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Third Circuit Affirms Bankruptcy Court’s Excision of Inadequately Disclosed Third-Party Release From Plan of Reorganization

In re Lower Bucks Hosp., 2014 WL 2981215 (3d Cir. July 3, 2014)

In this Opinion, the Third Circuit held that non-consensual third-party releases were correctly severed from a proposed plan of reorganization because of significant disclosure deficiencies.  In doing so, the Court reminds all practitioners of a hallmark of plan drafting and solicitation—that “[k]ey terms of a plan of confirmation, particularly those that release a non-debtor from claims by creditors, must be adequately disclosed [and] [f]ailure to do so in a clear and conspicuous manner risks excision of the release from the plan.”  Because the releases at issue failed in “both presentation and placement,” excision was warranted and thus, the lower court’s decision to do so was affirmed.

As of the date of its chapter 11 filing, Lower Bucks Hospital (the “Debtor”) owed approximately $26 million of allegedly secured debt to certain of its bondholders (the “Bondholders”).  During the proceeding, the Debtor commenced an adversary proceeding to invalidate the Bondholders’ liens, alleging that Bank of New York Mellon Trust Company (“BNYM”), the indentured trustee, failed to maintain a correct financing statement.  To resolve the dispute, the Debtor and BNYM reached a settlement that resulted in an allowed Bondholder secured claim in the amount of $8.15 million (the “Settlement”).  Significantly, the Settlement included a provision releasing all Bondholder claims against BNYM (the “Third-Party Release”).  At the hearing to approve the Settlement, no party directed the Bankruptcy Court’s attention to the Third-Party Release despite having the opportunity to do so.  Moreover, it was only briefly referenced in the related 9019 motion and proposed order.  According to the Third Circuit, it was clear that the Bankruptcy Court approved the Settlement without knowledge of the Third-Party Release.  Following the approval of the Settlement, the Debtor filed its proposed plan and disclosure statement.  Similar to the brevity with which it was addressed in the 9019 motion, the Third-Party Release was simply referenced on one page of each pleading.  It was not highlighted or emphasized in any way.  Ultimately, the Bankruptcy Court denied the Third-Party Release, holding that the Bondholders did not receive adequate notice.  The Court found that the Third-Party Release was not conspicuous and failed to provide Bondholders with information regarding the merits or value of the released claims against BNYM.

On appeal, the Third Circuit held that the Bankruptcy Court did not abuse its decision when concluding that the release was inadequately disclosed.  As noted, the Third-Party Release was essentially an injunction that must be described in “specific and conspicuous language” in both the plan and disclosure statement, see Fed. R. Bankr. P. 3016(c), so that a hypothetical investor is able to make an informed judgment about the plan.  See 11 U.S.C. § 1125(a)(1).  The Third Circuit observed that only a single paragraph in the disclosure statement referenced the Third-Party Release (with no use of distinguishing font) and that the plan was even less direct.  The Court agreed with the Bankruptcy Court that the pleadings failed on both “presentation and placement.”  As such, the record easily supported a finding of inadequate disclosure and the resulting denial of the Third-Party Release.  See In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000) (requiring, among other things, fairness and adequate consideration for approval of a non-consensual third-party release).