minority concludes that the bankruptcy courts lack the power to discharge any claims against non-debtors.³

The Zale and Western Real Estate cases are strikingly similar in their holdings in this vein. In both cases, the courts held that a temporary injunction or stay prohibiting actions against non-debtors under §105 may be permissible during the pendency of a bankruptcy to facilitate reorganization. Zale, 62 F.3d at 760; Western Real Estate, 922 F.2d at 601. However, the stay may not be extended post-confirmation in the form of a permanent injunction that effectively relieves the non-debtor from its own liability to third parties. See Zale, 62 F.3d at 760 citing Western Real Estate, 922 F.2d 601 ("Not only does such a permanent injunction improperly insulate non-debtors in violation of §524(e), it does so without any counteracting justification of debtor protection...").

Although the minority view depends on a strict interpretation of the Code, the holding in Lowenschuss takes the analysis a step further. In fact, the Ninth Circuit holding in Lowenschuss provides the strongest support for denying confirmation of plans that include non-debtor releases and injunctions intended to protect third parties. In Lowenschuss, the debtor's plan contained a global release for the debtor, the debtor's children, the debtor's professional corporation and the pension plan for the debtor's professional corporation, as well as a release of all liens against certain trusts, custodian accounts and the pension plan, and a satisfaction of all outstanding judgments, executions and levies against released persons and their affiliates. Lowenschuss, 67 F.3d at 1401.

The Lowenschuss court rejected the debtor's argument that the global release was appropriate. The court first noted that bankruptcy courts lack the power to confirm plans of reorganization that do not comply with applicable Code provisions as required by 11 U.S.C. §1129(a)(1). The court then noted that the plain language of §524(e) does not provide for the release of third parties from liability and the inclusion of such releases is inconsistent with the Code. This interpretation, it stated, was consistent with a long line of Ninth Circuit law that holds that §524(e) precludes a bankruptcy court from discharging liabilities of non-debtors. Lowenschuss, 67 F.3d at 1401-02, citing American Hardwoods Inc. v. Deutsche Credit Corp. (In re American Hardwoods Inc.), 885 F.2d 621, 626 (9th Cir. 1989); Underhill v. Roay, 769 F.2d 1426, 1432 (9th Cir. 1985); Commercial Wholesalers Inc. v. Investors Commercial Corp., 172 F.2d 800, 801 (9th Cir. 1949).

The court rejected the notion that the general equitable powers bestowed upon a bankruptcy court under §105(a) permits a court to approve such releases. The court noted that this argument was specifically rejected in its holding in American Hardwoods. See American Hardwoods, 885 F.2d at 625-26. Section 105, the court held, "does not authorize relief inconsistent with more specific law...[and] the specific provision of §524 displaces the court's equitable powers under §105 to order the permanent relief [against the non-debtor] sought by [the debtor]." Lowenschuss, 67 F.3d at 1402, citing American Hardwoods, 885 F.2d at 625-26.

The strong support for the court's decision comes from the court's inclusion of an analysis of the 1994 amendments to the Bankruptcy Code and the resulting addition of §524(g). Under this provision, bankruptcy courts are permitted to issue injunctions against third parties to prevent litigation in asbestos cases where certain conditions are satisfied. The Lowenschuss court stated that "[t]he numerous conditions of §524(g) make it clear that this subsection constitutes a narrow rule specifically designed to apply in asbestos cases only.... That Congress provided explicit authority to bankruptcy courts to issue injunctions in favor of third parties in an extremely limited class of cases reinforces the conclusion that §524(e) denies such authority in other non-asbestos cases." Lowenschuss, 67 F.3d 1402, n.6.

Although the Ninth Circuit's analysis in Lowenschuss has strong appeal, the minority's strict adherence to the plain-language doctrine may be detrimental to the flexible approach needed in the large bankruptcy cases being filed today. One only has to look at the news headlines to realize that bankruptcy courts are facing increasingly complex issues in increasingly complex cases. As a result, the equitable powers of a bankruptcy court are often needed to accomplish the goals of the debtor and the creditors, or to fill in the gaps where the Bankruptcy Code may be silent. The flexibility of the majority view and their ability to grant relief warranted by the circumstances of the case is just the kind of approach desired by those involved in complex cases. For this reason, the majority view appears to be the appropriate analysis for the current bankruptcy climate.

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Footnotes

¹ Indemnification claims would continue post-petition where the debtor has elected to retain its contractual obligations to indemnify officers and directors pursuant to the debtor's bylaws or as contained in contracts with such officers and directors. Return to article

² Section 1123(b)(6) permits a plan to include any appropriate provision not inconsistent with the applicable provisions of the Code. Return to article

³ In Zale, the court held that the bankruptcy court had no jurisdiction to consider the issue because the third-party action sought to be enjoined, involving the debtor's D&O insurer, a former board member and a D&O excess policy insurer, was not sufficiently related to the bankruptcy. See In re Zale Corp., 62 F.3d at 756. The interesting aspect of this holding is that the debtor's D&O insurer had entered into a global settlement with the debtor regarding the debtor's claims against its directors and officers, had paid the policy limits to the debtor and had negotiated a global release as part of the settlement. The settlement was a fundamental aspect of the debtor's reorganization. Return to article