Over the past few years, the Richmond division of the Bankruptcy Court for the Eastern District of Virginia has become a preferred venue for large retail chapter 11 debtors, including Ascena (Ann Taylor), Pier One, Gemstone Solutions Group (Gymboree), and Toys R Us. The chapter 11 plans in these cases have a common theme: the inclusion of third-party releases.
Unlike the discharge of the debts of the chapter 11 debtor, a third-party release extinguishes claims between two non-debtor entities. Third-party releases are also distinct from exculpation provisions, which release claims against professionals and other fiduciaries of the bankruptcy estate. Releases can cover a wide variety of claims and a wide range of parties, including the debtor’s officers and directors, lenders, the unsecured creditors’ committee and its members, and other contributing parties. As the typical recipients demonstrate, the purpose of third-party releases is often to incentivize these parties to, among other things, extend credit to the debtor or support the chapter 11 plan, all in exchange for protection from liability for an array of pre-confirmation actions.
Two types of third-party releases exist: consensual and non-consensual. With the consent of creditors and equity holders, a chapter 11 plan can generally release liabilities of non-debtors. Nonconsensual third-party releases, however, are subject to a more onerous standard within the Fourth Circuit and the majority of circuits. In the minority of circuits, plans that include nonconsensual releases are considered inimical to section 524(e) of the Bankruptcy Code and cannot be confirmed. As a result, objections to third-party releases (often by the Office of the United States Trustee) force courts to grapple with the requirements for stakeholder consent, i.e., what makes a third-party release consensual, rather than nonconsensual.
Of significance in this unsettled area are opt-out mechanisms in plan solicitation materials. To confirm a chapter 11 plan, the debtor must circulate the plan, detailed disclosures, and ballots to the parties entitled to vote for or against the plan. Where the chapter 11 plan includes third-party releases, the voting package will often include the ability to opt out of the third-party release provisions. Courts disagree with respect to whether an eligible voter who abstains from voting – and therefore does not affirmatively opt out – is deemed to consent to the third-party releases. Notably, no consensus has emerged among the bankruptcy judges of Delaware and the Southern District of New York (two venues where large chapter 11 cases are often filed) as to whether silence equals acceptance of release provisions. In Richmond, the answer consistently has been yes.
It is likely that third-party releases will continue to be a vital element of chapter 11 reorganization efforts. The parties’ ability to negotiate a chapter 11 plan with the shared expectation that the court will recognize the terms of their agreement is critical to a successful reorganization. The Richmond division’s clear and dependable stance on this issue is an asset to debtors, creditors, and interest holders alike, and the Fourth Circuit pending review of the opt-out procedures used in the confirmation of the Ascena chapter 11 plan will likely provide further clarity as well.
Luis F. Ruiz