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Non-debtor Releases for Plan Funders, Investors and Other Contributors to a Reorganization
by Andrew I. Silfen
Olshan Grundman Frome Rosenzweig & Wolosky LLP
Web posted and Copyright © March 24, 2000, American Bankruptcy Institute.
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....In two recent Delaware cases, Hon. Mary F. Walrath (Bankr. D. Del.) applied the Master Mortgage factors and analysis in two slightly different contexts. Each case in some fashion deals with the release of significant contributors to the reorganization. The earlier case dealt with releases of causes of action by the debtor and related derivative claims by creditors and equity holders against non-debtors who contributed to the reorganization. The second case dealt with not only third-party releases of the debtor's claims and related derivative claims, but also direct claims of creditors and equity holders of the debtor against other certain non-debtor third-parties who contributed to the reorganization. Judge Walrath's cases clearly demonstrate the permissibility of voluntary releases and non-consensual releases in certain limited circumstances—a necessary step toward a more liberal attitude towards releases.
In In re International Wireless Communications Inc., No. 98-2007 (MFW), slip op. dated March 26, 1999, at pp. 16-24, Judge Walrath approved non-consensual releases in favor of the entity that funded the debtors' plan of reorganization and certain other non-debtors from claims that the debtors may have against them and the related derivative claims. Judge Walrath concluded that a plan may provide for releases by the debtor against third-parties under certain limited circumstances.
International Wireless Communications Holdings Inc. was a holding company that, through its subsidiaries, including other debtors in the case, owned interests in operating companies that provide cellular and wireless telecommunications services in foreign companies. The debtors held interests in operating companies in other countries but had no operations of their own. In the past, the debtors had never earned any profits since the debtors had no operating income of their own and their investments had not returned any capital. Therefore, historically, the debtors raised money by debt or equity offerings.
The proposed plan provided for the release of the debtors' single largest shareholder and such shareholder's officers and directors from all claims held by the debtors arising in connection with the shareholder's investment in the debtors (including, as a result, derivative claims). The minority shareholders alleged that they held direct claims against the largest shareholder. Over the objection of the debtors' minority shareholders, the court first approved all releases contained in the plan as to each creditor or equity holder who voted for the plan and then approved the non-consensual releases.
Due to the "exceptional circumstances" of the case, and applying the Master Mortgage analysis, the court held the releases were appropriate since the Master Mortgage factors were satisfied. The first factor was satisfied because any action brought by the debtors against the very largest shareholder would deplete the assets of the debtors' estates and would be hotly contested, a waste of resources and costly, and would divert the debtors' attention from reorganization. The second factor was met since the debtors lacked sufficient liquidity to reorganize without the debtor-in-possession financing and additional plan funding, all provided by the largest shareholder. Further, the largest shareholder was exchanging its interests in certain properties for the debtors' properties, thereby relieving the debtors from making substantial cash infusions in those properties before any return on the investment. The third factor was satisfied since the releases were essential to the debtors' reorganization. Fourth, the debtors' plan was "overwhelmingly" accepted by creditors. Fifth, in light of the debtors' insolvency, the court noted that under the plan the objecting minority shareholders were receiving some warrants and retained whatever direct claims they might have had against the largest shareholder. The court noted that the debtors were so insolvent that it would be almost impossible for the shareholders to obtain any recovery. Noting these circumstances and the fact that the Bankruptcy Code's priorities in distribution were followed and that direct claims were preserved, Judge Walrath approved the plan, including its release provisions, over the objections of minority shareholders.
Recently, in In re Zenith Electronics Corp., 241 B.R. 92 (Bankr. D. Del. 1999), Judge Walrath was again confronted with the issue of the permissibility of third-party releases and related issues. In this case, Judge Walrath again approved the plan provisions allowing the release of Zenith's claims and third-party derivative claims against certain non-debtors who contributed to the reorganization. This time the court had the opportunity to deal with the issue of creditors and equity holders release of direct claims against non-debtor third-parties. With respect to direct claims, the court would not approve involuntary releases. The court only allowed the release of direct claims of any creditor or equity holder against third parties to the extent such creditor actually voted in favor of the plan.
