Recently the Fifth Circuit handed down a thorough opinion regarding Chapter 15 cross-border insolvency and its effects on domestic and foreign creditors. Beyond the Chapter 15 context, however, the court of appeals in In re Vitro S.A.B. de CV was faced with whether or not a bankruptcy court could allow the non-consensual discharge of a third party during the course of a debtor’s ongoing bankruptcy proceeding. The answer may be surprising to some creditors, because such “extraordinary” relief has not been foreclosed upon in all federal circuits.
How might such obligations and release arise? In Vitro and in an earlier Fifth Circuit case, guarantors of notes held by secured creditors urged the bankruptcy court to release them from any and all liability related to the administration of the Chapter 11 plan of reorganization. The guarantors contended that without the proposed release, the reorganization plan could not be financed appropriately. Citing § 524(e)’s language that “the discharge of a debt of the debtor does not affect the liability of any other entity on … such debt,” the Fifth Circuit rejected the guarantors’ argument.
Other circuits have likewise held that § 524(e) absolutely precludes a bankruptcy court from discharging the liabilities of non-debtors. These circuits include the Third, Eighth, Ninth, Tenth and Eleventh Circuit. In contrast, the Fourth Circuit has held that where “reorganization hinged on the debtor being free from claims against parties with indemnity or contribution claims against it,” and that the plan was overwhelmingly approved, such non-debtors could be released.
In contrast, certain circuits have not closed the door on third-party releases, though they caution that the circumstances must be extraordinary to approve a non-debtor release. These courts include the First, Second and the Sixth Circuit, which has developed an onerous seven factor test that the third parties must pass before release may be granted. The Seventh Circuit does not bar the release of third parties, where the release is consensual, non-coercive, and would bind only those creditors voting for the plan.
Although not all courts follow the Fifth Circuit’s strict prohibition on discharging the liability of third parties within an active bankruptcy proceeding, such third parties face a steep, if not impossible, ascent towards release, which is all the more treacherous in a Chapter 15 proceeding.