Law360, New York (November 21, 2014, 10:28 AM ET) --
The fall of Washington Mutual Bank, which at one time was the nation’s largest savings and loan association, remains among the largest financial institution failures in the country’s history. The bankruptcy proceedings commenced in connection with the bank’s collapse sparked a number of important decisions. One such decision is often referred to as the seminal ruling on release and exculpation provisions, In re Washington Mutual Inc., 442 B.R. 314, 322 (Bankr. D. Del. 2011), which supports the proposition that only estate fiduciaries should be included in the exculpation provisions of a plan.
Recently, in the Laboratory Partners Inc. and Fisker Automotive Holdings Inc. Chapter 11 cases, Washington Mutual’s ruling on the exculpation of nonestate fiduciaries has come into question, and some Delaware bankruptcy judges appear to be departing from the rigid bar on exculpation of nonestate fiduciaries espoused by the court in Washington Mutual in favor of a more flexible standard allowing consideration of the particular circumstances of the case.
Washington Mutual and Its Progeny
After WMB collapsed, it was seized by regulators and the Federal Deposit Insurance Corp., in its capacity as receiver, sold substantially all of WMB’s assets to JPMorgan Chase Bank NA.[1] One day after this sale, Washington Mutual, Inc. (WaMu), the parent of WMB, and its affiliate WMI Investment Corp., which held a variety of investments and securities, commenced Chapter 11 proceedings in the Delaware bankruptcy court.[2]
After the bankruptcy proceedings were commenced, disputes arose between the debtors, the FDIC, and JPMC regarding the ownership of certain WMB assets, leading to litigation in the bankruptcy court and the United States District Court for the District of Columbia.[3] The parties ultimately reached a settlement with respect to the various claims asserted against one another (the “global settlement”) that provided for the disposition of over $25 billion worth of disputed assets and liabilities.[4] The debtors projected that the global settlement, which was incorporated into their plan, would provide in excess of $6 billion in value, and permit a 100 percent recovery to unsecured creditors and a 70 to 80 percent recovery to subordinated unsecured creditors.[5]
The proposed plan exculpated certain parties, including WMB, JPMC, the FDIC, the indenture trustee for each tranche of debt, and a group of settling noteholders, with respect to actions taken during the bankruptcy proceedings.[6] Various parties, including certain noteholders, the equity committee appointed in the bankruptcy cases, and the office of the United States trustee, objected to, among other things, the exculpation provision on the basis that it was too broad.[7]
Judge Mary Walrath concluded that the global settlement was fair and reasonable, but found that the plan was not confirmable unless certain deficiencies, including the exculpation provision, were addressed. In agreeing with the objecting parties, Judge Walrath ruled that the proposed exculpation provision was much too broad and “must be limited to the fiduciaries that serve during the bankruptcy proceedings: estate professionals, the [c]ommittees and their members, and the [d]ebtors’ officers and directors.”[8] The court reasoned that exculpation provisions simply state the standards to which estate fiduciaries are held.[9] Thus, nonestate fiduciaries are not entitled to receive the benefit of plan exculpation.[10]
The Washington Mutual decision was later followed by Judge Brendan Shannon in In re Indianapolis Downs LLC, 486 B.R. 286 (Bankr. D. Del. 2013). In Indianapolis Downs, the proposed plan included a provision exculpating a group of the debtors’ second-lien debt holders (the “ad hoc committee”) and Fortress Investment Group LLC, a substantial holder of the debtors’ third-lien debt.[11] Both the ad hoc committee and Fortress actively participated in the bankruptcy proceedings. Among other things, the ad hoc committee and Fortress were parties to a restructuring support agreement with the debtors, which ultimately resulted in the successful sale of the debtors’ assets to a casino operator for $500 million, and, each party played a significant role in the development of the plan.[12]
After the U.S. trustee and certain other parties in interest objected to the exculpation of the ad hoc committee and Fortress, the debtors modified the provision so that it only applied to estate fiduciaries.[13] Nonetheless, the court addressed the contours of exculpation in its opinion, affirming Washington Mutual’s ruling that exculpation provisions should be limited to fiduciaries who have served during the Chapter 11 proceedings: estate professionals, committees and their members, and the debtors’ directors and officers.[14]
The Laboratory Partners Ruling
More recently, in the bankruptcy proceedings commenced by Laboratory Partners, a clinical testing firm, the Delaware bankruptcy court considered whether Marathon Special Opportunity Fund LP, the lead arranger of Laboratory Partners’ prepetition secured debt facility, was entitled to receive the benefit of an exculpation provision.
The U.S. trustee objected to the exculpation provided to Marathon, arguing that the court’s decision in Washington Mutual limited exculpation to fiduciaries that serve during the Chapter 11 cases.[15] In response, Laboratory Partners asserted that the exculpation of Marathon’s activities was appropriate in light of Marathon’s involvement and substantial contribution to the bankruptcy proceedings.
