The Fifth Circuit recently held that claims and defenses arising from an indemnification agreement with a debtor could not be asserted against a liquidation trust because the chapter 11 plan barred those claims and defenses, and the trust was not a successor-in-interest to the debtor.

TAKEAWAYS

• A liquidation trust is a separate legal entity from a debtor. Accordingly, a right to indemnity from a debtor cannot be asserted against the trust prosecuting claims assigned to it by bondholders.
• A creditor with actual knowledge ignores a bankruptcy at its peril and may be barred from asserting rights if it did not act to preserve them during the case.

While chapter 11 is commonly associated with reorganization, not all debtors emerge from chapter 11 intact. Sometimes, a liquidation trust is formed to pool and liquidate the debtor’s assets, resolve and prosecute claims and causes of action, and distribute proceeds to trust beneficiaries. Although the liquidation trust is a separate legal entity from the debtor, thorny questions may arise when a creditor tries to assert claims against the trust. The Fifth Circuit recently considered whether indemnification rights stemming from a pre-petition agreement with a debtor could be asserted against a liquidation trust and concluded they could not. (See Raymond James & Assocs., Inc. v. Jalbert (Matter of German Pellets Louisiana, L.L.C.), 91 F.4th 802 (5th Cir. 2024).)

Background
Debtor Louisiana Pellets, Inc. sold $300 million in bonds to raise funds to build a wood processing facility. Pursuant to bond-issuing agreements between Louisiana Pellets and Raymond James & Associates, Raymond James purchased and resold bonds to investors and provided them with bond-offering memoranda detailing the project’s financial viability. Louisiana Pellets indemnified Raymond James for losses resulting from untrue or misleading statements in the bond-offering memoranda.

Despite raising the necessary funds, Louisiana Pellets defaulted on its bonds, ceased operations, and filed for chapter 11. Although Raymond James neither participated in the bankruptcy case nor was listed as a creditor, it monitored the case and communicated with Louisiana Pellets’ counsel. Eventually, the bankruptcy court confirmed a chapter 11 plan that provided for the establishment of a liquidating trust. Louisiana Pellets transferred its remaining assets and causes of action to the trust. Any recoveries would be distributed by the trustee to the trust’s beneficiaries.

Approximately one year later, the bondholders assigned their claims against Raymond James to the trust, and the trustee sued Raymond James for violating state securities laws. Raymond James asserted setoff, recoupment and compensation counterclaims against the trustee based on the pre-petition indemnification from Louisiana Pellets. The trustee argued that (i) Raymond James was barred from asserting its claims by the express language of the confirmation order and (ii) the trust and debtor were separate entities, such that the indemnification claim could not be asserted against the trustee. Raymond James countered that (i) it was not bound by the plan and confirmation order, (ii) the plan was invalid and inequitable, and (iii) it could not have anticipated the assignment of the bondholders’ claims to the trust. The bankruptcy court enforced the confirmation order against Raymond James and refused to allow Raymond James to assert its affirmative defenses and counterclaims. The district court affirmed in all respects, and Raymond James appealed to the U.S. Court of Appeals for the Fifth Circuit.

The Fifth Circuit’s Decision
The Fifth Circuit affirmed the lower courts, finding that the plan applied to Raymond James and barred the claims and defenses it sought to assert against the trustee.

As a sophisticated party, Raymond James should have known of litigation risks and potential liability arising from the issuance and sale of the bonds. Thus, while Louisiana Pellets had an obligation, and failed, to list Raymond James as a creditor, Raymond James had actual knowledge of the case and could have taken action to try to preserve its indemnity claim and rights. Raymond James, however, failed to assert its rights and claims or object to plan provisions that extinguished those rights and claims. Because it could have acted, and did not, and had actual knowledge of the case, Raymond James was subject to confirmation order and the plan’s provisions expressly prohibiting its recoupment and setoff counterclaims based on Louisiana Pellet’s pre-petition indemnity obligations.

Moreover, Raymond James could not raise its setoff and recoupment defenses against the post-confirmation liquidation trust. Raymond James’ defenses only existed against the debtor Louisiana Pellets, the Fifth Circuit held. But the claims asserted by the trustee were not causes of action transferred from the debtor to the trust; they were claims of non-debtor bondholders that were assigned to the trust after confirmation of the plan. As a result, the Fifth Circuit held that Raymond James was trying to “invok[e] a defunct debtor’s obligation to defend against third-party allegations”—a maneuver Raymond James acknowledged would have failed had the bondholders sued it directly.

The Fifth Circuit also dismissed Raymond James’ argument that the trust “stands in the shoes” of Louisiana Pellets’ estate. The trust agreement made clear that the trust had a separate legal existence from Louisiana Pellets and was not its successor-in-interest. Additionally, the bondholders were not successors-in-interest to the debtor. As a result, the Fifth Circuit found that the post-confirmation trust and Louisiana Pellets’ bankruptcy estate were distinct, so defenses that might have been available to the debtor could not be invoked against the trustee.

Conclusion
The Fifth Circuit’s decision serves as a cautionary tale to creditors and parties to indemnification agreements. If the debtor has indemnified a creditor, the creditor should consider participating in the bankruptcy case to preserve its indemnification rights to avoid being deemed to have forfeited them. This could include filing a timely proof of claim or taking appropriate steps to ensure that the claim is susceptible to liquidation and payment in the event of distributions to creditors. The creditor can also object to confirmation of a plan that does not permit claims or defenses that could be asserted against the debtor to be asserted against a liquidating trust in the hope of getting that exclusion excised from the plan. Although on the particular facts here Raymond James could not have affirmatively asserted its indemnification rights against the trust even if it had preserved them (because the trust was not asserting the debtor’s claims and was not the debtor’s successor), it might have received a recovery on account of its claim (effectively giving it a setoff right). Raymond James also may have been able to use its claim as a bargaining chip in negotiations with the trustee—not because Raymond James could have asserted the indemnity as a defense, but because Raymond James would have diluted the recovery to other general unsecured creditors that the trustee was trying to increase by suing Raymond James.

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