Third Circuit Holds That Share Purchasers Take Shares Subject to Plan, Including Releases of Liability for Debtor’s Post-Confirmation Acts

by Kramer Levin Naftalis & Frankel LLP

Kramer Levin Naftalis & Frankel LLP

The Bottom Line

A three-judge panel for the Third Circuit Court of Appeals recently held, in Chapter 15 case In re Arctic Glacier Int’l, Inc., No. 17-2522 (3d Cir. Aug. 20, 2018), that when purchasers of stock of a debtor are on notice of the debtor’s bankruptcy, they take those shares subject to both the plan’s benefits and its burdens, including liability releases. Specifically, the panel held that releases in Arctic Glacier International Inc.’s (“Arctic Glacier” or the “Debtors”) plan (the “Plan”) and the Plan’s res judicata effect precluded the appellants (the “Brodskis”) from challenging the Debtors’ distribution of a dividend. The panel rejected the Brodskis’ arguments that (1) the Plan could not bar liability for the Debtors’ post-confirmation acts, (2) failure to comply with FINRA’s rules rendered the distribution invalid, (3) the Brodskis were not “transferees” subject to releases contained in the Plan, and (4) the Due Process Clause forbade applying the releases to them.

What Happened?


Arctic Glacier filed for bankruptcy in 2012 under the Companies Creditors’ Arrangement Act, Canada’s analogue to Chapter 11 of the U.S. Bankruptcy Code. The Debtors then filed for and received recognition under § 1521(a) of the Code, which granted the Plan full effect in the United States. The Plan included broad releases of liability for the Debtors in connection with the bankruptcy and gave the Monitor (the Canadian equivalent of a U.S. trustee) broad authority to make distributions to shareholders with 21 days’ notice of any distribution.

On Dec. 11, 2014, following sale of their assets and repayment of their creditors, the Debtors announced that shareholders as of Dec. 18 would receive a dividend from the Debtors’ remaining funds. The Debtors also announced this information in a press release and posted it on the Monitor’s website and on Canada’s database of corporate disclosures.

None of these announcements stated when or how much the Debtors would distribute, and the Debtors did not contact FINRA to disclose the planned distribution. Moreover, the Debtors included no reference in the Plan to FINRA or its rules. These omissions are important because FINRA’s rules would have set an “ex-date” of Jan. 23, 2015, entitling share purchasers before that date to the dividend. Under FINRA’s rules, the ex-shareholder of the Brodskis’ shares would have received the dividend on those shares but would have been obliged to send that amount to the Brodskis.

Despite Arctic Glacier’s clear statement that shareholders as of Dec. 18 would receive the dividend, which should have depressed the share price by an amount equal to the expected dividend, the share price remained steady through Jan. 22, 2015. No doubt following the market’s assumption that the dividend would comply with FINRA’s rules, between Dec. 16 and Janu. 22 the Brodskis purchased over 12,600,000 Arctic Glacier shares. On Jan. 21, the Monitor announced it would distribute a 15.5557-cent dividend the following day pursuant to the Dec. 11 announcement. Accordingly, and contrary to FINRA’s rules, the holders as of Dec. 18 of the Brodskis’ shares received the dividend and did not send that amount to the Brodskis.

The Brodskis sued, claiming that Arctic Glacier owed them the dividend. The Brodskis asserted that (1) Arctic Glacier negligently failed to pay them the dividend under the Plan; (2) Arctic Glacier negligently, without FINRA’s approval, granted the dividend to shareholders as of Dec. 18; (3) the officers of Arctic Glacier breached their fiduciary duties to the Brodskis; (4) Arctic Glacier negligently failed to disclose material information; and (5) and (6), Arctic Glacier committed securities fraud and common-law fraud by failing to disclose this material information.

The Bankruptcy Court for the District of Delaware dismissed the Brodskis’ complaint, holding that both the releases in the Plan and res judicata barred the suit. The District Court affirmed on the same rationales. The Third Circuit agreed to hear the Brodskis’ appeal, and argument was held on March 22, 2018.

