James Millar Speaks On Third-Party Releases

The recent decisions are ultimately likely to be helpful to creditors because, going forward, the review of third-party releases will need to be much more rigorous.  The bottom line is that third-party releases fall into a bucket of chapter 11 provisions that bankruptcy courts typically review, broadly speaking, under fairly vague standards, such as “did the recipients of the release provide ‘substantial value’?” or “are the releases ‘necessary for the success of the reorganization?’”  Creditors pursuing confirmation objections based on those standards have an exceedingly difficult job, and they regularly get overruled.  These decisions put the brakes on, to some extent, the free-flow of third party releases, which should result in chapter 11 plans that are ultimately fairer to all creditors.

Proponents of third-party releases regularly claim that those releases are beneficial to the reorganization process as a whole because they allow for the resolution of a vast universe of claims within one proceeding.  This has some validity, no doubt, and indeed some creditor groups in given situations support a universal solution because they have obtained a recovery that they feel is satisfactory.  Presumably, the recovery is greater because those that are being released from creditor claims are willing to contribute more towards the overall deal to obtain global relief.

The drawback for creditors is that those receiving the benefits of the additional consideration are not necessarily the same as those creditors being forced to grant third-party releases.  Let’s tease that out a bit through an example.  Imagine a situation where the primary creditor group and the debtor (and its shareholders) are at loggerheads over the economics of a proposed plan.  The creditor group wants to receive $100 million in recovery, but the debtor/shareholder group is only willing to provide $90 million—thus leaving a $10 million gap between the bid and the ask.  Also, further, accept as a given that there is a separate, smaller group of creditors that allege unique claims directly against the shareholders.

The shareholders are willing to accept a deal whereby they contribute an additional $10 million to the pot if they can obtain a third-party release of all claims, including those alleged by the smaller creditor group.  Indeed, having studied their prospective liability, they view this resolution as getting off cheap.  The larger group of creditors like this deal as well, as since they obtain the recovery that they want without giving up anything they considered valuable.  The parties then announce a “global deal” and tell the bankruptcy judge about the “sensitive” and “fragile” nature of the resolution and ask for prompt confirmation of their chapter 11 plan that encapsulates the so-called global deal.

The problem, however, is that the gap between the bid and the ask of our two warring constituencies was filled by consideration given involuntarily by someone else who, in all likelihood, wasn’t even at the table and probably won’t receive the full benefit of what they are forced to give up.  Those kinds of deals are, frankly, easy to do when the primary parties are spending other people’s money.  Moreover, if and when the disenfranchised parties object to such a deal, they are characterized as holdouts who seek to leverage a bad situation for their own personal benefit.

While the two recent decisions turn on some complex legal analysis, the near-term result likely will be that bankruptcy courts will have to be much more exacting in their analysis of third-party releases.  Since plan proponents won’t be able to rely on every objection being overruled, one would expect that they will strive that much harder to reach a consensual resolution with all creditors.  That should result in chapter 11 plans that are inherently fairer to all involved, including those that otherwise would have been runover.