Eastern District of Pennsylvania Bankruptcy Conference Case Problem Series: Eagle Technologies

24 Min Read By: Aaron S. Applebaum


The Eastern District of Pennsylvania Bankruptcy Conference (“EDPABC”) is a non-profit organization that was formed in 1988 to promote the education and interests of its members and the citizens of the Commonwealth of Pennsylvania residing in the ten counties within the United States District Court for the Eastern District of Pennsylvania. Members include lawyers, other professionals and paraprofessionals who specialize in the practice of Bankruptcy and Creditors’ Rights law in the Eastern District of Pennsylvania. Please visit EDPABC’s website, www.pabankruptcy.org, for more information or to join.

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Each year, the EDPABC’s Education Committee formulates challenging hypotheticals based on recent case law. At the EDPABC’s Annual Forum, typically held in January each year, professors from local law schools facilitate lively discussions among EDPABC members about the hypotheticals in small-group breakout sessions. The hypotheticals are always engaging—and sometimes deliberately ambiguous—to mirror the complexity of everyday practice and foster debate among even the most seasoned bankruptcy professionals.

The hypotheticals are accompanied by summaries of the underlying case law and other relevant authorities inspiring the fact patterns. The summaries are intended to give readers insights into how similar issues have been argued before and decided by the courts, and to inform their answers to the questions presented in the hypotheticals.

This hypothetical from a previous Forum, titled “Eagle Technologies,” describes the bankruptcy case of a fictitious sports equipment company founded by former professional football players “Carson” and “Fletcher.” After stealing a competitor’s intellectual property, the company faced patent infringement and other civil actions; a multi-district class action litigation as a result of product defects; and a criminal prosecution for regulatory violations. The hypothetical poses questions relating to the approval of a settlement by the debtor and its secured lender with the creditors’ committee. It raises issues relating to the Supreme Court’s decision in Jevic, WARN Act liability, and third-party releases.

Eagle Technologies

Carson and Fletcher retire from lucrative professional football careers and decide to go into business for themselves.  They made millions playing football, but want to turn their millions into billions.  Before professional football, Carson attended one of North Dakota’s top science and engineering colleges.  Fletcher has a natural entrepreneurial spirit, and cannot wait to put his business skills to use.  It is a match made in heaven.  They form Eagle Technologies, LLC, a Delaware limited liability company, in which Carson and Fletcher each hold 50% membership interests.

They perceive an untapped market for improved football helmets.  The football industry is suffering after revelations about the long-term health effects football players suffer, such as traumatic brain and orthopedic injuries.  The leagues implement new rules making the game less enjoyable for fans, resulting in declining revenues for the billion dollar industry.  The pair sees this as an opportunity – if they could design better helmets, football could regain its hard-hitting, bone-crunching glory days, and they could make a fortune in the process.

Carson and Fletcher get to work.  Carson creates new helmet designs while Fletcher looks for funding.  Carson soon realizes, however, that without medical training, he cannot tell if the new helmets are actually safer.  At the same time, Fletcher finds little enthusiasm in the capital markets for their business model – especially without a ready-to-market design.

Investors suggest Carson and Fletcher invest their own money into years of R&D, and come back when they have a product ready.

Carson and Fletcher confer and decide to turn to Plan B.  Instead of designing new helmets, they will duplicate an existing design and find a way to build it more cheaply.  They can then market their equipment as both cheaper and safer.  Carson gets a computer hacker to steal proprietary designs from a chief competitor, Giant Helmets, Inc., and Fletcher develops contacts with companies overseas who can develop components to mirror the stolen designs at a fraction of the cost incurred by Giant.  They take their “new design” and supply contracts to an institutional lender, Cowboy Bank, N.A. Cowboy sees potential, and signs a letter of intent to loan $100 million to Eagle, secured by substantially all of Eagle’s assets and personally guaranteed by Carson and Fletcher.  Cowboy’s LOI is conditioned on: (a) Eagle obtaining a patent for Carson’s equipment design; and (b) Eagle obtaining preliminary regulatory approval from the Consumer Product Safety Commission (the “CPSC”), the agency charged with regulatory oversight of safety-related issues concerning sports equipment.

