Please Release Me? Colorado Bankruptcy Court Answers “Perhaps” in Midway Gold Case

by Nicole Leonard and Jeffrey Bernstein

This article is  reprinted with the permission of the American Bankruptcy Institute. It originally appeared in Volume 17, Number 1 of the ABI Business Reorganization Committee Newsletter, May 2018.

The permanent release of a nondebtor from a debt owed to a third party in a chapter 11 plan is barred per se in some courts and must meet a high standard to be allowed in others. The U.S. Bankruptcy Court for the District of Colorado in In re Midway Gold US Inc. addressed this issue in connection with confirmation of the joint chapter 11 plan of 14 debtor entities in the gold mining and exploration business.[1]

As a threshold issue, the Midway court looked to whether third-party releases are ever allowed in the Tenth Circuit or whether they are barred per se as had been argued and applied in other cases. The court analyzed the Western Real Estate case and concluded a chapter 11 plan could not “bar litigation against nondebtors for the remainder of the discharged debt” and that the court’s authority under § 105(a) could not be used in a manner inconsistent with § 524(e). However, such finding did not translate into an absolute bar of all nondebtor releases in all circumstances.[2]

In connection with its analysis of the nondebtor release, the Midway court reviewed the treatment of nondebtor releases in other circuits and found that while the “Fifth and Ninth Circuits have held a bankruptcy court does not have authority to issue and enforce third-party non-debtor releases in a Chapter 11 plan,” these circuits are in the minority.[3] Rather, the Midway court sided with the majority, represented by the First, Second, Third, Fourth, Sixth, Seventh, Eighth and Eleventh Circuits, permitting third-party releases under certain narrow circumstances.

Section 524(e) of the Bankruptcy Code provides in pertinent part 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.” The majority of the circuits view this language as a “savings clause” that preserves post-confirmation rights (e.g., the right to pursue a nondebtor for a debt) rather than “an absolute bar to third-party releases.”[1]

Further, the court observed that, read together, §§ 105(a),[2] 1123(b)(3)(A)[3] and 1123(b)(6)[4] indicate that “enjoining a creditor’s claims against a nondebtor may be necessary, and within the bankruptcy court’s authority, to achieve a successful reorganization.”[5]

Before forging its own path, the court examined the standards used by the other circuits in determining whether nondebtor releases are acceptable, some of which overlap. The First and Eighth Circuits look generally to the following nonexclusive list of factors outlined in the case In re Master Mortg. Fund (the “Master Mortgage Factors”), including whether:

(1) there is an identity of interest between the debtor and the third party, usually an indemnity relationship, such that a suit against the nondebtor is, in essence, a suit against the debtor or will deplete assets of the estate;

(2) the nondebtor has contributed substantial assets to the reorganization;

(3) the injunction is essential to reorganization (i.e., without it, there is little likelihood of success);

(4) a substantial majority of the creditors agree to such injunction; specifically, the impacted class (or classes) has “overwhelmingly” voted to accept the proposed plan treatment; and

(5) the plan provides a mechanism for the payment of all, or substantially all, of the claims of the class or classes affected by the injunction.[6]

The Midway court found that courts in the Third Circuit do not have a specific test, although a Delaware bankruptcy court has looked to the Master Mortgage Factors as a foundation along with “other relevant factors.”[7] Third-party nondebtor releases are allowed in the Second and Seventh Circuit only “when truly ‘unusual circumstances’ exist.”[8] The Sixth Circuit also restricts allowing such releases to “unusual circumstances” and further looks to a set of seven factors, certain of which are identical or substantially similar to the Master Mortgage Factors referred to as the “Dow Corning Factors.” The Midway court found that the U.S. Courts of Appeals for the Fourth and Eleventh Circuits have also looked to the Dow Corning Factors.[1]

After analyzing Western Real Estate and the other circuits, the Midway court determined that “while § 524(e) does not expressly provide for the release of a third party’s claims against a nondebtor, § 524(e) does not expressly preclude such releases.” However, such releases are not given “carte blanche” and are acceptable only “in certain, and very limited, circumstances if the release is “appropriate” and not inconsistent with any other provision of the Bankruptcy Code, including § 524(e).”[2]

For its own approach, the Midway court found that “the Court must parse out exactly who is releasing whom from what.”[3] In other words, the court stressed the importance of distinguishing “between the Debtors’ release of nondebtors and third parties’ release of nondebtors” and to “find the release to be necessary for the reorganization and appropriately tailored to apply only to claims arising out of or in connection with the reorganization itself, and not to matters which would have no effect upon the estate.”[4] If not, there is potential for a jurisdictional issue that would preclude the authority of the bankruptcy court to enter a final order.

The court further warned against the releases providing “nondebtors with ‘blanket immunity’ for all times, transgressions and omissions and may not include immunity from gross negligence or willful misconduct.”[5] As the Midway court summarized it, “[i]t is not the intention of the Court to permit nondebtors to purchase immunity from unrelated torts, no matter how substantial their contribution to a debtor’s reorganization.”[6]

In summary, most jurisdictions will allow third party releases of nondebtors — but only in certain narrow circumstances. Courts will determine the issue based on the facts and dynamics of each case and will require that such releases be fully justified. Plan proponents must walk the tightrope of providing for the releases necessary to have a plan accepted while avoiding overbroad language and staying within the lines of bankruptcy jurisdiction.

