Nonconsensual Third-Party Release Limits: Substantial Financial Contribution Won’t Buy Non-Debtors a Release From Claims That Don’t Also Lie Against the Debtor

Pillsbury Winthrop Shaw Pittman LLP

Pillsbury Winthrop Shaw Pittman LLPBankruptcy Judge Alan M. Koschik warns that “non-debtors should not be able to simply buy their own release or quasi-discharge without themselves being bankruptcy debtors.”

  • Third-party releases in Chapter 11 plans should be a means to, and not an apparent purpose of, reorganization.
  • Substantial contribution alone is not sufficient to justify nonconsensual third-party releases. Nonconsensual third-party releases of claims that do not lie against the debtor may be problematic.
  • Overly broad third-party releases can impede approval of a debtor’s disclosure statement, not just confirmation of a debtor’s Chapter 11 plan.

Reorganization plans providing for non-debtor releases (i.e., releasing non-debtors from claims by creditors of the debtor) have been regularly challenged in recent years, frequently by the United States Trustee and other government agencies. In determining whether to approve such releases, courts analyze a variety of factors, including what constitutes “consent” (e.g., voting versus not voting, opting-in versus opting-out) and when (if ever) nonconsensual releases for non-debtors are permissible.

In an April 4, 2019 oral ruling, Judge Alan M. Koschik of the Northern District of Ohio refused to approve FirstEnergy Solutions Corporation’s disclosure statement, partly reasoning that the third-party releases in the plan were an apparent purpose of, not a mere means to, the debtors’ reorganization.[1]

The crux of the problem was the releases in favor of the debtors’ parent and other affiliates (none of which were in bankruptcy). A central concern for the Court was that non-consenting and non-voting creditors of the debtors would be deemed to waive and release their claims against the debtors’ non-bankrupt parent and other affiliates, which claims did not lie against the debtors at all.

The Objecting Parties

Several government agencies, including the EPA, NRC and FERC, opposed the third-party releases by questioning the Court’s subject matter jurisdiction and arguing that the releases were not permissible under the Sixth Circuit test established in In re Dow Corning, 280 F.3d 648, 658 (6th Cir. 2002).

Although many of the agency claims could not be specifically identified, Judge Koschik found the claims were plausible. The objectors argued that their potential claims—“for environmental cleanup or other damages, including unknown latent claims arising from actions occurring long ago, concerning facilities owned and operated for decades by the debtors’ parent corporation and its non-debtor affiliates”—should not be released for the benefit of creditors who would receive the bulk of the financial accommodations under the plan.

The Oral Ruling

Ultimately, Judge Koschik found that the plan not only failed to satisfy Dow Corning, but also violated the spirit of Dow Corning by making the third-party releases an apparent purpose of, and not a mere means to, reorganization. Although the releases were not before the Court in the context of plan confirmation, Judge Koschik explained that because the plan was “patently unconfirmable” it would be futile to approve the disclosure statement and to solicit votes when “under no conceivable circumstances or evidence” could the nonconsensual third-party releases in the plan be justified.

Judge Koschik began by overruling the jurisdictional challenge, relying on Dow Corning, where the Sixth Circuit held that nonconsensual third-party releases are not explicitly prohibited by the Bankruptcy Code. Judge Koschik reiterated that nonconsensual releases of third-party claims against non-debtors are permissible, but that they are the exception and not the rule.

Before addressing the Dow Corning factors, Judge Koschik noted that the cases leading to Dow Corning, and several decisions that followed (such as The City of Detroit[2]), all involved debtors who sought contribution from third parties that were secondarily liable (or allegedly so) for the claims against the debtors, such as insurers or affiliates alleged to have some role in the injuries suffered by the claimants. In FirstEnergy’s case, however, the releases included “claims that do not lie at all against the Debtor, and yet result in the release of a non-Debtor.”

In applying the Dow Corning factors, the Court found that most of the factors were not satisfied or did not apply, and that the debtors might satisfy only one factor—substantial contribution—at confirmation. Specifically, Dow Corning requires:

  • an identity of interest between the debtor and the third-party benefitting from the release;
  • substantial contribution by the third-party;
  • the release to be essential to the reorganization by hinging on the debtor being free from indirect lawsuits against parties who have indemnity or contribution claims against the debtor;
  • the impacted class to vote overwhelmingly to accept the plan;
  • that the plan have a mechanism for paying all or a substantial portion of the claims in the classes affected by the release;
  • that the plan provide an opportunity for claimants who choose not to settle to recover in full; and
  • factual findings by the court to support its conclusion.

First, the Court found that the release included claims that lie against the non-debtors only and consequently would apply to claims for which there is no identity of interest between the debtors and the non-debtor parties (meaning the debtors and non-debtors were not co-obligors on the released claims).

Second, the Court acknowledged that the non-debtors were providing a substantial amount of consideration to the debtors, including hundreds of millions of dollars in cash, three times as much in the form of notes and the release of various claims held by the parent corporation against the debtors. But the Court explained that, even if the consideration is adequate, it may be necessary to determine which affiliate provided the consideration (or if that distinction matters). Nevertheless, the Court assumed that the debtors would be able to satisfy the second Dow Corning factor at confirmation.