Eagle submits its design to the patent and trademark office, and Fletcher bribes the patent office to obtain approval, despite the obvious similarity to Giant’s existing patented design.  For help with the CPSC, they are thrilled to find that Nelson, another former teammate, has a sister, Kelsey, with a mid-level position at the CPSC.  For a 20% share in the company (split between Nelson and Kelsey), Kelsey agrees to forge paperwork showing CSPC preliminary approval of the design.

With patent and apparent CPSC preliminary approval in hand, Cowboy funds the loan and Eagle is off and running.  Eagle puts the stolen designs into development, and by outsourcing all components of the equipment, Eagle easily undercuts Giant and all its other competitors.  With these competitive advantages, Eagle enters into lucrative, exclusive supply contracts with most professional, collegiate, high school and junior football teams.  Demand keeps increasing, and Eagle develops into a company with over 1,000 employees, rapidly spreading into other sports equipment product lines and clothing.  After a few years, the helmets that started Eagle’s empire become a small part of an otherwise legitimate and successful business.

Unfortunately, the house of cards starts to collapse.  Giant sues Eagle, Fletcher and Carson for patent infringement, conversion and a host of other civil causes of action.  Eagle also finds itself as a target of multi-district class action litigation, as the cheap foreign parts were poor substitutes for the quality components usually used in Giant’s helmet designs, and football players started experiencing worse and more frequent brain injuries than ever before.  To top it off, the Federal Government commences criminal prosecution against Carson, Fletcher, Nelson and Kelsey as questions arise concerning Eagle’s CPSC approval process.  Eagle’s mounting legal expenses put a strain on liquidity, and Eagle misses two scheduled loan payments to Cowboy.

Eagle hires an investment banker to explore sale and reorganization options.  With all of the negative publicity surrounding the civil and criminal lawsuits, however, the only parties interested are liquidators, who just want the non-helmet inventory, and Giant, who wants to expand into Eagle’s non-helmet product lines and who places a high value on Eagle’s customer list.  Eagle and Giant begin intense negotiations, resulting in a stalking horse APA valued at roughly $65 million – much higher than the liquidators would pay but far less than the secured loan balance owed to Cowboy.  The APA also contains a financing contingency, a material adverse change clause which would permit Giant to terminate if any of Eagle’s 50 largest customers cancel their supply contracts, and the requirement of bankruptcy court approval of a substantial breakup fee and expense reimbursement.  Eagle takes the deal to Cowboy, who agrees to fund a $2 million debtor-in-possession financing credit facility, just enough to get a sale process approved assuming closing occurs within 1 month of filing.

APA and DIP facility in hand, Eagle files its chapter 11 case and seeks approval of an expedited sale process.  The unsecured creditors’ committee objects to everything, arguing that the sale process effectuates a sub rosa plan, provides insufficient marketing, and amounts to a bankruptcy foreclosure benefiting only the secured creditor without any benefit for unsecured creditors.  Eagle and Cowboy negotiate with the committee, and ultimately settle the committee’s disputes.  Through the settlement, Cowboy agrees to a carve-out from the sale proceeds of $500,000 in favor of general unsecured creditors, in which insiders and priority claimants will not share.  The Internal Revenue Service objects, alleging that the sale will leave unpaid a large priority income tax claim and that the settlement violates the absolute priority rule.

1. Should the bankruptcy court approve the settlement with the committee and the sale procedures?

2. Can the court approve a carve-out only for non-priority, general unsecured creditors without any assurance that priority and/or administrative expense claims will be paid in full?

3. Does the timing matter?   To what extent should the court’s decision be influenced by the fact that the case will remain open after consummation of the sale?

