Joshua M. Silverstein, Hiding in Plain View: a Neglected Supreme Court Decision Resolves the Debate Over Non-debtor Releases in Chapter 11 Reorganizations

• Publication year: 2011

ARTICLES

HIDING IN PLAIN VIEW: A NEGLECTED SUPREME COURT DECISION RESOLVES THE DEBATE OVER NON-DEBTOR RELEASES IN CHAPTER 11 REORGANIZATIONS

Joshua M. Silverstein^*

INTRODUCTION ................................................................................................ 15

I. A TAXONOMY OF NON-DEBTOR RELEASES ......................................... 22

A. Involuntary Non-Debtor Releases of Direct Claims ..................... 22

B. Voluntary Non-Debtor Releases of Direct Claims ....................... 25

C. Non-Debtor Releases of Derivative Claims and Rights Under a Debtor's Insurance Policies ...................................................... 26

D. Provisional Injunctions Shielding Non-Debtors ........................... 29

II. THE EQUITABLE AUTHORITY AND DISCHARGE PROVISIONS OF THE

BANKRUPTCY CODE ............................................................................. 30

A. Sections 105(a) and 1123(b)(6) and the General Equitable

Powers of Bankruptcy Courts ....................................................... 31

B. Section 524 and the Bankruptcy Discharge ................................. 41

III. THE SPLIT IN THE COURTS OVER THE PROPRIETY OF NON-DEBTOR

RELEASES ............................................................................................. 44

A. The Anti-Release Cases ................................................................ 44

B. The Pro-Release Cases ................................................................. 53

1. MacArthur Co. v. Johns-Manville Corp. ................................ 53

2. In re A.H. Robins Co. ............................................................. 56

3. Robins's Progeny and the Power to Grant Non-Debtor

Releases .................................................................................. 59

4. Circumstances in Which Pro-Release Courts Will Grant a

Non-Debtor Release ............................................................... 64

C. The Anti-Release Position Revisited: Channeling Releases and the Risk of Plan Failure ......................................................... 80

D. Can the Pro- and Anti-Release Decisions Be Reconciled? .......... 86

IV. UNITED STATES V. ENERGY RESOURCES CO. .......................................... 90

A. Internal Revenue Law Background .............................................. 90

1. Trust Fund Taxes .................................................................... 90

2. Voluntary Versus Involuntary Payment of Taxes ................... 91

B. In re Energy Resources, Co. ......................................................... 91

C. In re Newport Offshore, Ltd. ........................................................ 93

D. Consolidated Appeals Before the First Circuit ............................ 94

E. Proceedings Before the United States Supreme Court ................. 97

1. Briefs of the United States ...................................................... 97

2. Respondents' Brief ............................................................... 101

3. Opinion of the Supreme Court .............................................. 102

V. ENERGY RESOURCES AND NON-DEBTOR RELEASES ............................ 104

A. Energy Resources and Sec. 105(a) and 1123(b)(6) ...................... 106

1. The Substantive Equitable Power of Bankruptcy Courts ..... 106

2. The Scope of a Bankruptcy Court's Substantive Equitable

Powers After Energy Resources ........................................... 111

3. The Equitable Authority of Bankruptcy Courts to Allocate the Risk of Plan Failure ........................................................ 119

B. Energy Resources and Sec. 524 ...................................................... 122

C. Energy Resources and Conflicts Between Equitable Orders and Nonbankruptcy Law ............................................................. 131

CONCLUSION .................................................................................................. 137

ABSTRACT

This Article presents a novel resolution of a long-standing circuit split on an issue of critical significance to bankruptcy and tort law: whether bankruptcy courts may extinguish liabilities of parties that have not filed for bankruptcy. Such "non-debtor releases" are similar in effect to a bankruptcy discharge and have become particularly common in both mass tort disputes and general insolvencies adjudicated through the bankruptcy process. In this Article, I illustrate how an overlooked Supreme Court decision-United States v. Energy Resources, 495 U.S. 545 (1990)-offers crucial support for the pro-release position. Energy Resources demonstrates that the bankruptcy courts' "general equitable power" allows them to extinguish claims against non-debtors and that such relief is not forbidden by any specific provision in the Bankruptcy Code.

