Second And Seventh Circuits Issue Decisions On Third-Party Releases

For decades now, debtors in chapter 11 have proposed in

their chapter 11 plans "third-party releases,"

whereby creditors are deemed to have released certain nondebtor

parties (such as officers, directors, or affiliates of the

debtor) upon the confirmation and effectiveness of the plan.

For an equally long period, such third-party releases have

engendered controversy in the courts and elsewhere as to when,

if ever, such releases are appropriate. Over the years, the

issue has been considered by several courts of appeals, with

somewhat differing results. Until recently, the Second Circuit

Court of Appeals (covering New York, Connecticut, and Vermont)

was widely thought to be one of the most favorable

jurisdictions to debtors on the issue of the propriety of

third-party releases in a chapter 11 plan.

On February 15, 2008, however, the Second Circuit struck

down a third-party release in the long-running Johns-Manville

Corporation chapter 11 case, In re Johns-Manville

Corp., 517 F.3d 52 (2d Cir. 2008), and in so doing

potentially signaled a shift in that Circuit's position on

the issue. Not long after, on March 12, 2008, the Seventh

Circuit Court of Appeals (covering Illinois, Wisconsin, and

Indiana) issued its own opinion on third-party releases in the

case of In re Airadigm Communications, Inc., 2008

WL649704 (7th Cir. Mar. 12, 2008). In approving the third-party

release in that case, the Seventh Circuit now may be viewed as

a relatively favorable jurisdiction for debtors on the issue.

As such, the Circuit split on third-party releases

continues.

Third-Party Releases Under a Chapter 11 Plan

In general, a chapter 11 plan may contain two different

types of releasesan estate release and a third-party

release. An estate release is a release by the debtor of claims

that the debtor itself possesses. By contrast, a third-party

release prevents a nondebtor (especially creditors) from

prosecuting claims against another nondebtor. There are two

types of third-party releasesvoluntary and involuntary.

Voluntary third-party releases are those to which a creditor

has consented, for instance by agreeing to the release on its

plan ballot. Most courts do not find voluntary third-party

releases controversial, since they essentially represent an

agreement between the creditor and the released nondebtor

party.

By contrast, involuntary third-party releases compel a

creditor or nondebtor to release another nondebtor without

consent. These releases always have been controversial. In

fact, the Ninth and Tenth Circuits essentially have found such

releases to be prohibited by the Bankruptcy Code. See In re

Lowenschuss, 67 F.3d 1394 (9th Cir. 1995); In re

Western Real Estate Fund Inc., 922 F.2d 592, 600 (10th

Cir. 1990). Similarly, the Fifth Circuit has held that a

bankruptcy court lacks jurisdiction to grant an involuntary

third-party release where the third-party claim is not

sufficiently related to the bankruptcy. See In re Zale

Corp., 62 F.3d 746 (5th Cir. 1995). The Fourth and Sixth

Circuits, by contrast, have permitted third-party releases in

certain mass-tort cases, but only where the nondebtor that is

released makes a substantial contribution to the plan. See

In re A.H. Robins, 972 F.2d 77 (4th Cir. 1992); In

re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002).

Previously, the Second Circuit also had permitted third-party

releases (including in prior proceedings in the

Manville case itself) where the court found that the

release was important to the chapter 11 plan and where the

parties covered by the release were necessary to the plan. See

In re Drexel Burnham Lambert Group, Inc., 960 F.2d 285

(2d Cir. 1992); MacArthur Co. v. Johns-Manville Corp.,

837 F.2d 89 (2d Cir. 1988). Prior to the Airadigm

case, the Seventh Circuit had never ruled on the issue.

Instead, it ruled in In re Specialty Equipment Co., 3

F.3d 1043 (7th Cir. 1993), that consensual third-party releases

were permissible, although the language of its opinion

potentially suggested a negative view of involuntary

third-party releases.

The Second Circuit's Opinion in

Johns-Manville

The recent Second Circuit Manville case arose out

of an attempt by various of Manville's asbestos

personal-injury claimants to bring conspiracy and

breach-of-duty claims against Travelers Insurance Company.

Travelers was Manville's primary insurer from 1947 to 1976

and became a focal point of the Manville bankruptcy

case once Manville filed for chapter 11 in 1982 as a result of

spiraling asbestos personal-injury lawsuits against the

company. Aprimary asset of the Manville bankruptcy available to

pay asbestos creditors was the insurance coverage that

Travelers had provided to Manville over the years...