4. Does this settlement implicate the Supreme Court’s decision in Jevic?

5. Would court approval be more likely if the movants show that expected priority claim recoveries would be unchanged by the settlement, because priority claim holders would expect to get $0 under any circumstances?

The court permits the sale process to go forward.  However, at the last minute, Giant terminates the deal, alleging a breach of the material adverse change clause following non-renewal of several customers’ supply contracts.  Giant’s termination results in a default under Cowboy’s DIP facility, and, left with no alternative, Eagle notifies its employees of an immediate closure and mass layoff.  A group of Eagle’s employees commences an adversary proceeding in the bankruptcy case alleging violations of the WARN Act, and requesting allowance of their damages claim as an administrative expense of the estate under section 503(b) of the Bankruptcy Code.

6. Do the circumstances surrounding the layoff give rise to WARN Act liability?

7. What factors should be relevant in the court’s analysis of WARN Act liability?  Giant’s “out” clauses?  Giant’s status as a competitor?

8. Does the bankruptcy court’s approval of the sale process, including the stalking horse APA, provide a defense to WARN Act liability?

9. If WARN Act liability exists, are the claimants entitled to administrative expense treatment under section 503(b)?  What evidence should the employees present?

Hoping to grab victory from the jaws of defeat, Fletcher and Carson decide to propose a new-value reorganization plan, in an attempt to save the valuable components of the business.  They file a plan and disclosure statement which provides for the reorganization of the non-helmet components of the business in exchange for a new value contribution of $120 million – enough to pay off the balance of Cowboy’s secured debt plus make some distribution to unsecured creditors.  In exchange for this new value they seek broad third-party releases and injunctions to cease their ongoing civil litigation with Giant, the class action lawsuits and the criminal prosecution.  The proposed plan does not require the consent of any party who would be granting a release.

10. Does the bankruptcy court have either “arising in” or “related to” jurisdiction to grant a non-consensual third-party release?  Is the answer to this question influenced by Fletcher and Carson’s indemnification rights under Eagle’s operating agreement?  Even if the court has subject matter jurisdiction, is the court’s constitutional authority under Stern implicated?

11. For the plan to be confirmable, must the ballots soliciting votes on the plan provide for an “opt-out” mechanism?

12. Assume the court agrees to the third-party release, but only if claimants are given an opt-out right.  At the time of solicitation, it is impossible to know the full universe of potential claimants related to injuries from use of the helmets.  Can Carson and Fletcher satisfy due process concerns with respect to unknown claimants by notice publication or otherwise?  For purposes of this question, only consider the third-party claims against Carson and Fletcher, and assume the plan adequately addresses direct claims against Eagle.

Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017)

In Czyzewski v. Jevic Holding Corp. (“Jevic”), the Supreme Court addressed the issue of “structured dismissals” in chapter 11 bankruptcy cases.  In most cases, upon dismissal of a bankruptcy case, the Bankruptcy Code effectuates a “restoration of the prepetition status quo.”  Jevic, at 978; citing 11 U.S.C. § 349(b).  In the underlying bankruptcy case, however, in dismissing the case, the bankruptcy court “ordered a distribution of estate assets that gave money to high-priority secured creditors and to low-priority general unsecured creditors but which skipped certain dissenting mid-priority creditors.”  Id.

The Jevic debtors filed their chapter 11 cases owing $53 million to their senior secured creditors and over $20 million to tax and general unsecured creditors.  The bankruptcy court entered a $12.4 million judgment against the debtors in favor of a group of the debtors’ former truck drivers for WARN Act violations, of which $8.3 million was afforded priority treatment under section 507(a)(4) of the Bankruptcy Code.  In addition, the unsecured creditors’ committee commenced an adversary proceeding against the secured creditors, asserting claims arising from their pre-petition leveraged buyout of the debtors.  The parties sought to settle the committee’s lawsuit pursuant to an agreement through which, in sum, the secured creditors would ensure payment of administrative expenses and a distribution to general unsecured creditors, with no distribution to the priority WARN Act claimants, and the dismissal of the bankruptcy cases.  The bankruptcy court approved the settlement and dismissed the case.  The Third Circuit Court of Appeals affirmed, finding that Congress only “codified the absolute priority rule . . . in the specific context of plan confirmation.”  Id. at 982 citing In re Jevic Holding Corp., 787 F.3d 173, 178 (3d Cir. 2015).