INTRODUCTION

The ultimate policy of chapter 11¹of the Bankruptcy Code²("the Code") is the successful reorganization of debtors.³A successful reorganization is one that both rehabilitates the debtor and minimizes creditor forfeitures.⁴These two aims, while frequently in conflict,⁵are promoted by the Code's complex array of provisions-provisions that carefully balance the interests of debtors and creditors.⁶

In addition to its specific directives, the Code entrusts bankruptcy courts with "broad equitable powers to balance the interests of the affected parties, guided by the overriding goal of ensuring the success of the reorganization."⁷

This equitable authority emanates primarily from Sec. 105(a),⁸which states that "[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title."⁹Another source of general equitable power is Sec. 1123(b)(6),¹⁰which permits a chapter 11 plan to

"include any other appropriate provision not inconsistent with the applicable provisions of this title."¹¹There is substantial disagreement over the scope of the authority conferred by these statutes.¹²And the controversy is particularly acute in the context of "non-debtor releases."¹³

A key component of debtor rehabilitation is the "fresh start" provided by chapter 11's discharge provision. Under Sec. 1141(d)(1), the confirmation of a plan of reorganization discharges the bankrupt party from all of its preconfirmation debts (with limited exceptions).¹⁴The debtor emerges from bankruptcy with only the obligations set forth in its plan.¹⁵The plan also is binding on all of the debtor's creditors, including those that objected to its approval.¹⁶Pursuant to Sec. 524 of the Code, the discharge benefits the debtor alone; the liabilities of guarantors, sureties, joint tort-feasors, shareholders, directors, employees, and related companies are not impacted.¹⁷Creditors thus generally are free to collect any deficiencies in bankruptcy payments from coliable parties and pursue independent claims against insiders and affiliated entities.¹⁸However, this is not always so. While the discharge itself does not shield third parties, a substantial number of bankruptcy courts have used the general equitable powers conferred by the Code to extinguish claims against non-debtors-i.e., to grant "non-debtor" or "third-party" releases.¹⁹

Resources recognized the broad equitable powers accorded bankruptcy courts under 11 U.S.C. Sec. 105(a) and

For at least eighteen years, the federal courts have been divided over whether such releases are permissible.²⁰The Code does not expressly sanction the issuance of non-debtor releases.²¹However, "pro-release" courts contend that the equitable powers flowing from Sec. 105(a) and 1123(b)(6) allow for this type of relief.²²And they see no explicit prohibition on releases in the Code or elsewhere.²³"Anti-release" courts, as their label suggests, disagree. Many

"anti-release" courts have concluded that non-debtor releases run afoul of

Sec. 524(e), which provides that the "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."²⁴They read this language, and the bankruptcy policies underlying it, to prohibit third-party releases.²⁵Other anti-release courts do not believe that Sec. 524(e) constitutes a bar. Instead, they think that Sec. 105(a) and

1123(b)(6) simply do not grant sufficient equitable power to permit the release of claims against non-debtors.²⁶

Commentators are also deeply split on the propriety of non-debtor releases. They have produced numerous articles defending a variety of pro-release and anti-release positions.²⁷

If anything is clear, it is that non-debtor releases are receiving "growing judicial acceptance" and are becoming increasingly common in chapter 11 plans of reorganization.²⁸Indeed, one commentator has suggested that "the practice of approving non-debtor releases is more widespread than the number of published judicial opinions would suggest[,]" because appellate challenges to plans of reorganization are often mooted by consummation of the plan.²⁹

And whereas in 2005 the number of corporate bankruptcies finally began falling from record levels,³⁰the recent scandals rocking Wall Street and the broader American business community are giving rise to precisely the type of mass-tort disputes that have inspired courts to approve of non-debtor releases in the past.³¹

The propriety of third-party releases is thus an issue that cries out for Supreme Court guidance,³²particularly since "the bankruptcy court is quickly becoming the forum for resolution of many of the largest and most complex mass litigations."³³If the High Court does join the fray, there is a largely overlooked decision from which the Justices should seek guidance-the Court's own ruling in United States v. Energy Resources Co. ("Energy

Resources").³⁴Energy Resources held that bankruptcy courts may use their equitable powers under Sec. 105(a) and 1123(b)(6) to compel the Internal Revenue Service ("IRS") to allocate a chapter 11 debtor's tax payments to those tax liabilities...