Fourth Circuit Clarifies Position on Non-Debtor Releases

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On December 9, 2011, the U.S. Court of Appeals for the Fourth Circuit held that although non-debtor releases are permissible in certain contexts, the District Court for the Eastern District of Virginia erred in affirming a bankruptcy court’s order approving the National Heritage Foundation’s (“NHF”) chapter 11 plan containing non-debtor releases. Behrmann v. Nat’l Heritage Found., Inc., 663 F.3d 704, 712-13 (4th Cir. 2011).  The Fourth Circuit found that the bankruptcy court had not stated facts sufficient to justify its decision approving the debtor’s plan.  The Fourth Circuit refrained from adopting a particular test that must be satisfied before non-debtor releases may be approved, as other U.S. Circuit Courts of Appeal have done, instead emphasizing that Fourth Circuit bankruptcy courts should make such determinations on a case-by-case basis and explain such determinations with detailed facts.  Id.   Although Behrmann does not provide a test for determining whether particular non-debtor releases are permissible in the Fourth Circuit, the opinion provides some guidance as to the specificity necessary in bankruptcy court orders approving such provisions, and should be kept in mind by bankruptcy professionals preparing proposed findings of fact in support of chapter 11 plans.

Non-Debtor Releases Generally

Releases are commonplace in negotiated plans of reorganization, and are often required by various creditor and other constituencies as a condition to providing support for a plan. Although the primary function of bankruptcy plan releases is to release the debtor from liability associated with the bankruptcy case, a majority of courts extend such protection to third parties if certain unusual circumstances merit such relief.  See Airadigm Communications, Inc. v. FCC (In re Airadigm Communications, Inc.), 519 F.3d 640, 656 (7th Cir. 2008), reh’g denied, 2008 U.S. App. LEXIS 11100 (7th Cir. May 13, 2008); Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 143 (2d Cir. 2005); Class Five Nev. Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648, 658 (6th Cir. 2002); Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 215 (3d Cir. 2000).  These courts typically permit such releases pursuant to section 105(a) of the Bankruptcy Code, which provides bankruptcy courts with broad equitable powers to effectuate other provisions of the Bankruptcy Code.  However, a minority of courts, such as the Ninth Circuit Court of Appeals in Resorts International, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401 (9th Cir. 1995), and the Tenth Circuit Court of Appeals in In re Western Real Estate Fund, Inc., 922 F.2d 592, 600 (10th Cir. 1990), hold that section 105, by itself, does not provide a basis for non-debtor releases.  Further, these courts interpret section 524(e) of the Bankruptcy Code, which states in pertinent part that a “discharge of a debt of the debtor does not affect the liability of any other entity on, or in property of any other entity for, such debt”, as expressly precluding the approval of non-debtor releases.

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