Seventh Circuit Upholds Chapter 11 Plan s Third Party Release

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1 (The following article is posted on this website from the July 2008 issue of the Norton Bankruptcy Law Adviser with permission. Copyright 2008 Thomson Reuters/West. For more information about this publication please visit Seventh Circuit Upholds Chapter 11 Plan s Third Party Release Kathryn Pamenter and Danielle Wildern Juhle Kathryn Pamenter is counsel, and Danielle Wildern Juhle is an associate, in the bankruptcy group at Goldberg Kohn Bell Black Rosenbloom & Moritz, Ltd. Ms. Pamenter, together with Ronald Barliant, represented Airadigm Communications, Inc. in all stages of the 2006 bankruptcy case and related appeals. Having previously approved of consensual nondebtor releases in In re Specialty Equipment Companies, 1 the Seventh Circuit recently in Airadigm Communications, Inc. v. FCC (In re Airadigm Communications, Inc.), 2 answered the question whether a bankruptcy court can release a nondebtor from creditor liability over the objections of the creditor through a plan of reorganization. In holding that such third party releases can be appropriate in certain circumstances, the Seventh Circuit joined the majority of the Circuits that have addressed this issue. Under those decisions, because 524(e) of the Bankruptcy Code does not expressly prohibit the inclusion of a nonconsensual nondebtor release within a plan of reorganization, and because 105(a) and 1123(b)(6) afford bankruptcy courts broad discretion to approve appropriate provisions not inconsistent with the Bankruptcy Code, bankruptcy courts have the power to approve nonconsensual nondebtor release provisions in a plan of reorganization. 3 While the majority of these courts have found that nonconsensual, nondebtor releases may be permissible Managing Editors: Hon. Keith M. Lundin, United States Bankruptcy Judge, Nashville, Tennessee Hon. Randolph J. Haines, United States Bankruptcy Judge, Phoenix, Arizona Hon. William H. Brown, United States Bankruptcy Judge ( ), Memphis, Tennessee Hon. Thomas F. Waldron, United States Bankruptcy Judge ( ), Dayton, Ohio Published by Thomson Reuters/West; 50 Broad St. East, Rochester, NY 14694

2 in a plan of reorganization, the decisions do not establish a single standard for determining when such a release is appropriate. Further, when applying their different standards for approval of nonconsensual third party releases, these courts have allowed releases as part of a plan of reorganization only under unique circumstances. In Airadigm, the Seventh Circuit held not only that nonconsensual nondebtor releases can be appropriate in certain circumstances, but also concluded that the third party release at issue was appropriate in the context of the plan of reorganization under review. This article discusses Airadigm, certain of the Circuit Courts standards, and practical points that may be considered when advocating for or against a third party release in a plan of reorganization. The Airadigm Release 4 Airadigm Communications, Inc. ( Airadigm ) acquired 15 personal communications services licenses in auctions that the Federal Communications Commission (the FCC ) conducted in The licenses authorized Airadigm to use portions of the electromagnetic spectrum to provide wireless telecommunications services in parts of Wisconsin, Iowa and Michigan. Airadigm financed its acquisition through the FCC s installment payment program. In 1999, due to its inability to pay the FCC, Airadigm filed its first Chapter 11 petition. In 2000, the bankruptcy court confirmed Airadigm s first plan of reorganization (the 2000 Plan ). The FCC took the position in Airadigm s 1999 case that the licenses had automatically cancelled due to Airadigm s bankruptcy filing. As a result, under the 2000 Plan, no action could be taken with respect to the FCC s claim until the FCC made its decision regarding reinstatement of the licenses. It was not until August 8, 2003, that the FCC decided that the licenses had never canceled in the first place. 5 This outcome was required by the U.S. Supreme Court s decision in FCC v. NextWave Personal Communications, Inc., 6 which held that the similar cancellation of NextWave s license was unlawful under 525 of the Bankruptcy Code. As a result, Airadigm owned the licenses. Because of changed economic circumstances and the lapse of its financing under the 2000 Plan, Airadigm could not pay the FCC. To address that problem, Airadigm commenced its second bankruptcy case on May 8, 2006 (the 2006 Case ). On October 31, 2006, the bankruptcy court approved a second plan of reorganization (the 2006 Plan ). Under the terms of the 2006 Plan, Telephone and Data Systems, Inc. ( TDS ) was to provide financing to Airadigm. As a condition to that financing, TDS and Airadigm agreed to the following third party release provision in the 2006 Plan: On the Effective Date, any and all Claims of the Debtor against TDS shall be released and forever discharged. Except as expressly provided in this Plan, as of the Effective Date, neither TDS, its affiliates, parents or subsidiaries, nor any of its respective members, shareholders, officers, directors, employees, agents, attorneys, or professionals shall have or incur any liability to the Debtor, the Reorganized Debtor, or to any holder of any Claim or equity interest for any act or omission arising out of or in connection with the Case, the confirmation of this

