Nondebtor releases in Chapter 11 reorganizations: a limited power.

• Author: Gamble, Elizabeth

Introduction I. The History of Nondebtor Releases and Injunctions A. Basics of a Chapter 11 Proceeding 1. Bankruptcy Courts' Traditional Exercise of Jurisdiction Under Chapter 11 2. Bankruptcy Courts' Equitable Powers Under Section 105 B. Which Nondebtor Third Parties Request Releases and Injunctions? II. Seminal Decisions and Reasons for and Against Nondebtor Third Party Releases and Injunctions A. Judicial Disagreement on the Treatment of Nondebtor Third Party Releases and Injunctions in Chapter 11 Plans 1. Seminal Pro-Release Decisions a. In re Johns-Manville Corp b. In re Drexel Burnham Lambert Group, Inc c. In re A. H. Robins Co 2. Seminal Anti-Release Decisions a. In re American Hardwoods, Inc b. In re Continental Airlines B. Arguments for and Against Granting Nondebtor Releases and Injunctions to Insiders and Insurers in Chapter 11 Plans 1. Should Insiders Be Granted Nondebtor Releases or Injunctions? a. Arguments for Allowing Releases and Injunctions to Insiders b. Arguments Against Allowing Releases or Injunctions to Insiders 2. Should Debtors' Insurers Be Granted Nondebtor Releases or Injunctions? a. Arguments for Granting Releases and Injunctions to Insurers b. Arguments Against Granting Releases and Injunctions to Insurers III. The Limited Power of Bankruptcy Courts to Grant Nondebtor Releases and Injunctions A. Policy Considerations Dictate that Injunctions and Releases Be Granted to Insurance Companies in Mass Tort and Class Action Cases, Subject to Several Caveats B. Policy Considerations and a Changing Landscape Dictate that Releases and Injunctions Not Be Granted to Debtors' Insiders 1. Shift Towards Pre-Arranged Bankruptcies and Use of Turnaround Management Renders the Insider Assistance and Cooperation Justification for Insider Releases and Injunctions Moot 2. Shift Towards Pre-Arranged Bankruptcies and Use of Turnaround Management Renders the Contributing Nondebtor Justification for Insider Releases and Injunctions Moot 3. Need to Obtain Releases from Indemnity and Contribution Claims is an Illusory Justification for Granting Insider Releases and Injunctions 4. Two Caveats to Refusing Releases and Injunctions to Insiders: Temporary Stays and Consensual Releases ....... Conclusion INTRODUCTION

On April 20, 2010, an explosion at BP p.l.c.'s ("BP") Deepwater Horizon oil rig (the "Rig") caused a massive oil gush 5000 feet below sea level, resulting in the largest environmental disaster in United States history and the largest oil-related disaster in the world. (1) As a result of the explosion, eleven workers were killed, seventeen others were seriously injured, (2) and thousands more in the Gulf area suffered, and continue to suffer, financial losses. The extensive scope of the injuries and economic losses has led to the filing of thousands of claims and hundreds of class actions against BP and other potentially responsible parties for economic damages, environmental cleanup costs, and other losses. (3) BP insiders, including Anthony B. Hayward, the former Chief Executive Officer ("CEO") of BP and former Executive Director of the Board of Directors, face numerous derivative liability suits for breach of fiduciary duties to the company and its shareholders. (4) Transocean Ltd., the company that owned and operated the Rig, which it leased to BP, also faces liability for the disaster. (5) In addition, Cameron International Corporation ("Cameron"), the company that manufactured the blowout preventer that failed to function on the Rig, is confronted with potential liability. (6) Lastly, Halliburton Energy Services, Inc. ("Halliburton"), a subcontractor to the Rig and the company that was servicing the cement casing meant to seal the wellhead to the sea floor, faces extensive liability claims for its part in the disaster. (7)

In response to the onslaught of claims and pressure from President Obama, BP agreed to place $20 billion into an escrow account (the "BP Oil Spill Fund" or "Fund") to pay damage claims. (8) Claimants who choose to recover from the BP Oil Spill Fund must, in exchange for compensation, waive their rights to pursue claims against both BP and others, including Halliburton and Cameron. (9) The question arises: is it fair to release BP from liability in exchange for its contribution of $20 billion?