Third, the Court rejected at the outset that the non-debtors’ substantial contributions alone satisfied the third factor, reminding the parties that substantial contribution is its own factor. The Court expanded on the Second Circuit’s warning in In re Metromedia Fiber Network Inc., 416 F.3d 136 (2d. Cir. 2005), cautioning that “permitting the contribution itself to justify the release would lend this device to abuse.” Moreover, the Court was surprised by the attempt to release claims solely against the non-debtors noting that it “turns many of the Dow Corning factors on their heads.” As to claims that lie against the non-debtors only, the debtors’ reorganization did not hinge on being free from indirect suits from those claims, as contemplated by Dow Corning, because the non-debtors would have no right of recourse against the debtors.

Fourth, there was no provision for the affected parties whose claims would be released (namely, government agencies with environmental claims) to vote on the plan. Given the agencies’ oppositions, the Court concluded that they were not likely to vote in favor of the plan. The Court also rejected the argument that the fourth Dow Corning factor was satisfied because of the overwhelming support of the plan by other classes of unsecured creditors (on the theory that if the government agencies’ claims were ever liquidated, then they would be part of the unsecured class that voted in favor of the plan). The Court explained that this was not an acceptable application of the fourth factor because, unlike other unsecured creditors, the government agencies would not be receiving cash or equity under the plan.

Fifth, the Court found that the objecting parties have no monetary claims that would be paid under the plan. The only mechanism offered to the objecting parties was a promise that the debtors, with a new capital structure facilitated by the released parent corporation, would “stalwartly stand by and satisfy those claims if and when they arise.”

Lastly, the Court found that the sixth factor had no parallel application and that the seventh factor was not relevant in the context of a disclosure statement hearing.

Judge Wiles’ Decision in Aegean Marine Petroleum Network Inc.

Four days after Judge Koschik’s oral ruling, Judge Michael E. Wiles of the Southern District of New York denied nonconsensual third-party releases in Aegean Marine Petroleum Inc.’s bankruptcy case.[3] There, the releases benefited some of the debtor’s board of directors and Mercuria, the debtors’ pre- and post-petition lender and the purchaser of assets under the plan.

Judge Wiles noted that too often parties seek to impose involuntary releases on the basis that anybody who contributes to the case has earned a third-party release. If this were enough, then “releases would never be limited to the ‘rare’ and ‘unusual’ circumstances” contemplated by Metromedia. Like Judge Koschik, Judge Wiles emphasized that “[d]oing positive things in a restructuring case—even important positive things—is not enough.” Third-party releases are “not a merit badge . . . participation trophy . . . [or] a gold star for doing a good job.” Unless barring a particular claim is important to accomplish a particular feature of the restructuring, third-party releases should not be granted.

Judge Wiles found that the Aegean debtors failed to prove the facts necessary to support the releases because, among other things, they did not identify specific claims against Mercuria that had to be barred to enable the reorganization (or the owners of such claims). As to the directors, the Aegean debtors argued that the directors could be subject to securities law claims (but that they would be without merit) and that they are the beneficiaries of indemnifications from the debtors. But Judge Wiles “fail[ed] to see how the possibility of an indemnification claim is a proper justification to take away the rights that claimants may have to pursue claims that they own directly against the officers and directors.” This statement is seemingly at odds with Judge Koschik’s ruling and Dow Corning, which held that indemnity claims against the debtor could suffice in some cases to make a release essential to the reorganization.


Judge Koschik’s and Judge Wiles’ rulings underscore how intensely bankruptcy courts are being pushed by objectors (frequently the government) to analyze and reject or substantially limit third-party releases. Their decisions reflect a relative strict adherence to the requirements for obtaining releases for non-debtor third parties, rather than expanding the scope of permissible releases. The particular lesson of FirstEnergy is that a parent company spinning-off a business line with potentially significant latent liabilities may not eliminate its exposure by placing the spinoff into bankruptcy and seeking a parent release, particularly where the released claims do not lie against the debtor. The decision is also a reminder that while plan objections are usually reserved for the confirmation hearing, some objections are so serious that they can prevent approval at the disclosure statement stage.[4] Judge Wiles’ decision arguably raises the bar further by questioning whether indemnification claims against the debtor are sufficient for permitting third-party releases or to support a finding that the releases are essential to the reorganization.

[1] In re FirstEnergy Solutions Corp., No. 18-50757 (Bankr. N.D. Ohio April 4, 2019), Transcript of Oral Ruling by the Honorable Alan M. Koschik; see alsoOrder Denying Motion to Approve Disclosure Statement, Doc. 2500 (April 11, 2019).

[2] In re the City of Detroit, 524 B.R. 147 (Bankr. E.D. Mich. 2014).

[3] In re Aegean Marine Petroleum Network Inc., — B.R. —, 2019 WL 1527968 (Bankr. S.D.N.Y. Apr. 8, 2019).

[4] On April 18, 2019, the debtors filed an amended plan that eliminates the non-consensual third-party releases and modifies the consensual releases in the plan so that they are granted only by claimants that (i) vote to accept the plan or (ii) are deemed to accept the plan by virtue of being unimpaired. See In re FirstEnergy Solutions Corp., No. 18-50757, Docs. 2529; 2531 at 2; 2533 (Bankr. N.D. Ohio April 18, 2019).

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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