3 Plan, the consummation of this Plan, or the administration of this Plan or property to be distributed under this Plan, except for willful misconduct. 7 The FCC objected to this release provision. The bankruptcy court overruled the FCC s objection and found that the Bankruptcy Code, specifically 524(e), 8 does not expressly prohibit nonconsensual nondebtor releases: [w]hile a third party release... may be unwarranted in some circumstances, a [per] se rule disfavoring all releases in a reorganization plan would be similarly unwarranted, if not a misreading of the statute. 9 The bankruptcy court, though, recognized that such releases are not appropriate in all circumstances. A release might be warranted if the nondebtor is contributing substantially to the reorganization, if the release is essential to the reorganization, and if the release is closely tailored to the need for it. 10 Here, the bankruptcy court upheld the release finding that (a) TDS was giving substantial consideration to Airadigm s reorganization, (b) the release terms were narrowly tailored, (c) the release was essential to Airadigm s reorganization and (d) the release of TDS [was] provided to a third party at arm s length, distinguishing it from a release to corporate principals, officers or affiliates. 11 Further, the bankruptcy court noted that without financing from TDS, there likely would be no reorganization. 12 The district court affirmed. Relying on Specialty Equipment, the district court held that the release provision did not violate 524(e) of the Bankruptcy Code. The court stated that the issue is not one of the authority of the bankruptcy court to approve a plan provision releasing TDS from certain liability, but rather the propriety of including the provision under the particular circumstances. 13 The court noted that [c]ommon among judicial considerations have been the extent of contribution to the estate by the released party, the importance of the release to consummation of the plan and the breadth of the release. 14 The district court found the bankruptcy court s findings of fact to be reasonable and concluded that [t]his is a unique circumstance warranting confirmation of a plan containing a third party release. 15 The Seventh Circuit Decision in Airadigm In affirming the district court s decision, the Seventh Circuit considered two questions. First, the court addressed whether 524(e) prohibited nonconsensual nondebtor releases, and upheld its earlier conclusion in Specialty Equipment: Section 524(e) is a saving clause; it limits the operation of other parts of the bankruptcy code and preserves rights that might otherwise be construed as lost after the reorganization (e) does not purport to limit the bankruptcy court s powers to release a nondebtor from a creditor s claims. If Congress meant to include such a limit, it would have used the mandatory terms shall or will rather than the definitional term does. And it would have omitted the prepositional phrase on, or... for, such debt, ensuring that the discharge of a debt of the debtor shall not affect the liability of another entity whether related to a debt or not. 16 After concluding that 524(e) did not preclude a third party release of a creditor s claims, the Seventh Circuit

4 then considered whether bankruptcy courts possessed the authority to approve the release of third parties with respect to a creditor s claims when the creditor has not consented. 17 The court looked to both 105(a), which grants a bankruptcy court power to effect any necessary or appropriate order to carry out the provisions of the Bankruptcy Code, and 1123(b)(6), which permits a court to include any other appropriate provision not inconsistent with the applicable provisions of this title. 18 In light of these Code sections, the Seventh Circuit stated that this residual authority permits the bankruptcy court to release third parties from liability to participating creditors if the release is appropriate and not inconsistent with any provision of the bankruptcy code. 19 Looking to the facts in Airadigm, the Seventh Circuit found that the release included within the 2006 Plan was appropriate because it was narrowly tailored and necessary for the reorganization. 20 Specifically, the release provision did not offer blanket immunity, but applied only to claims arising out of or in connection with the reorganization and did not include willful misconduct. 21 Further, the Seventh Circuit noted that TDS made a substantial contribution to Airadigm s reorganization efforts, and without its funding, the reorganization simply would not have occurred. 22 The Various Standards Despite decisions approving nonconsensual nondebtor release provisions in principle, the circuit courts have expressed reluctance to approve such provisions. 23 Prior to the Seventh Circuit s decision in Airadigm, there was uncertainty regarding whether the articulated standards for obtaining a third party release could be satisfied, without also providing for some sort of settlement fund: A.H. Robins The Fourth Circuit upheld a nonconsensual nondebtor release which corresponded to the global settlement of mass tort liabilities, whereby claimants were to be paid consideration for the release. Although the Fourth Circuit did not articulate a definite standard for determining whether such third party releases are permissible, the court noted that [1] where the Plan was overwhelmingly approved, [2] where the Plan in conjunction with insurance policies provided as a part of a plan of reorganization gives a second chance for even late claimants to recover... and [3] where the entire reorganization hinges on the debtor being free from indirect claims it was within the bankruptcy court s equitable power to enjoin the suits. 24 Continental Airlines The Third Circuit did not articulate a rule. Instead, the court found that the release provision under consideration could not pass even the most flexible test because it lacked the hallmarks of permissible nonconsensual releases fairness, necessity to the reorganization, and specific factual findings to support these conclusions. 25 Because the bankruptcy court did not make any specific findings that the release was fair and was necessary to the debtor s reorganization, the court stated that a release and permanent injunction cannot stand on their merits under any of the standards set forth in the case law of other circuits. 26 Dow Corning The Sixth Circuit held that bankruptcy courts may enjoin a nonconsensual creditor s claims against