Zenith, a leader in the design and manufacturing of consumer electronics, had suffered substantial financial difficulties over a substantial period prior to the filing. In April 1998, a restructuring of Zenith's debt and equity was proposed. The restructuring proposal was reduced to a pre-packaged plan of reorganization. Article X of the proposed pre-packaged plan provided for certain releases, injunctions and exculpations. The release provision provided Zenith's release of its claims against its officers and directors, investors and debenture holders and the exculpation of the debtor, its officers and directors, investors and debenture holders from liability to third parties for causes of action arising from the pre-packaged plan process. Specifically, the pre-packaged plan of reorganization contained a provision that provided for the release of Zenith's officers and directors, L.G. Electronics Inc.—a shareholder of Zenith and other related companies—the Bondholders' Committee and its professionals and other related parties from claims that the debtor had against them, and the creditors who had accepted the plan or are in a class that had accepted the plan or are deemed to accept the plan may have against them.
The Equity Committee objected to this provision of the plan as patently unfair and in bad faith. First, the Equity Committee objected to Zenith's release of its claims against various parties. Second, the Equity Committee objected to the exculpation provisions of the pre-packaged plan whereby certain non-debtor entities are released from liability for plan-related activity.
The court, once again applying the Master Mortgage factors, concluded that the release of Zenith's claims contained in the plan were not objectionable or in bad faith. To support this conclusion with respect to the first factor, the court found that the officer and director releasees shared an identity of interest with Zenith. LGE, as the funder of the plan, and the Bondholders' Committee, which was instrumental in formulating the plan, similarly shared an identity interest with Zenith in having the plan succeed and Zenith reorganize. The second factor was satisfied because all of the releasees had made a substantial contribution to the reorganization. The officers and directors contributed by designing and implementing the operational restructuring and negotiation of the financial restructuring. By funding the plan and agreeing to compromise its claim, LGE substantially contributed to the reorganization. Similarly, the Bondholders' Committee contributed by negotiating the pre-packaged plan and assisting in the solicitation of the bondholders. The third factor was met by the court finding that the releases were an integral part of the agreement of LGE to fund the plan. Similarly, the release of the officers and directors are necessary for the continued success of the reorganization because they assure that the directors and officers are not distracted by any litigation by the estate. The fifth factor was satisfied because the overwhelming majority of creditors had agreed to the releases, and no impaired class of creditors had rejected the plan. Bondholders had voted in favor of the plan by 98.6 percent in amount and 97.01 percent in number. LGE and Citibank, a secured creditor of Zenith, also voted to accept the plan. Finally, the fifth factor was satisfied since the plan provided for a distribution to creditors in exchange for the releases. Under the plan, with the exception of LGE and subordinated debenture holders, all of Zenith's creditors were to be paid in full. The evidence presented also demonstrated that the bondholders would receive less under a liquidation. Moreover, absent the support of LGE, the debtor would have had no choice but to liquidate. Based on the foregoing, the court approved the provisions allowing the release of Zenith's claims and third-party derivative claims against all of the specified releasees.
The court, however, would not approve the releases of third-party direct claims against LGE by creditors who had not voted for the plan. The court would not permit involuntary releases of direct claims. The court held that without the affirmative agreement of the affected creditor, a release of third-party direct claims could not be accomplished. Absent such a consent, the court concluded that this provision of the plan providing for releases of creditors in a class that had accepted the plan or who received a distribution under the plan should be deleted.
The developing body of recent case law, including Judge Walrath's decisions, demonstrates a more liberal or permissive attitude towards third-party releases. While Judge Walrath's decisions do not go as far as some of the cases in the Second Circuit and certain other courts, they certainly demonstrate a judicial recognition that such releases may be necessary, useful and valuable. Such a permissive approach further evidences the courts' realization that such releases may encourage necessary parties, including investors, acquirors, plan funders and creditors, to contribute to a plan and the reorganization process. Another likely beneficial consequence of allowing the use of non-debtor releases is reducing the cost of money by eliminating the risk and attendant cost of potential third-party actions. As long as the view prevails that the Bankruptcy Code does not flatly bar such releases, courts should welcome third-party releases as another useful tool in the effort, not just to confirm plans, but to confirm plans that will be successfully effectuated.
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