11th Circuit Upholds Release of Third Parties in Bankruptcy Plan of Reorganization

Most of the United States circuit courts have had to review whether a debtor in its Plan of Reorganization filed in a Chapter 11 bankruptcy can provide in the Plan for a bar order that effectively releases a specific third party, usually officers and directors of the debtor, from liability for claims against the debtor.  Most of the United States circuits courts have ruled on this issue, with the majority, but not all, holding that the Plan  of Reorganization, if it meets certain criteria, can provide for such a bar order effectively releasing such third party.  For those of us in Florida, our circuit court, the 11th Circuit, had not clearly allowed such a bar order in a Plan of Reorganization before deciding In SE Prop. Holdings, LLC v. Seaside Engineering & Surveying, 780 F. 3d 1070 ( 11th Cir, 2015) (“Seaside”) this year .

Why is the release of officers and directors or even shareholders of a debtor by way of a bar order in the debtor’s Plan of Reorganization important.  Many times the only chance for the business of the debtor to continue and succeed after a Chapter 11 Plan of Reorganization is confirmed, is the continued efforts of the existing officers, directors and shareholders.  This may take the form of  the continuing efforts of the existing officers of the reorganized company or pursuading existing shareholders to put up funds to allow a Plan of Reorganization to be confirmed.  The courts in other circuits have taken into account the fact that leaving these folks vulnerable to be sued for the claims against the debtor would discourage their involvement and impact the ability of the debtor to make all of the payments under the Plan of Reorganization. Most courts will allow confirmation of a Plan of Reorganization with such a bar order release if every creditor votes for the plan.  The problem arises where one or more creditor objects to the Plan of Reorganization based on the bar order release of third parties.   This right to such a bar order or release is not clearly contained in the Bankruptcy Code and has had to be developed by the various federal courts.

The lack of a case from the 11th Circuit on this subject made planning to include a bar order release of third parties (e.g. officers, directors and shareholders) a problem for Chapter 11 bankruptcy counsel in Florida.  In this day and age filing Chapter 11 usually means using the bankruptcy court to sell the business assets of the Debtor in a so-called 363 sale, but not always.  If the Debtor plans to continue operations and offer up a Plan of Reorganization to its creditors (in Seaside the plan provided for payment of 100% of claims) so that the Debtor or a successor company can continue the business, it may be crucial to relieve related third parties of the threat of litigation arising from the Debtor’s debts.

In SE Prop. Holdings, LLC v. Seaside Engineering & Surveying, 780 F. 3d 1070 ( 11th Cir, 2015), the 11th Circuit found for the Debtor, Seaside Engineering & Surveying (“Seaside”) over the objection of SE Prop. Holdings, LLC (the “SE Prop”) and upheld the confirmation of the Plan of Reorganization in which certain officers, directors and shareholders were released from liability for any obligations of Seaside (even though this obligation was more indirect then direct).  In so holding the 11th Circuit sided with the majority of other circuit courts, but made it clear: “We also agree, however, with the majority   view that such bar orders ought not to be issued lightly, and should be reserved for those unusual cases in which such an order is necessary for the success of the reorganization, and only in situations in which such an order is fair and equitable under all the facts and circumstances.  The inquiry is fact intensive in the extreme.” SE Prop. Holdings, LLC v. Seaside Eng’g & Surveying (In re Seaside Eng’g & Surveying), 780 F.3d 1070, 1078-79 (11th Cir. 2015).

The court then adopts a seven part test to determine if a bar order releasing third parties in a Plan of Reorganization is permitted over the objection of a creditor.
“Like the Fourth Circuit in Behrmann v. National Heritage Foundation, 663 F.3d 704, 712 (2011), we commend for the consideration of bankruptcy courts the factors set forth by the Sixth Circuit in Dow Corning Corp., 280 F.3d at 658. There, the Sixth Circuit established a seven-factor test to guide bankruptcy courts, as follows:  

[W]hen the following seven factors are present, the bankruptcy court may enjoin a non-consenting creditor’s claims against a non-debtor: (1) There is an identity of interests between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debtor 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, namely, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against [15]  the debtor; (4) The impacted class, or classes, has overwhelmingly voted to accept the plan; (5) The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction; (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.”  SE Prop. Holdings, LLC v. Seaside Eng’g & Surveying (In re Seaside Eng’g & Surveying), 780 F.3d 1070, 1079 (11th Cir. 2015)

The court also held that it was in the discretion of the bankruptcy court to determine which of these seven factors should apply to the facts and circumstances of a particular Plan of Reorganization.  As you can see from the seven factors, the court’s major concern was that the released party must be necessary for the reorganization and the corporation must have some kind of liability to reimburse the third party for losses.  This will generally be the case in regard of officers, directors and even shareholder, if they participate in the company after reorganization or even if they are putting up money to fund the Plan of Reorganization.  Also it can be argued, but not in Seaside supra., that a bar order releasing third parties will allow the Plan of Reorganization to be confirmed with the assent of shareholders rather than resorting to using the so-called “cramdown” to get the plan approved.  The other important factor is the acceptance of the Plan of Reorganization by an overwhelming majority of the creditors, which was certainly the case in Seaside.

Seaside is a crucial piece in putting together a Plan of Reorganization for a business debtor that is using Chapter 11 to resurrect its business and deal with its creditors.  The crucial issue will be convincing the court if a confirmed Plan of Reorganization is challenged that the parties being released by a bar order are vital to the reorganized company.  Some commenters have argued that the released officers, directors and shareholders in Seaside may not have risen to the high standard set by the 11th Circuit Court, but the court still upheld the release.  Any business planning to file a Chapter 11 in order to resurrect their business must consult with competent bankruptcy counsel to make sure that, if they want or need to release certain third parties, that any Plan of Reorganization meets the standard of Seaside and the cases cited by Seaside.


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