Summary of a Recent
Judicial Development in
Bankruptcy

Third-Party Release Provisions Only Allowed if "Appropriate"

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In In re Berwick Black Cattle Co., 394 B.R. 448 (Bankr. C.D. Ill. 2008), the United States Bankruptcy Court for the Central District of Illinois denied confirmation of a Chapter 11 bankruptcy plan because the proposed third-party release provisions were not "appropriate" and because, if allowed, they would effect pending state court actions filed pre-petition over which the bankruptcy court had no jurisdiction.

Background

Ward Feed Yard (WFY), a secured creditor of involuntary Chapter 11 debtors, along with its subsidiaries and related entities, provided a substantial portion of the financing that allowed the debtors to reorganize. Id. at 450-51. The debtors and WFY sought confirmation of their plan, which contained three release provisions indemnifying WFY and certain other parties against claims from other creditors. Id. at 451. The Twifords, another creditor, had brought an action against WFY in state court prior to the filing of the bankruptcy petition, and the release provisions purported to release WFY's liability to them in that case as well. Id. at 455-57.

Arguments

WFY argued for a "wide open door" policy for third-party releases without any particular guidelines or limitations. Id. at 457.

Analysis and Holdings

The court stated that although § 524(e) of the Bankruptcy Code was not an absolute bar to third-party releases, it was one of the most fundamental substantive provisions of the Code, so third-party releases should "be viewed with a healthy dose of skepticism." Id. at 460. The court further stated that a nonconsensual third-party release of claims provision should be limited to acts or omissions made in the bankruptcy proceeding, with gross negligence and wilful misconduct excluded. Id. The court found that two of the provisions were inappropriate as they were "blanket provisions" which purported to release WFY's liability to the Twifords concerning a state court action filed pre-petition which the bankruptcy court had no jurisdiction over. Id. The court also noted that such release provisions only applied to "participating creditors," meaning those who were participating in the bankruptcy case at least to the extent that they had actual notice and opportunity to object to the release provision; the Twifords had not received the full notice required by the Code so they were not "participating creditors." Id. Moreover, the court pointed out that while some equitable considerations favored allowing the release provision, others did not, and the Twifords and other unsecured creditors would not receive any compensation for losing their claims. Id. at 461. The court also reasoned that this case was more of a liquidation than a reorganization, and the rationale for allowing third-party releases was much less compelling, if not nonexistent, in liquidations. Id. The court also questioned who was actually providing the funds for the reorganization, as the plan was unclear on that issue, and only creditors who substantially contributed to the reorganization were entitled to a release. Id. at 462. The provision also purported to release another secured creditor, High Plains Farm Credit, from liability, but High Plains had contributed nothing of present value. Id. Lastly, the court recognized no basis for extending indemnification to non-debtor claims made against WFY which would not have any effect on the bankruptcy estate. Id. The court therefore held that it did not have jurisdiction to allow the releases and, even if it did have jurisdiction, such action would not be appropriate, and thus denied confirmation of the Chapter 11 plan. Id.

The case was decided on September 23, 2008.