Some argue that without the BP Oil Spill Fund, BP would be embroiled in litigation with tort claimants for years to come, and the success of the company would be severely in question. The Fund also enables claimants to be compensated far more quickly than they otherwise would be if they were required to obtain a judgment in court. For many Gulf residents, receiving compensation now is imperative, as they cannot afford to wait for their claims to take the inevitably lengthy route through the traditional judicial system. While the Fund offers several benefits, with BP paying the vast majority of these claims, what justification can there be for releasing BP's insiders, Halliburton, and others from liability?

Although BP did not enter bankruptcy, the BP Oil Spill Fund and the proposed releases of BP, BP's insiders, and other potentially liable companies parallel many of the issues faced by bankruptcy courts assessing Chapter 11 plans. Bankruptcy courts have long struggled with the question of whether a Chapter 11 plan can contain a provision releasing the liabilities of, or grant injunctions preventing claims from being asserted against, parties other than the debtor, including insiders of the debtor and others entities tangentially related to the debtor, namely insurance companies. (10)

This Note will argue that the power of bankruptcy courts to grant nondebtor third party releases and injunctions should be carefully limited. As the BP case illustrates, there are significant benefits to the creation of a claimants trust, both for the company and claimants. Claimants trusts most often arise in the bankruptcy context in cases where the debtor faces mass tort claims or securities class actions. (11) In these cases, the debtor's insurer often agrees to make a contribution to the fund or to channel proceeds of the insurance policy into a fund in exchange for a release from future liability and an injunction barfing future action by claimants against the insurer. This Note will argue that bankruptcy courts should continue to grant releases and injunctions in exchange for the insurer's substantial contribution to the plan of reorganization when the debtor is faced with class action or mass tort litigation that threatens to upend any efforts to reorganize the debtor. The insurer's contribution to a claimants trust can aid the debtor's reorganization because the debtor can avoid time-consuming litigation with the insurer over the scope of the insurance policy, the cost of which would deplete assets of the estate. These assets will instead be available to creditors. Insurer releases and injunctions in exchange for channeling insurance proceeds into a fund may further promote the fair and equitable distribution of assets to creditors because the proceeds will be distributed under the supervision of the bankruptcy court, as opposed to the state law rule of first-come, first-served that leaves some creditors paid in full and others with little or no compensation.

Recent developments in the Chapter 11 process have important implications for whether courts should grant releases to another type of nondebtor third party--insiders of the debtor. (12) In the past, many courts were willing to grant insider releases or injunctions based on various theories, including the need to obtain the insider's assistance and cooperation with the reorganization, the debtor's need to obtain the release of the insider's indemnity or contribution claims against the debtor, and the need to secure monetary contributions from the insider to the plan of reorganization. (13) This Note will argue that recent shifts towards pre-arranged bankruptcies and the increased use of turnaround specialists render at least two of these justifications moot. (14) These changes to the traditional Chapter 11 proceeding indicate that large corporate debtors do not view existing management as integral to the reorganization of the debtor, and that it is, therefore, unnecessary to provide the insiders with releases or permanent injunctions. Securing existing management's cooperation and assistance is no longer, and may never have been, a valid reason for granting a release or an injunction. (15) In addition, since corporations more and more frequently replace existing management, the need to grant a release in exchange for the insider's contribution of new value to induce the insider to retain an equity interest in the reorganized entity is also no longer a valid justification. (16) Lastly, as some commentators have argued, the debtor's need to obtain releases from insiders' indemnification and contribution claims is an illusory argument that courts have too often accepted without question. (17)

This Note proceeds in three parts. Part I addresses the history of nondebtor releases and injunctions, the origins of bankruptcy courts' jurisdictional powers, the traditional and more unique ways in which bankruptcy courts interpret and exercise this power, and the policy goals behind Chapter 11. Part II explores seminal decisions on whether bankruptcy courts have the power to grant nondebtor third party releases and injunctions. It also lays out the main arguments asserted by both courts and scholars on both sides of the argument. Lastly, Part III sets forth my argument that courts should never grant permanent releases to insiders and only under rare circumstances, to the debtor's insurers.

1. THE HISTORY OF NONDEBTOR RELEASES AND INJUNCTIONS

   In a Chapter 11 bankruptcy, one of the main policy goals includes successful reorganization of a debtor with going concern value and fair and equitable distribution to creditors. (18) Deciding when a...