The Supreme Court reversed, ruling that the bankruptcy court does not have the legal power to order priority skipping of this kind “in connection with a Chapter 11 dismissal.”  Id. (emphasis in original).  The Court recognized that the Bankruptcy Code “permits the bankruptcy court, ‘for cause,’ to alter a Chapter 11 dismissal’s ordinary restorative consequences.”  Id. at 979.  The Court also recognized the Bankruptcy Code’s “basic system of priority,” making clear that “distributions of assets in a Chapter 7 liquidation must follow this prescribed order.”  Id., citing 11 U.S.C. §§ 725, 726.  The Court further noted that, even though chapter 11 plans may impose a different ordering with the consent of affected parties, bankruptcy courts “cannot confirm a plan that contains priority-violating distributions over the objection of an impaired creditor class.”  Id., citing 11 U.S.C. §§ 1129(a)(7), 1129(b)(2).  The Court noted that both chapter 7 liquidations and chapter 11 plans must satisfy the absolute priority rule, and that mere silence in section 349(b) of the Bankruptcy Code was insufficient to conclude Congress intended a departure to a priority system “long … considered fundamental to the Bankruptcy Code’s operation.”  Id. at 984.

In re Short Bark Industries, Inc. et al., Case No. 17-11502(KG) (Bankr. D. Del. 2017)

In Short Bark, the debtors sought approval of debtor-in-possession financing and sale procedures in connection with a sale under section 363(b) of the Bankruptcy Code, to which the unsecured creditors’ committee objected.  The debtors also filed schedules listing priority creditors with claims totaling nearly $500,000.  The debtors, lenders and the committee subsequently settled the objections to the financing and the sale procedures, and filed a motion for approval of the settlement under Federal Rule of Bankruptcy Procedure 9019.

In addition to agreements preserving certain estate causes of action, the settlement agreement provided that the first $110,000 of sale proceeds, whether from the stalking horse, a competitive bidder, or the secured lenders’ credit bid, would be escrowed by the lender and set aside for a pro rata distribution to general unsecured creditors.  Importantly, the settlement did not provide for payment of the scheduled priority claims.

The United States Trustee asserted that the proposed settlement violated the Supreme Court’s decision in Jevic, because it effectuated a priority-skipping distribution without the consent of the skipped priority creditors.  There was no assurance that there would be funds remaining in the debtors’ estates to pay such priority claims, and thus, even though not in the context of dismissal, the Jevic prohibition on priority-skipping distributions should apply.

The debtors and the committee argued that Jevic was inapplicable, as this was not an “end of the case” distribution, but rather a permissible early-case distribution that enabled the debtor to obtain financing, effectuate a sale, and save jobs.  The debtors and committee noted that, even in the Jevic decision, the Supreme Court noted that certain early case distributions which did not follow the priority scheme, such as those found in wage and critical vendor orders, were necessary for the operation of a chapter 11 case.

The bankruptcy court agreed with the debtors and the committee and approved the settlement.  Judge Gross concluded that Jevic was limited to priority-skipping in the context of dismissal, at the end of the case, and thus did not apply to an early case settlement and carve-out in the context of a sale and debtor-in-possession financing.  The bankruptcy court further noted that priority creditors were not harmed by the settlement, because the secured lenders were so undersecured that priority creditors would not receive any distribution in a chapter 7 liquidation in any event.  The United States Trustee appealed the decision to the District Court but the parties settled before proceeding further.

