Lender Beware: Ensure Plan Releases are Limited to Debtor’s Obligations

A creditor who settles with a debtor during a bankruptcy case must be sure to continue following the case during the plan stage, or risk the plan affecting the creditor’s rights against third parties.  Iberiabank learned that lesson the hard way, after a plan was confirmed in the chapter 11 case of FFS Data, Inc. (the “Debtor”) which contained a discharge of all claims by creditors against the debtor’s principal and an injunction against the enforcement of such claims.  In re FFS Data, Inc., 24 Fla. L. Weekly Fed. B297a (Bankr. S.D. Fla. 2014).

Iberiabank asserted a claim against the Debtor in the Debtor’s chapter 11 bankruptcy case arising out of a guaranty in favor of Iberiabank of certain obligations of the Debtor’s affiliate and landlord, Siena Realty Associates, LLC (“Siena”).  The Debtor disputed the amount of Iberiabank’s claim, but ultimately settled the claim dispute by agreeing to recognize a $2 million claim in favor of Iberiabank under the Debtor’s Amended Chapter 11 Plan of Reorganization.  In exchange, Iberiabank agreed not to object to confirmation of the Amended Plan, and to vote to accept the Amended Plan, or any subsequent plan promulgated by the Debtor.

Apparently, counsel for Iberiabank failed to carefully review the discharge, injunction and release sections of the Amended Plan.  In exchange for the principal of the Debtor, Bradford Geisen (the “Principal”), releasing his insider claims and making a new value contribution, the Amended Plan expressly provided for a discharge of all claims against the Principal by all of the Debtor’s creditors.  This was stated unequivocally in the Discharge section of the Amended Plan, which was entitled “Discharge of Debtor and Insider” and provided that:

 “. . .  the rights afforded herein and the treatment of all Claims and Equity Interests herein shall be in exchange for and in complete satisfaction, discharge and release of Claims . . . of any nature whatsoever . . . against the Debtor . . . or its officer and/or director, Bradford Geisen.”  Another section of Amended Plan provided for an injunction relating to the discharge, and enjoined “ . . . all Persons who have held, hold or may hold Claims against the Debtor or its officer and/or director, Bradford Geisen . . . from (i) commencing or continuing in any manner any action or other proceeding of any kind with respect to any such Claim . . .; (ii) enforcing, attaching, collecting or recovering by any manner or means any judgment . . . against . . . the Debtor or its officer and/or director, Bradford Geisen . . . .”

The term “Claims” was defined broadly, and was not limited to claims against the Debtor.

A third section of the Amended Plan provided for the general release of claims by all of the Debtor’s creditors, not only against the Debtor, but also against the Released Parties, which included the Principal.  However, this section clarified that the general release was only of claims relating to the Debtor, the chapter 11 case or the Amended Plan.  The Amended Plan recited that this general release was in exchange for the Principal’s agreement to release insider claims totaling $1,000,817.30 and providing a new value payment to enable the Debtor to demonstrate the feasibility of its Amended Plan.

Following confirmation of the Debtor’s Amended Plan, Iberiabank sought to enforce the Principal’s guaranty of the Siena obligations, and requested a determination from the bankruptcy court that the Principal had not been released from the Siena guaranty under the Amended Plan and confirmation order.  First, Iberiabank filed a motion in which it argued that the release of the Principal violated the test for non-debtor releases set out in In re Dow Corning Corp., 280 F.3d 648, 658 (6th Cir. 2002) and In re Transit Group, Inc., 286 B.R. 811 (Bankr. M.D. Fla. 2002).  Specifically, Iberiabank asserted that the Principal’s release of the Siena guaranty was not explicitly and clearly identified in the governing provisions of the Amended Plan, citing to In re Applewood Chair Co., 203 F.3d 914 (5th Cir. 2000).  Iberiabank also argued that the discharge of the Principal was only in his representative capacity as an officer and director of the Debtor, and not individually, and that the bankruptcy court lacked subject matter jurisdiction to confirm the provisions of the Amended Plan that constituted a non-debtor release.

The bankruptcy court denied Iberiabank’s motion, finding that the discharge and injunction provisions were independent provisions of the Amended Plan, distinct from the general release provision, and that procedural due process had been served.  Iberiabank had actual notice of the Amended Plan and the requested release, and failed to object to the release, which had been approved years earlier. The confirmation order approving the Amended Plan was never appealed and was res judicata with regard to the matter. Essentially, Iberiabank’s argument that the release should never have been entered constituted an impermissible collateral attack on the confirmation order.

Four months later, Iberiabank filed a second motion in the bankruptcy court, seeking similar relief, but on different grounds.  In its second motion, Iberiabank argued that the description of the claims covered by the release in the Amended Plan did not include Iberiabank’s claim against the Principal, which arose from a transaction that did not involve the Debtor.  Iberiabank further argued that the provisions of the Amended Plan were not sufficiently “specific” to cover the Principal’s guaranty of the Siena obligations, relying upon the Fifth Circuit’s decision in Applewood.

In analyzing the second motion, the bankruptcy court found that the Applewood decision stood for the proposition that a non-debtor release contained in a reorganization plan or confirmation order must specifically identify each claim released or it has no res judicata effect.  The court also considered a subsequent Fifth Circuit decision, FOM Puerto Rico S.E. v. Dr. Barnes Eyecenter, Inc., 255 F. App’x 909 (5th Cir. 2007), which held that a claim against a non-debtor, allegedly released in a confirmed plan, must be clearly referenced in the subject release or there would not be sufficient identity between the plan provision and the claim to satisfy the requirements of res judicata.

The rulings in both of these decisions, however, were tempered by the U.S. Supreme Court’s decision in Travelers Indemnity Co. v. Bailey, 557 U.S. 137 (2009).  The Bailey decision arose out of the Johns-Manville bankruptcy case, in connection with claims asserted against one of the debtors’ insurers who had been released under a decade-old confirmed plan in consideration for a settlement which provided funds to a trust that funded payments to victims of asbestos-related injuries.  The Supreme Court held:

 “. . . once the [confirmation and settlement orders] became final on direct review (whether or not proper exercises of bankruptcy court jurisdiction and power), they became res judicata to the parties and those in privity with them, not only as to every matter which was offered and received to sustain or defeat the claim or demand, but as to any other admissible matter which might have been offered for that purpose.”  Id. at 152.

The bankruptcy court found that the Supreme Court’s decision in Bailey mandated a ruling that where the confirmation order is final and non-appealable, it and the Amended Plan are entitled to res judicata effect.  As a result, since Iberiabank had adequate notice of the terms of the Amended Plan and an opportunity to object, and the Amended Plan covered Iberiabank’s claim against the Principal, the court found that Iberiabank’s unintended release of the Principal was effective, and consequently denied Iberiabank’s second motion.

Topics:  Chapter 11, Commercial Bankruptcy, Debt, Debtors, EU, Lenders

Published In: Bankruptcy Updates, Civil Procedure Updates, General Business Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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