Non-Consensual Third Party Releases Permitted in Chapter 11 Reorganizations

By: Craig Lutterbein

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

The Seventh Circuit, in Airadigm Communications, Inc. v. Federal Communications Comm’n. (In re Airadigm Communications, Inc.), has joined the circuits permitting the non-consensual release of a non-debtor third party from its obligations to creditors in chapter 11 reorganization.

[1]

   The case revolved around Airadigm Communication’s purchase and financing of fifteen personal communication services licenses from the FCC.

[2]

  When Airadigm began to fail the company filed for reorganization, and the FCC cancelled the licenses.

[3]

  During Airadigm’s first chapter 11 reorganization, it received financing from Telephone and Data Services (TDS), who agreed to repay the FCC the debt owed on the licenses if the FCC reinstated the licensees.

[4]

  Although the FCC did not originally reinstate the licenses, in FCC v. Next-Wave Personal Communications Inc., the Supreme Court ruled that FCC could not legally cancel licenses simply because a communication company files bankruptcy.

[5]

  Thus, the FCC was forced to reinstate Airadigm’s licenses, which caused Airadigm to file a second Chapter 11 case.

[6]

  The plan confirmed by the bankruptcy court contained a release protecting TDS from all liability “in connection with” the reorganization except willful misconduct.

[7]

  On appeal, the Seventh Circuit found that the release was necessary and appropriate because the release was narrowly drawn and TDS was making a substantial contribution that was necessary for Airadigm’s reorganization to be successful.

[8]

The Seventh Circuit identified the threshold issue to be whether the Bankruptcy Code expressly prohibits the release of a non-debtor.

[9]

  Although section 524(e) reads “[D]ischarge of debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt,”

[10]

the court followed earlier Seventh Circuit decisions interpreting the provision merely to preserve non-debtor third party obligations in the absence of a court ruling specifically addressing the third-party’s obligations.

[11]

  The court reasoned that because section 524(e) does not include the words “shall” or “will” it does not prevent the court from making a specific ruling altering third-party liability.

[12]

  The court further supported its conclusion by contrasting section 524(e) to specific wording of the prior Bankruptcy Act that prohibited releases.

[13]

 

The court then turned to the question whether a bankruptcy court has affirmative power to release a non-debtor third party from its obligations to a creditor,

[14]

an issue of first impression in the circuit.  Answering that question in the affirmative, the court explained that bankruptcy courts are meant to have board equity powers in ensuring the success of a re-organization.

[15]

  This broad equitable power is codified in section 105(a), which authorizes courts to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title”, and in section 1123(b)(6), which permits plans to “include any other appropriate provision not inconsistent with the applicable provisions of this title.”

[16]

  Finally, the Seventh Circuit held that the release was proper in this case because it was tailored narrowly and TDS’s involvement was absolutely essential to the success of Airadgim’s reorganization.

[17]

  Although the particular release in this case related to actions taken in connection with the reorganization, the court noted that fact only as part of its analysis of whether the particular release was appropriate in the context of this case.

[18]

  The opinion appears to broadly validate the bankruptcy court’s power to grant non-debtor releases generally.

 

The validity of third party releases splits the circuits and is ripe for Supreme Court review.  The Ninth and Tenth Circuits have held that section 524 (e) expressly prohibits bankruptcy courts from releasing non-debtor third parties in bankruptcy proceedings.

[19]

   On the other hand, the majority of circuit courts have ruled that bankruptcy courts have the equitable power to grant non-debtor third party releases.   However, those circuits have developed varying standards for determining when it is proper for a bankruptcy court to exercise this power.  For example, the Sixth Circuit applies a seven-factor balancing test, while the Second Circuit permits release if the participation of the third party is important to the reorganization.

[20]

  Thus, the situation is ripe for a Supreme Court ruling clarifying the purpose of section 524(e) and the applicable standard for non-debtor third party releases.