In re AE Liquidation, Inc. et al, 866 F.3d 515 (2017)

In AE Liquidation, the Third Circuit addressed a manufacturer’s obligation under the Worker Adjustment and Retraining Notification (WARN) Act to give fair warning to its employees before effecting a mass layoff.  In particular, the appellate court faced the question of whether a business must notify employees of a pending layoff once the layoff becomes “probable,” or if the mere foreseeable probability that a layoff may occur is enough to trigger the WARN Act’s notice requirements.  The court found that an employer’s obligation to give notice did not arise until closing was probable.

The debtor (formerly known as Eclipse Aviation Corporation) filed bankruptcy in November 2008.  The company entered bankruptcy with an agreement to sell the company to its largest shareholder.  Had that agreement closed, the company would have continued its operations.  The sale, however, required substantial funding from the shareholder’s lender, a state-owned Russian bank, and the funding never materialized.  The debtor held out as long as it could for the funding to materialize (with continuous assurances that the funding was imminent, including, apparently, from President Putin himself), but was eventually forced to cease operations.

The Third Circuit commenced its analysis by noting that the WARN Act requires employers to give all affected employees sixty days’ notice prior to a mass layoff.  AE Liquidation, 866 F.3d at 523.  The court also noted that “the Act contains multiple exceptions, and Eclipse asserts one of them – the ‘unforeseeable business circumstances’ exception.”  Id.  That exception affords employers an affirmative defense and applies “when the closing or mass layoff is caused by business circumstances that were not reasonably foreseeable as of the time that notice would have been required.”  Id., citing 29 U.S.C. § 2102(b)(2)(A).  To prevail on this affirmative defense, the employer must show “(1) that the business circumstances that caused the layoff were not reasonably foreseeable and (2) that those circumstances were the cause of the layoff.”  Id., citing Calloway v. Caraco Pharm. Labs., Ltd., 800 F.3d 244, 251 (6th Cir. 2015); 20 C.F.R. § 639.9(b).

The Third Circuit concluded that the company satisfied the criteria for the unforeseeable business circumstances exception.  With respect to causation, the Court agreed with the company’s assertion that, if the sale had gone forward, employees would have been retained.  Thus, because employees would have been retained had the sale closed, the Third Circuit agreed with the District Court that failure to obtain financing for the sale was the cause of the layoff.

With respect to foreseeability, the court noted a lack of criteria in the federal guidelines, which only suggested inquiry into whether “in failing to anticipate the circumstances that caused the closing, the employer ‘exercised such commercially reasonable business judgment as would a similarly situated employer in predicting the demands of its particular market.’“ Id. at 528, citing Loehrer v. McDonnell Douglas Corp., 98 F.3d 1056, 1060 (8th Cir. 1996).  The court also noted that lower courts in this circuit had adopted the test from the Fifth Circuit requiring that “in order to be ‘reasonably foreseeable’ and event must be ‘probable.’“ Id. at 528, citing Halkias v. General Dynamics Corp., 137 F.3d 333, 336 (5th Cir. 1998).

The court found that every other circuit court to consider the foreseeability standard had applied a “probable” test, and agreed this was the appropriate test.  The court found that it struck “an appropriate balance in ensuring employees receive the protections the WARN Act was intended to provide without imposing an ‘impracticable’ burden on employers that could put both them and their employees in harm’s way.”  Id. at 50.  Given the circumstances and the numerous assurances the debtors had received regarding funding for the sale, and possibly the unique situation where the funding source was a state-owned Russian bank, the court agreed the company had satisfied its burden to assert the unforeseeable business circumstances exception to WARN Act liability.

