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By: Justin Henderson

St John’s University School of Law

American Bankruptcy Institute Law Review Staff Member

           The United States Court of Appeals for the Fifth Circuit, in SEC v. Stanford International Bank, Ltd., held that the United States District Court for the Northern District of Texas abused its discretion when it approved a settlement that would preclude third-parties from bringing claims against the debtor’s insurers (the “Underwriters”).[1]  As a result of a ponzi scheme perpetrated by the Stanford International Bank and related entities (the “Stanford Entities”), more than 18,000 investors lost a total of over $5 billion.[2] After the Securities and Exchange Commission initiated a securities fraud lawsuit, the district court appointed an equity receiver (the “Receiver”) for Stanford International Bank, the Stanford Entities, and various insurance company Underwriters to take control of the receivership estate. [3] On June 27, 2016, the Receiver and Underwriters entered into a settlement whereby the Underwriters agreed to pay $65 million, and, upon such payment, coinsureds would be barred from pursuing any claim against the Underwriters relating to policy proceeds or the Stanford entities.[4] The district court overruled the objections of former managers, directors, and employees of the Stanford Entities, approved the settlement, and issued separate final judgments and bar orders in each action before the court against the Underwriters.[5]

           Certain former Stanford managers and employees ( the “Appellants”) then appealed the district court’s orders preventing them from pursuing independent, non-derivative, third-party claims against the Underwriters.[6] The Receiver disagreed, arguing that a court’s equitable power may be used to bar third-party extracontractual claims, such as common law bad faith breach of duty and claims under the Texas Insurance Code, against the Underwriters but unrelated to the Receivership property.[7]

           Relying on an unpublished Fifth Circuit case, SEC v. Kaleta, where the court enjoined investors defrauded by a debtor from attacking insurance proceeds, the Receiver contended that the district court had authority to approve the settlement and issue orders barring claims against the Underwriters and  the receivership estate.[8] The Court of Appeals rejected the Receiver’s argument finding that the court in Kaleta entered an order protecting the assets of the Receivership estate, which included insurance proceeds, but did not enjoin actions against the insurers.[9]

           The Court of Appeals found that the purpose of equity receiverships, like bankruptcy receiverships, is to “marshal assets, preserve value, equally distribute to creditors, and, either reorganize, if possible, or orderly liquidate.”[10] To accomplish this purpose, courts exercise their discretion in issuing orders barring claims that would diminish the receiverships assets or interfere with the collection and distribution of the assets.[11] However, the receiver and receivership court do not exercise unlimited power in determining the appropriate relief.[12] Here, the Court of Appeals highlighted the unfairness of the settlement agreement as it placed “Appellants in a vise,” by allowing the Receiver to sue Appellants but preventing Appellants from filing any claim against the Underwriters, which would have been unfair.[13] The Court of Appeals for the Fifth Circuit therefore concluded that the district court had abused its discretion by enjoining third-party extracontractual claims against t