Prior to the petition date, for instance, Marathon provided Laboratory Partners with $350,000 in funds so that it could meet payroll and operating expenses while negotiating with a potential stalking horse bidder for its long-term care facilities (the “LTC division”).[16] In addition, according to Laboratory Partners, the plan would not have been possible without the support of Marathon, which agreed to allow priority and administrative claims to be paid despite the impairment of its secured claims.[17]
Absent this concession, the bankruptcy court found that these creditors likely would have received nothing.[18] Also, when the sale of the LTC division initially failed, Marathon stepped in and formed a joint venture to purchase this division.[19] Instead of cherry-picking the assets, Marathon purchased nearly the entire LTC division and continued it as a going concern, saving more than 900 jobs.[20]
Laboratory Partners further argued that the Washington Mutual decision erroneously interpreted prior case law “as creating a per se bar to exculpation provisions for nonfiduciaries.”[21] According to Laboratory Partners, In re PWS Holding Corp., the case relied upon by the court in Washington Mutual, merely upheld a provision restating the standard for estate fiduciaries under the Bankruptcy Code — it did not create a bar on a debtor’s ability to limit the liability of third parties.[22] Because Marathon, among other things, “open[ed] up its checkbook” to allow the payment of administrative and priority claims and took on the risk of operating the LTC division, Laboratory Partners asserted that the exculpation provision was appropriate.[23]
Judge Peter Walsh upheld the exculpation provision finding that “[t]he exculpation is unusual, but [Marathon’s] activity in this case was surely unusual.”[24] The proceedings appeared to be heading toward liquidation, but due to Marathon’s contributions, liquidation was avoided.[25] In light of Marathon’s substantial contributions, the court held that the exculpation provision was appropriate.[26]
The Fisker Decision
The Delaware bankruptcy court also recently ruled that the exculpation of nonestate fiduciaries was appropriate in the bankruptcy proceedings commenced by electric car maker Fisker. During the course of the company’s Chapter 11 cases, Hybrid Tech Holdings LLC, Fisker’s senior lender, and Wanxiang America Corp., the purchaser of substantially all of the Fisker’s assets, asserted significant claims against the company, which were ultimately settled.[27]
An essential element of the settlements with both Wanxiang and Hybrid was the inclusion of a plan provision exculpating these parties for actions taking place in connection with Fisker’s Chapter 11 cases or related to Fisker’s plan.[28] The U.S. trustee objected to this provision, however, on the basis that Washington Mutual created a bright-line rule that only estate fiduciaries may receive the benefit of a plan exculpation provision.[29]
Like Laboratory Partners, Fisker argued that Washington Mutual was based on an incorrect interpretation of the Third Circuit’s decision in PWS.[30] Fisker asserted that in PWS, the Third Circuit specifically rejected a per se rule prohibiting plan provisions that limit the liability of third parties.[31] Instead, under PWS, plans seeking to limit a third party’s liability must be “assessed in light of the particular circumstances at issue.”[32]
According to Fisker, exculpation of Wanxiang and Hybrid was appropriate in light of these parties’ substantial contributions during the cases. Wanxiang and Hybrid were involved in the development of the plan and agreed to waive significant claims against Fisker.[33] Moreover, the settlements with Wanxiang and Hybrid resulted in creditors receiving significant distributions.[34] Absent these settlements, Fisker would have been required to engage in very costly litigation, which likely would have reduced or eliminated recoveries to creditors.[35]
Moreover, if a judgment was entered in Hybrid’s favor, Fisker likely would have been rendered administratively insolvent.[36] Finally, Fisker argued that Wanxiang made a significant contribution by agreeing to enhance a warranty program for car owners originally included in the purchase agreement.[37]
Judge Kevin Gross rejected the bright-line test set forth in Washington Mutual and found that nonestate fiduciaries may be exculpated under a plan in appropriate circumstances.[38] The court noted, however, that exculpation of nonestate fiduciaries must be “extremely restricted ... to an exceptional situation.”[39] In that case, the bankruptcy court found that Wanxiang had made a substantial contribution that provided value to unsecured creditors and protected car owners.[40]
The court also found that Hybrid played a significant role in Fisker’s Chapter 11 cases.[41] Without the settlement reached with Hybrid, there would have been significant litigation, which would increase expenses and reduce distributions to creditors.[42] Rejection of the exculpation provision negotiated by Wanxiang and Hybrid would have resulted in these parties not receiving recognition for the substantial benefits they provided to the Chapter 11 proceedings.[43] Thus, the court approved the exculpation of Wanxiang and Hybrid.
Conclusion
As indicated by the cases above, there is a divergence within the District of Delaware as to whether nonestate fiduciaries may be exculpated. Recent decisions on this issue have rejected the bright-line rule set forth in Washington Mutual and followed in Indianapolis Downs in favor of a more flexible standard that allows nonestate fiduciaries to be exculpated in exceptional circumstances. As noted in Fisker, it would be inequitable to deny exculpation where a nonestate fiduciary makes a substantial contribution and the exculpation provision was an essential part of the consideration requested in providing such contribution.
In both Fisker and Laboratory Partners, the nonestate fiduciaries seeking exculpation each made a substantial contribution directly to creditors that went above and beyond the contributions made in Washington Mutual and Indianapolis Downs.