In re Millennium Lab Holdings II, LLC, et al., Bankr. Case No. 15-12284(LSS), Dist. Ct. Case. No. 16-110-LPS (D. Del., March 17, 2017)

In Millennium Lab, the District Court of Delaware addressed the issue of nonconsensual third-party releases as part of a chapter 11 plan of reorganization.  On appeal, the District Court was asked to determine whether bankruptcy courts had subject matter jurisdiction to approve nonconsensual third-party releases, and whether the bankruptcy court had constitutional authority to permanently release such claims in light of the Supreme Court’s decision in Stern v. Marshall, 131 S. Ct. 2594 (2011).

The debtors were providers of laboratory-based diagnostic testing services, and derived a significant portion of their revenue from Medicare and Medicaid reimbursements.  The company was indebted since 2014 pursuant to a $1.825 billion secured credit facility, issued as part of a “dividend recapitalization” transaction, through which the company’s two primary equity holders received nearly $1.3 billion as a special dividend.

By early 2012, the company was under a joint criminal and civil investigation by the United States Department of Justice (the “DOJ”).  By the end of 2014, the company was informed claims would be brought, and in February 2015 the Centers for Medicare and Medicaid Services (“CMS”) notified the company it was revoking billing privileges based on billings submitted for at least 59 deceased patients.  Privileged were also later revoked for alleged submission of fraudulent claims for services without valid physician orders.  The company negotiated a settlement with the DOJ and CMS, but was unable to effectuate it through an out of court restructuring.

The company then filed for bankruptcy, contemporaneously filing a reorganizing plan and disclosure statement.  The plan called a $325 million contribution by the two non-debtor equity holders, of which $256 million would fud the settlement of the DOJ’s claims, $50 million would be paid to the debtors’ lenders, and the remaining $19 million would be used as operating capital.

The plan provided full releases for the non-debtor equity holders, including any claims brought directly by non-debtor lenders, and including claims related to the $1.3 billion special dividend paid out in 2014.  The plan provided no ability for parties to “opt-out” of the third-party releases, meaning the releases would be granted upon confirmation regardless of whether a creditor consented.

The appellants had commenced a fraud action against the non-debtor equity holders and other related parties in the district court prior to confirmation, asserting claims for RICO violations, fraud, and restitution.  The appellants also objected to confirmation of the plan, arguing, among other things, that the court lacked either “arising in” or “related to” subject matter jurisdiction to approve the nonconsensual third-party releases.  The appellants also objected that the bankruptcy court lacked constitutional authority under Stern to approve the releases.

The bankruptcy court overruled the objections and confirmed the plan.  The bankruptcy court held that it at least had “related to” subject matter jurisdiction, and stated that it need not consider (and had not had time to consider) the Stern challenge, given its finding of subject matter jurisdiction.  The bankruptcy court found that the releases were fair and necessary to the reorganization.

On appeal, the district court noted that a finding of “related to” jurisdiction does not end the inquiry, as the bankruptcy court must have constitutional authority as well.  The court noted that “there appears to be no dispute between the parties that Appellants’ state common law fraud and RICO claims are non-bankruptcy claims between non-debtor which do not ‘stem[] from the bankruptcy itself’ and would not ‘necessarily be resolved in the claims allowance process.’”  Millennium Lab, at p. 25, citing Stern, 131 S. Ct. at 2618.  The district court concluded these were claims “between two private parties”, not closely intertwined with a federal regulatory program, and thus did not involve matters of public rights.  Id.  Thus, the district court concluded appellants were “entitled to Article III adjudication of these claims, and Stern dictates that no final order be entered on such claims by an Article I court, barring consent of the parties (which has not been provided here).”  Id.  However, despite the “seeming merits” of appellants’ Stern position, because the bankruptcy court had not itself ruled on the issue, the district court remanded so the bankruptcy court could first adjudicate the Stern issue.