Third Circuit Opinion

The Third Circuit Court of Appeals affirmed the Bankruptcy and District Courts. The panel held that: (1) a plan can insulate a debtor from liability for post-confirmation actions; (2) nothing in the Debtors’ Plan required paying the Brodskis; and (3) the Plan, including its releases and their res judicata effect, carried over with the shares when the Brodskis purchased them, and the Brodskis’ nonbankruptcy claims did not overcome the releases.

The panel first held that because a bankruptcy court’s confirmation order is a final judgment, that confirmation order is res judicata. As a consequence, challengers must raise their objections to a plan prior to its confirmation. The Brodskis, who had not timely objected, were unsuccessful in persuading the panel to interpret Holywell Corp. v. Smith, 503 U.S. 47 (1992), to stand for the proposition that a plan cannot bar liability for any post-confirmation acts. Rather, the court distinguished Holywell Corp. as upholding a liability that arose post-confirmation, with no relationship to implementation of the plan, whereas the liability alleged by the Brodskis arose as a consequence of implementation of the confirmed Plan. While the panel admitted that a plan’s preemptive scope is not unlimited, it declined to quantify that scope because the Brodskis’ challenge had not been so nuanced.

Next, the panel held that the Plan did not require paying the Brodskis because the Plan did not incorporate, and was not subject to, the FINRA rules. Moreover, even if the FINRA rules imposed obligations on Arctic Glacier separate of the Plan, a suit to redress violations of those hypothetical obligations would have needed to overcome the Plan’s releases of liability (because the releases, as part of the confirmed Plan, carried the Plan’s res judicata effect).

The Brodskis challenged the releases on two grounds. First, they argued that the releases did not apply to them because purchasing shares of stock did not make them “transferees” subject to both the benefits and burdens attached to the shares. Second, they argued that the Due Process Clause forbade applying the releases to them. The panel disagreed with both arguments.

The panel was unpersuaded by the Brodskis’ first argument, holding that buying a share of stock constitutes a “transfer” and that, under the reasoning of In re KB Toys, Inc., 736 F.3d 247 (3d Cir. 2013), the transfer of a share of stock, like that of a claim, remains subject through the transfer to the limitations on the interest in the hands of the transferor. The panel also rejected the Brodskis’ related argument that they were not represented and could not have objected to the Plan, since the original shareholders had had the opportunity to object and the Brodskis had been on notice of the Plan when they bought the shares.

Finally, the panel also upheld the releases in the face of the Brodskis’ due process challenge. The Brodskis relied on Jones v. Chemetron Corp., 212 F.3d 199 (3d Cir. 2000), which held that due process mandates providing notice or representation to claimants before discharging their claims in bankruptcy. The panel found this case inapposite for two reasons: first, because Chemetron bore no relation to the transfer of shares and the plan that travels with them; and second, because the case did not extend the Due Process Clause to buyers who had received notice by publication and representation by their sellers. The Brodskis could not overcome these distinguishing factors simply by their desire to undo their unfortunate bargain.

Why This Case Is Interesting

The Third Circuit disagreed with the Brodskis, whose share purchases occurred under the same assumption that the market made following Arctic Glacier’s dividend announcement — namely, that the FINRA rules would dictate an ex-date of Jan. 23, 2015. The panel was unwilling to infer from this fact that the Brodskis were not on notice of the Plan’s conferral of broad authority on the Monitor to distribute dividends, including in contravention of FINRA’s rules. Moreover, the panel declined to read Holywell Corp. v. Smith as standing for the idea that a debtor’s silence on a matter in its plan does not foreclose liability post-confirmation for acts relating to that matter. Instead, the panel found that the Brodskis had been represented by the original shareholders, who could have objected to the Plan — ostensibly, to its indifference to FINRA’s rules, or at least to the broad and indefinite terms under which the Monitor could make distributions. Essentially, this case strongly affirms the likelihood that a debtor’s release from liability for post-confirmation acts — even acts not specifically detailed in the plan — will be upheld under res judicata.

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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