 

The Supreme Court Sets the Limits of Fee-Shifting for Bad Faith Conduct in Goodyear Tire & Rubber Co. v. Haeger

by Nicole Leonard and Jeffrey Bernstein

This article is  reprinted with the permission of the American Bankruptcy Institute. It originally appeared in Volume 15, Number 2 of the ABI Business Reorganization Committee’s Ethics & Professional Compensation Newsletter, June 2017.

[1]In a recent unanimous decision delivered by Justice Kagan,[2] the Supreme Court has made clear that federal courts, when awarding sanctions for bad faith conduct through the use of their inherent powers (not derived from rule or statute), must limit such sanctions to only compensatory damages that have a causal connection to the misconduct.

The underlying lawsuit involved a products liability action against Goodyear Tire & Rubber Co. (“Goodyear”) in which customers alleged a Goodyear G159 tire failed and caused their motor home to swerve off the road and flip over. The plaintiffs (the “Haegers”) theorized that the tire design could not withstand the level of heat generated by driving at highway speeds.

The Haegers repeatedly requested that Goodyear provide them with Goodyear’s internal test results regarding the tire. Goodyear’s responses to these requests were slow and less than forthcoming. Additional discovery battles ensued but the case eventually settled just before trial.

Months later, the plaintiff’s counsel became aware of a pertinent piece of information from an article in a newspaper on another lawsuit involving the exact same Goodyear tire. Apparently, Goodyear had supplied additional internal test results in the other matter that were not supplied to the Haegers despite the Haegers’ repeated requests. The test results, unsurprisingly, revealed that the tire became unusually hot at highway speeds. Goodyear later conceded that it withheld this information. The Haegers in turn requested sanctions against Goodyear which included attorneys’ fees and costs for Goodyear’s discovery fraud.

The District Court for the District of Arizona (the “District Court”) found that the conduct of Goodyear spanned years and was egregious. Based on the severity of the misconduct, the District Court determined that it was not confined to award only the legal fees incurred as a result of the conduct but, rather, could award all the legal fees incurred by the Haegers from the moment the misconduct occurred. The District Court recognized that typically it would have to establish a causal connection between the misconduct and the fee award but determined this case was not typical based on the pattern of abuse. However, as an apparent hedge, the District Court also entered a contingent award in a lower amount in the event the inclusion of legal fees lacking a causal connection in the award was rejected on appeal.

The Ninth Circuit Court of Appeals, in a departure from rulings in other Circuits, affirmed the District Court, though not without dissent.[3] The majority found that it was appropriate to award legal fees incurred by the Haegers during the period of time that Goodyear was misbehaving — as opposed to the legal fees incurred as a result of the misconduct. The Supreme Court disagreed.

First, the Supreme Court (the “Court”) recognized that apart from the authority derived from rule or statute, federal courts have inherent power to “manage their own affairs so as to achieve the orderly and expeditious disposition of cases” and “fashion an appropriate sanction for conduct which abuses the judicial process.”[4] However, if the sanction is awarded under civil, as opposed to criminal, procedures, the sanction is limited to compensating the aggrieved party for the loss and cannot contain a component based on punishment for the bad acts. Thus an award compensating an aggrieved party for legal bills caused by the misconduct would be appropriate, but including legal bills that would have been incurred regardless of the misconduct would not be appropriate. In other words, a “but for” test is used to determine the appropriate sanction.

Thus, it is clear that sanctions awarded through a federal court’s inherent power based on civil procedures may only compensate an aggrieved party and may not contain a punitive component. But how does the trial court determine what compensatory sanction is appropriate? The direction here is less precise. The Court acknowledged that ‘“[t]he essential goal” in shifting fees is “to do rough justice, not to achieve auditing perfection” and “[a]ccordingly, a district court “may take into account [its] overall sense of a suit, and may use estimates in calculating and allocating an attorney’s time.”’[5] Further, in certain circumstances, requiring a causal connection does not preclude an award of all of an aggrieved party’s fees if such fees would not have been incurred but for the misconduct. But, in the absence of that unusual circumstance, the trial court is tasked with scrutinizing fees and segregating “individual expense items.” However, substantial deference is afforded to the trial court to determine what fees were caused by the misconduct given the trial court’s “superior understanding of the litigation.”[6]

The Court found that the District Court’s award of all the fees incurred by the Haegers from the moment of the misconduct by Goodyear was not appropriate because the Haegers could not show that the litigation would have settled but for the bad faith withholding of discovery. In other words, if Goodyear had supplied all the requested internal test results, the case may not have settled as Goodyear had other defenses (which the Court noted Goodyear used in other litigation which proceeded to trial) that might have precluded settlement at that time. Thus, it is possible the fees would have been incurred even in the absence of the bad faith withholding of discovery by Goodyear.

The Haegers argued that Goodyear waived the ability to challenge the District Court’s contingent award which purportedly excluded the punitive component because the amount of such award was based on Goodyear’s own submission. The Court acknowledged that the District Court should address the waiver issue on an initial basis as it would end the matter if it found in favor of the Haegers. Otherwise, the analysis of the appropriate amount of the sanction would have to start anew under the correct standard.