In re SunEdison, Inc., et al., Bankr. Case No. 16-10992 (SMB) (Bankr. S.D.N.Y., Nov. 8, 2017)

In SunEdison, the bankruptcy court for the Southern District of New York issued a memorandum decision and order regarding third-party releases under a plan, which provided broad releases favor of non-debtors, and defined the Releasing Parties as “all Holders of Claims entitled to vote for or against the Plan that do not vote to reject the Plan.”  No such “non-voting releasor” filed an objection to confirmation, but the bankruptcy court sua sponte raised the issue of whether the release could be approved.  The bankruptcy court conclude that the debtors’ failed to show that non-voting releasors impliedly consented, that the court had jurisdiction to grant the releases, or that approval of non-consensual releases was appropriate under the Second Circuit’s Metromedia decision (Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136 (2d Cir. 2005).

On the issue of implied consent, the bankruptcy court noted many decisions finding such consent through an affirmative vote to accept a plan containing a third-party release.  However, consent by silence raised a more difficult question.  The court recognized some courts permitted silence to constitute consent where the creditor was given a clear opportunity to “opt-out” but chose not to do so, including the Delaware cases of In re Indianapolis Downs, LLC, 486 B.R. 286, 306 (Bankr. D. Del. 2013) and In re Spansion, Inc., 426 B.R. 114, 144 (Bankr. D. Del. 2010).  However, the court also found multiple decisions finding such implied consent impermissible, including In re Washington Mut., Inc., 42 B.R. 314, 355 (Bankr. D. Del. 2011) and In re Zenith Elecs. Corp., 241 B.R. 92, 111 (Bankr. D. Del. 1999).  The bankruptcy court agreed with the latter group of cases and found that silence, through non-voting, cannot be considered implied consent to the third-party release.  SunEdison, at p. 10.

With respect to jurisdiction, the bankruptcy court noted that, under Second Circuit precedent, the question is whether adjudication of the non-debtor’s claim might have any conceivable effect on the bankruptcy estate.  Id. at 12, citing Marshall v. Picard (In re Bernard L. Madoff Inv. Sec. LLC), 740 F.3d 81, 88 (2d Cir. 2014).  The bankruptcy court continued, “importantly, a financial contribution to the estate by the release, without more, does not confer subject matter jurisdiction to enjoin claims against the releasee.”  Id., citing Johns-Manville Corp. v. Chubb Indem. Ins. Co. (In re Johns-Manville Corp.), 517 F.3d 52, 66 (2d Cir. 2008).

In SunEdison, the debtors asserted subject matter jurisdiction arose because they might owe indemnification obligations to the released parties.  While the court agreed that indemnification rights could have an effect on the estate, thus establishing jurisdiction, it concluded that the broad third-party releases proposed exceeded the scope of indemnification obligations at issue.  The releases covered far more than the claims for which indemnification could be sought, and was not limited to parties with potential indemnification rights.

Based on the non-consensual nature of the releases and the overly broad scope of the releases in comparison to potential effect on the debtors’ estates, the bankruptcy court denied approval of the third-party releases.

In re Gawker Media LLC, et al., Bankr. Case No. 16-11700 (SMB) (Bankr. S.D.N.Y., Dec. 22, 2016)

On starkly different facts than those set forth in SunEdison, Judge Bernstein approved non-consensual third-party releases in Gawker.  There, the plan granted third-party releases in favor of the debtors’ employees and independent contractors (i.e., writers), all of whom held potential (and had asserted in the bankruptcy cases) indemnification claims against the debtors.  In exchange for the third-party releases, the released employees and independent contractors both supported the plan and agreed to waive their claims against the debtors for indemnification obligations.

The releases in Gawker in favor of the employees and independent contractors were binding on each holder of a claim or interest that received or was deemed to have received a distribution under the plan.  Thus, any creditor receiving a distribution (i.e., any party with a filed or scheduled claim), was subject to the release regardless of affirmative consent and without an ability to opt out.  The bankruptcy court approved the third party releases.  Importantly, as opposed to SunEdison, the releases in Gawker were limited to parties with actual indemnification obligations, and the court found such releases warranted by the particular facts and circumstances of the case.

By: Aaron S. Applebaum

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