Third-Party Releases – Better Make Sure They Are Adequately Disclosed

In Re Lower Bucks Hospital, No. 13-1311 (3d Cir., July 3, 2014)

CASE SNAPSHOT

In a recent non-precedential holding, the Third Circuit Court of Appeals affirmed a decision of the bankruptcy court finding that the disclosure of a third-party release in the settlement agreement and the disclosure statement accompanying a plan of reorganization was inadequate, and therefore the bankruptcy court was justified in striking the release provision from both the settlement agreement and the plan.

FACTUAL BACKGROUND

The chapter 11 debtor brought an action against the indenture trustee as the holder of secured notes, seeking a declaration by the bankruptcy court that the liens of the indenture trustee were voidable because of faulty financing statements that were ultimately corrected - but within the preference period. The indenture trustee asserted that the bonds were secured by the hospital's gross revenues. However, the hospital had changed its name after the original financing statements were filed. The original financing statements were not corrected to reflect the new name of the debtor until long after its name change, and the corrected financing statements were filed within 90 days of the bankruptcy filing.

Ultimately the case was settled and the settlement was reduced to a written agreement. The settlement agreement contained a release of the indenture trustee that was binding not only upon the debtor and the creditors committee, but also upon the bondholders who were not parties to the agreement. The proposed settlement was presented to the bankruptcy court judge as an attachment to a motion filed under Bankruptcy Rule 9019 seeking to have the agreement approved. Evidently neither the counsel to the debtor nor the counsel to the indenture trustee brought the contents of the third-party release to the bankruptcy judge's attention, and the judge approved the settlement.

Not long after the settlement was approved, the debtor filed its proposed plan of reorganization and disclosure statement. Those documents included the same third-party release, releasing the indenture trustee of any and all wrongdoing and causes of action by all creditors, including the bondholders. In neither document was the release highlighted or emphasized. At the disclosure statement hearing, the bankruptcy judge was not made aware of the release, which had not been highlighted, and was not conspicuous. The judge approved the disclosure statement and it was thereafter...