5 a third party only if the release meets the following stringent seven-part test: (1) There is an identity of interests between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate; (2) The non-debtor has contributed substantial assets to the reorganization; (3) The injunction is essential to reorganization, namely, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor; (4) The impacted class, or classes, has overwhelmingly voted to accept the plan; (5) The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction; (6) The plan provides an opportunity for those claimants who choose not to settle to recover in full; and (7) The bankruptcy court made a record of specific factual findings that support its conclusions. 27 Applying this test, the court held that the record did not support a finding of unusual circumstances to warrant the proposed third party release. Metromedia Though affirming the decision of the district court on the basis that the appeal was equitably moot, the Second Circuit stated that [a] nondebtor release in a plan of reorganization should not be approved absent the finding that truly unusual circumstances render the release terms important to success of the plan. 28 The Second Circuit placed a strong emphasis on the lack of findings by the bankruptcy court, and specifically noted that (a) there was no finding that the release itself was important to the Plan, (b) there was no finding regarding whether the breadth of the release was necessary, and (c) while good and sufficient consideration paid to an enjoined creditor has weight in equity, it is not required. 29 The Seventh Circuit s decision in Airadigm cited to each of the abovereferenced cases, and determined that a nonconsensual nondebtor release may be permitted if the release is appropriate and not inconsistent with any provision of the bankruptcy code. 30 To determine whether the TDS release was appropriate, the Seventh Circuit undertook a fact intensive analysis. The Seventh Circuit found that the release included within the 2006 Plan was appropriate because it was narrowly tailored and necessary for the reorganization. 31 Specifically, the Seventh Circuit found that the release provision did not offer blanket immunity or immunity affecting matters beyond the jurisdiction of the bankruptcy court, but applied only to claims arising out of or in connection with the reorganization. 32 Further, the court noted that the release provision was narrow because it did not provide TDS a release for willful misconduct. 33 Finally, the Seventh Circuit stated that TDS had made a substantial contribution to Airadigm s reorganization efforts, and without its funding, the reorganization simply would not have occurred. 34 Practical Considerations Although no single standard has emerged, the various circuit court decisions do provide guidance to parties proposing nonconsensual nondebtor releases in Chapter 11 plans. In general, while the majority of the circuits recognize that nonconsensual third party releases may be permissible, courts view such release provisions with skepticism. As the Second Circuit noted in Metromedia, a non-debtor release is a

