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Non-consenting Creditors not Enjoined from Future Suit Against Non-Debtor Parties

By: Brandon Auerbach

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff Member

           In certain instances, a debtor may propose a plan under chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”) that would, upon confirmation, enjoin creditors from pursuing their claims against the debtor and non-debtor entities. In In re FirstEnergy Sols. Corp. the United States Bankruptcy Court for the Northern District of Ohio held that a bankruptcy plan that enjoined creditors from pursuing claims against non-debtor entities associated with a debtor was “patently unconfirmable.”[1] On March 31, 2018, FirstEnergy Corporation and six affiliates (collectively, the “FE Debtors”) filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code with the Ohio Bankruptcy Court.[2] The FE Debtors  historically shared corporate level services with non-debtor affiliates (collectively, the “FE Non-Debtor Parties”).[3] The FE Debtors and FE Non-Debtor Parties were party to certain intercompany agreements related to the “core generation of business,” which included power purchase agreements, operating and maintenance agreements and fuel supply agreements.[4]

           The FE Debtors proposed a plan where creditors would release and be enjoined from pursuing claims against the FE Non-Debtor Parties stemming from their association with the FE Corp. Debtor Parties (the “FE Non-Debtor Parties’ Third-Party Release”).[5] No creditor or party in interest objected to the FE Non-Debtor Parties’ Third-Party Release.  However, the bankruptcy court ultimately found that releasing the Non-Debtor Parties of liability from creditors’ claims would contravene existing case law and the Bankruptcy Code.[6]

            Under 11 U.S.C. § 1123(b)(6), the proper inquiry is whether a third-party release is consistent with the “appropriate provisions” of the Bankruptcy Code.[7] The FirstEnergy Court followed a seven-step test laid out by the Sixth Circuit in In re Dow Corning Corp. to determine whether a bankruptcy court may enjoin non-consenting creditors from proceeding in a case against a non-debtor.[8] This seven step test considers, among other factors, whether the injunction is “essential” to the organization and whether the affected class has chosen to accept the plan.[9] The Dow Corning test is customarily applied to non-party liability releases involving one primary debtor where non-debtor parties agree to financially contribute to the plan; the proposed release here differed significantly because of its broad scope and potentially preclusive effect on the claims brought by non-consenting creditors.[10]  Applying the Dow Corning test, the bankruptcy court found that the FirstEnergy plan was “inconsistent” with the “appropriate provisions” of Section 1123(b)(6) of the Bankruptcy Code.[11]

           There is currently a “nearly even circuit split” among the circuit courts regarding whether bankruptcy courts have the power to release non-debtors from claims held by parties outside the reorganization agreement.[12] The Fifth, Ninth, and Tenth Circuits, have refused to answer this question and have held that non-debtors cannot be discharged of their liability from non-consenting parties.[13] On the other hand, several other circuit courts have much more lenient standards, such as the Fourth Circuit, which allows for the release of liability of non-debtors as long as the creditors agree to the terms of the plan,[14] and the Second and Seventh Circuits which allow for such release of liability, but only in extreme situations.[15] Accordingly, the forum of a debtor’s bankruptcy case is critical to the ability to obtain a non-debtor release.[16]

 


[1] See In re FirstEnergy Sols. Corp, No. 18-50757, at *17 (Bankr. N.D. Ohio Aug. 29, 2019) (“The Court holds that the Debtors’ Third Amended Plan is patently unconfirmable and therefore the Disclosure Statement corresponding to that plan cannot be approved.”).

[2] See id. at *6.

[3] See id. at *7 (enumerating the shared corporate-level services and intercompany agreements between the FE Debtor and non-debtor parties).

[4] See id.

[5] See id. at *13 (“FE Corp would wash its hands of any liability flowing from its historical ownership of the properties and operation of the businesses and facilities now or at any time owned and operated by the Debtors, or at least any liability to any party that also holds any ‘claim,’ as defined in 11 U.S.C. § 101(5) of the Bankruptcy Code, against the Debtors.”).

[6] See id. at *40 (“For the reasons set forth in this Memorandum Decision, the FE Non-Debtor Parties’ Third-Party Release proposed in Section VIILE of the Debtors’ Third Amended Plan is inconsistent with the applicable provisions of the Bankruptcy Code and, therefore, the Court concludes that the Plan is patently unconfirmable.”).

[7] See id. at *16 (“This Bankruptcy Court must, therefore, determine now whether the FE Non-Debtor Parties’ Third-Party Release would by its written terms be sufficiently and predictably constrained that its potential impact was consistent with the ‘applicable provisions’ of the Bankruptcy Code.”).

[8] See id. (citing Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F. 3d 648, 658 (6th Cir. 2002)) (“When the following seven factors are present, the bankruptcy court may enjoin a nonconsenting creditor’s claims against a nondebtor: (1) There is an identify of interest between the debtor and the third party . . . (2) The non-debtor has contributed substantial assets to the reorganization; (3) The injunction is essential to reorganization . . . (4) The impacted class, or classes, has overwhelmingly voted to accept the plan; (5) The plan provides a mechanism to pay . . . (6) The plan provides an opportunity for those claimants who choose not to settle to recover in full; and (7) The bankruptcy court made a record of specific factual findings that support its conclusions.”).

[9] See id.

[10]  See id. at *24 (“Here, instead, the release would cover a set of claims against nondebtors that do not lie at all against the Debtors.”).

[11] See id.

[12] See id. at *18.

[13] See id. (providing that under no circumstances an injunction can be granted to discharge a nondebtor).

[14] See id. at *19 (“The Fourth Circuit has held that the bankruptcy court has the power to release liabilities of a nondebtor under the terms of a chapter 11 plan when the affected creditors of the nondebtor approved of and accepted the terms of the plan.”).

[15] See id.

[16] See id. (finding that each court uses different reasoning when coming to conclusions on non-debtor releases).