In Fisker, for instance, in addition to waiving significant claims against the debtors, Wanxiang agreed to provide an enhanced warranty program to car owners and Hybrid agreed to fund payments to creditors. In Laboratory Partners, Marathon essentially opened up its checkbook and allowed administrative and priority claims to be paid despite the impairment of its secured claim, and purchased the LTC division as a going concern.
In Washington Mutual, JPMC and the FDIC made significant contributions by agreeing to the global settlement. Similarly, in Indianapolis Downs, the ad hoc committee and Fortress were actively involved in the formulation of a confirmable plan. However, unlike Fisker and Laboratory Partners, these parties did not provide any out-of-pocket contribution directly to creditors.
Furthermore, the contributions made by Hybrid and Wanxiang in Fisker and by Marathon in Laboratory Partners were crucial to the success of the debtors’ bankruptcy proceedings. Absent the settlement agreements with Wanxiang and Hybrid, Fisker faced the possibility of administrative insolvency. Similarly, Marathon’s contributions to Laboratory Partners prevented a potential liquidation and resulted in the preservation of business operations, saving more than 900 jobs. There is no indication that the contributions made in Washington Mutual and Indianapolis Downs were necessary to avoid administrative insolvency or to prevent the liquidation of the debtors’ businesses.
As a result of the Fisker and Laboratory Partners rulings, it appears that courts are edging away from the more rigid rule set forth in Washington Mutual prohibiting exculpation of nonestate fiduciaries. Although the standard for exculpation of nonestate fiduciaries is not entirely clear, for now, a lender or purchaser that desires to receive the benefits of exculpation should be prepared to establish that it made a substantial, out-of-pocket contribution that was essential to the success of the debtors’ bankruptcy.
—By Edmon L. Morton, Kenneth J. Enos and Ashley E. Markow, Young Conaway Stargatt & Taylor LLP
Edmon Morton is a partner and Kenneth Enos and Ashley Markow are associates in Young Conaway's Wilmington, Delaware, office.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] In re Washington Mutual Inc., 442 B.R. 314, 322 (Bankr. D. Del. 2011).
[2] See id.
[3] Id. at 322-23.
[4] Id. at 323-24.
[5] Id.
[6] Id. at 346, 350.
[7] See id. at 350-51.
[8] Id.
[9] Id.
[10] See id. at 351.
[11] Id. at 291-92.
[12] Id.
[13] See id. at 306.
[14] Id.
[15] United States Trustee’s Objection to the Debtors’ Joint Chapter 11 Plan, Case No. 13-12769 (PJW), at 3-5 (June 27, 2014); Laboratory Partners Confirmation Hr’g Tr., at 30-32.
[16] Declaration of William A. Brandt, Jr. in Support of First Day Relief (the “Laboratory Partners First Day Declaration”), Case No. 13-12769 (PJW), at 12, 15 (Oct. 24, 2013).
[17] Debtors’ Memorandum of Law in Support of Confirmation of the Debtors’ Joint Chapter 11 Plan (the “Laboratory Partners Confirmation Brief”), Case No. 13-12769 (PJW), at 1 (July 7, 2014); Laboratory Partners Confirmation Hr’g Tr., at 11.
[18] Laboratory Partners Confirmation Brief, at 34.
[19] Id.
[20] Laboratory Partners Confirmation Hr’g Tr., at 11.
[21] Laboratory Partners Confirmation Brief, at 36.
[22] Id.
[23] See Laboratory Partners Confirmation Hr’g Tr., at 23.
[24] Id. at 35.
[25] Id. at 35-36.
[26] Id.
[27] See Disclosure Statement for the Debtors’ Second Amended Joint Plan of Liquidation Pursuant to Chapter 11 of the Bankruptcy Code (the “Fisker Disclosure Statement”), Case No. 13-13087 (KG), at Article V.J. (June 10, 2014).
[28] Debtors’ Memorandum of Law (I) In Support of (A) Confirmation of the Debtors’ Second Amended Joint Plan of Liquidation Pursuant to Chapter 11 of the Bankruptcy Code (With Technical Modifications) and (B) Approval of Plan Modifications and (II) In Response to Objections Thereto (“Fisker Confirmation Brief”), Case No. 13-13087 (KG), at 37 (Jan. 1, 2014).
[29] See Fisker Confirmation Hr’g Tr., at 22.
[30] Fisker Confirmation Brief, at 36-37.
[31] Id.
[32] Id.
[33] See Fisker Confirmation Brief, at 31, 33.
[34] Id. at 27, 37.
[35] Fisker Confirmation Brief, at 22-25; Fisker Hr’g Tr., at 11.
[36] Fisker Disclosure Statement, at 3.
[37] Id.; Fisker Confirmation Hr’g Tr., at 13.
[38] Fisker Confirmation Hr’g Tr., at 26-27.
[39] Id. at 27.
[40] Id.
[41] Id. at 28.
[42] Id. at 28.
[43] Id.at 27.
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