6 device that lends itself to abuse [because] [i]n form, it is a release; in effect it may operate as a bankruptcy discharge arranged without a filing and without the safeguards of the [Bankruptcy] Code. 35 Reviewing courts will look closely for, and require specific findings of fact regarding, the unusual circumstances surrounding the release, the appropriateness of the release, or the necessity of the release provision. Moreover, the courts may require proof that the release is essential to the reorganization, such that the third party would not participate in the reorganization efforts of the debtor (e.g., provide funding for the plan of reorganization in many cases) without the release provision. Ultimately, the determination whether to approve a third party release in a plan of reorganization will be made on a case-by-case basis as part of a factintensive inquiry. To assist the court in making the necessary factual findings, the release should be as narrow as possible, and practitioners should explain why the proposed release is appropriate and necessary to the plan of reorganization through oral argument at the confirmation hearing, the brief in support of confirmation or affidavits or testimony speaking to the essential nature of the proposed release. Finally, counsel drafting the proposed confirmation order should include specific, detailed findings of fact supporting the release provision and a conclusion of law that under the unique circumstances of the debtor s case, such release is both necessary and appropriate. 36 Research References: Norton Bankr. L. & Prac. 3d 58:2, 109:14 West s Key Number Digest, Bankruptcy 2361, 3555 Notes 1. In re Specialty Equip. Cos., 3 F.3d 1043, (7th Cir. 1993). 2. Airadigm Commc ns, Inc. v. FCC (In re Airadigm Commc ns, Inc.), 519 F.3d 640, 655 (7th Cir. 2008). 3. See In re Airadigm Commc ns, Inc., 519 F.3d at 656; Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 142 (2d Cir. 2005); Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648, 658 (6th Cir.), cert. denied, 537 U.S. 816, 123 S. Ct. 85, 154 L. Ed. 2d 21 (2002); Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 214 (3d Cir. 2000); Menard-Sanford v. Mabey (In re A.H. Robins Co.), 880 F.2d 694, (4th Cir.), cert. denied, 493 U.S. 959, 110 S. Ct. 376, 107 L. Ed. 2d 362 (1989); but see Resorts Int l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401 (9th Cir. 1995), cert. denied, 517 U.S. 1243, 116 S. Ct. 2497, 135 L. Ed. 2d 189 (1996) (rejecting third party release); Landsing Diversified Properties-II v. First Nat l Bank & Trust Co. of Tulsa (In re Western Real Estate Fund, Inc.), 922 F.2d 592, 600 (10th Cir. 1990) (same). The Fifth Circuit and the Eleventh Circuit have addressed the issue of nonconsensual third party releases in the context of settlement agreement approvals. See Feld v. Zale Corp. (In re Zale Corp.), 62 F.3d 746, (5th Cir. 1995) (holding that 524(e) prohibited the release of nondebtors because the permanent injunction as entered improperly discharged the potential debt of a nondebtor, but allowing the temporary injunction of third-party actions where the court found that unusual circumstances existed to render such release proper); Munford v. Munford, Inc. (In re Munford, Inc.), 97 F.3d 449, (11th Cir. 1996) (approving the permanent injunction against nonsettling defendants where it was integral to settlement, and the bar order was fair and equitable). See also In re AOV Indus., Inc., 792 F.2d 1140, (D.C. Cir. 1986) (considering 11 U.S.C. 1123(a)(4), court rejected release provision where additional compensation was not provided to creditor whose claim against a third party was being released). 4. For a further description of the facts, see Airadigm, 519 F.3d at ; Memorandum and Order, Nos. 06-C-747-S, 07-C-073-S (W.D. Wis. Apr. 19, 2007) ( District Court Decision ); Memorandum Decision on Plan Confirmation, No (Bankr. W.D. Wis. Oct. 31, 2006) ( Bankruptcy Court Decision ). 5. In re Airadigm Commc ns, Inc., DA ,

7 2003 WL (F.C.C. Aug. 8, 2003), reconsideration dismissed, DA & , 2006 WL (F.C.C. Apr. 10, 2006). 6. FCC v. NextWave Personal Commc ns, Inc., 537 U.S. 293, 123 S. Ct. 832, 154 L. Ed. 2d 863 (2003). 7. Bankruptcy Court Decision at 2006 Plan, 8.1(b). 8. Section 524(e) provides that discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt. 11 U.S.C. 524(e). 9. Bankruptcy Court Decision at 6 (quoting Specialty Equip., 3 F.3d at 1047). 10. Bankruptcy Court Decision at Bankruptcy Court Decision at Bankruptcy Court Decision at District Court Decision at District Court Decision at District Court Decision at Airadigm, 519 F.3d at 656 (emphasis in original). 17. Airadigm, 519 F.3d at Airadigm, 519 F.3d at (quoting 11 U.S.C. 105(a), 1123(b)(6)). 19. Airadigm, 519 F.3d at Airadigm, 519 F.3d at Airadigm, 519 F.3d at Airadigm, 519 F.3d at See, e.g., Metromedia, 416 F.3d at 142 (explaining that (a) the only explicit authorization in the Bankruptcy Code for such releases is 524(g) in certain asbestos case contexts and (b) such a release may lead to abuse). 24. A.H. Robins Co., 880 F.2d at Continental Airlines, 203 F.3d at Continental Airlines, 203 F.3d at Dow Corning Corp., 280 F.3d at Metromedia, 416 F.3d at 143. See also SEC v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 960 F.2d 285, 293 (2d Cir. 1992); MacArthur Co. v. Johns- Manville Corp. (In re Johns-Manville Corp.), 837 F.2d 89, (2d Cir.), cert. denied, 488 U.S. 868, 109 S. Ct. 176, 102 L. Ed. 145 (1988). 29. Metromedia, 416 F.3d at Airadigm, 519 F.3d at Airadigm, 519 F.3d at Airadigm, 519 F.3d at Airadigm, 519 F.3d at Airadigm, 519 F.3d at Metromedia, 416 F.3d at Not all bankruptcy courts permit the filing of a lengthy, detailed draft confirmation order. In such circumstances, counsel should seek a ruling on the record or the issuance of a memorandum decision that includes appropriate findings of fact and conclusions of law regarding the release provision in the plan of reorganization.