No Clear Disclosure? No Third-Party Release In Ch. 11

The content of this update originally appeared on Law360 on January 28, 2013.

A recent appellate decision requires strict adherence to disclosure requirements before third-party releases contained in a Chapter 11 plan may be approved.

In In re Lower Bucks Hospital[1] the U.S. District Court for the Eastern District of Pennsylvania affirmed the decision of the bankruptcy court, which excised from the debtors' plan of reorganization a third-party release provision in favor of an indenture trustee. The bankruptcy court found that neither the debtors' disclosure statement nor notices provided by the indenture trustee to the bondholder constituency adequately disclosed the existence and significance of the release provision. The district court held that the bankruptcy court did not abuse its discretion in concluding that, as a result of this lack of notice, the debtors did not provide adequate information within the meaning of Section 1125(a) of the Bankruptcy Code to enable a reasonable creditor to make an informed judgment about the release.

Lower Bucks Hospital provides a detailed discussion of noticing obligations with respect to third-party releases and is of particular interest to indenture trustees engaged in settlement and plan negotiations with debtors and other creditor constituents.

Several years prior to its bankruptcy filing, Lower Bucks Hospital (LBH), obtained multiparty municipal bond financing under a trust indenture, and pursuant to certain associated agreements, LBH indemnified the indenture trustee for liabilities that may arise in performing its obligations and duties under the indenture, with limited exceptions for gross negligence or willful misconduct. As of the petition date, there was approximately $25 million outstanding in municipal bond financing.

Four months into the bankruptcy proceeding, LBH filed an adversary proceeding against the indenture trustee, seeking avoidance of the security interests created by the filing of certain financing statements by the indenture trustee on behalf of the bondholders within 90 days of the petition date. Litigation ensued for over a year.

During the course of plan negotiations, which included other creditor constituents, LBH and the indenture trustee ultimately reached agreement on the terms of a global settlement that provided for dismissal of the adversary proceeding, allowance of the indenture trustee's secured claim in the reduced amount of $8.15 million, and the exchange of mutual releases between LBH and the indenture trustee.

Additionally, as part of the proposed settlement, the indenture trustee obtained a third-party release in its favor, which barred claims against the indenture trustee. The release specifically provided for the "release of any and all claims and causes of action arising under or in any matter related to the Bond Documents against the . . . Indenture Trustee by any and all parties, including without limitation all Bondholders …"[2]

LBH sought approval of the proposed settlement pursuant to Rule 9019 of the Federal Rules of Bankruptcy Procedure and notice of the settlement motion was provided to the bondholders. In addition, the indenture trustee sent a series of informal notices to the bondholders concerning the status of the bankruptcy proceeding, the last of which summarized the proposed settlement between LBH and the indenture trustee and attached the proposed release provision. No objections to the settlement motion were made and the hearing was devoid of any detailed discussion regarding the third-party release. The bankruptcy court entered an order approving the settlement, subject to plan confirmation.

LBH subsequently sought approval of its plan and disclosure statement, which included the third-party release provision in favor of the indenture trustee. The disclosure statement did not highlight the text of the release provision in bold, italics or underlining, and did not provide a discussion of the release provision or the potential claims that might have been asserted if they were not released. The court approved the disclosure statement, and thereafter, 95% of the bondholders voted to accept the plan.

One individual bondholder, however, objected to confirmation of the plan, moved to reconsider the settlement approval order and filed a class action against the indenture trustee for losses incurred in connection with the bondholders' recovery on the municipal bond financing claim that the indenture trustee agreed to reduce as part of the settlement. In an unusual procedural maneuver, the bankruptcy court confirmed the plan but reserved consideration of the plan's third-party release provision for a subsequent hearing, at which point it would determine whether to allow the release provisions to be included in the plan.

The bankruptcy court ultimately refused to permit the third-party release in the confirmed plan. Although an overwhelming majority of bondholders voted to approve the plan, the court found that this approval was based on inadequate information and notice. Rule 3016(c) of the Federal Rules of Bankruptcy Procedure requires a disclosure statement "to describe in specific and conspicuous language (bold, italic, or underlined text) all acts to be enjoined and identify the entities that would be subject to the injunction."

The bankruptcy court determined that the disclosure of the third-party release provision was in no way conspicuous and rather was embedded in lengthy recitations of boilerplate disclosures of the debtors' release provision. The bankruptcy court was not persuaded that the multiple informal notices provided to bondholders by the indenture trustee cured the failure to satisfy the "specific and conspicuous" requirements of Rule 3016(c), finding that nothing in the notices specifically alerted bondholders to potential claims against the indenture trustee related to the perfection issues raised in the adversary proceeding. Thus, the bankruptcy court concluded that bondholders were unable to make an informed judgment on the third-party release provision.

On appeal, the indenture trustee argued that bondholders received adequate information regarding the third-party release provision because notice was provided to them numerous times, both through the disclosure statement as well as by the multiple informal notices provided by the indenture trustee. Additionally, the indenture trustee contended that the bondholders consented to the third-party release by failing to object to entry of the Rule 9019 settlement order. Finally, the indenture trustee urged the court to consider that, even if the third-party release was nonconsensual, it was in the best interests of the bondholders and was necessary for an effective reorganization.

Concluding that the bankruptcy court "meticulously analyzed the purpose of the third-party release, the factors that the Bondholders needed to evaluate whether the global settlement was in their best interest, and the content of the disclosures,"[3] the district court affirmed the conclusions of the bankruptcy court that the notice provided to the bondholders of the third-party release was inadequate, that the bondholders did not consent to the third-party release and that the third-party release was not a permissible, nonconsensual release.

The Lower Bucks Hospital holdings provide important guidance for indenture trustees. Navigating the course required by these opinions demands that indenture trustees ensure proposed third-party release provisions are clearly, specifically and conspicuously disclosed to bondholders in disclosure statements and any informal bondholder notices. The disclosures also should include explanatory information regarding the potential claims to be released and the indenture trustee also must ensure that the release provisions are brought to the court's attention in conjunction with a Rule 9019 settlement motion or motion to approve a disclosure statement.

[1] The Bank of New York, Mellon Trust Company NA, as Indenture Trustee v. Becker (In re Lower Bucks Hospital), 2013 WL 28056 (E.D. Pa. Jan. 2, 2013), affirming, In re Lower Bucks Hospital, 471 B.R. 419 (Bankr. E.D. Pa. 2012).

[2] In re Lower Bucks Hosp., 471 B.R. 419, 430 (Bankr. E.D. Pa. 2012).

[3] The Bank of New York, Mellon Trust Company NA, as Indenture Trustee, 2013 WL 28056, at *20.