Sixth Circuit Does Not Permit Third-Party Releases In Equity Receiverships

• Published date: 23 August 2023
• Subject Matter: Corporate/Commercial Law, Insurance, Insolvency/Bankruptcy/Re-structuring, Financial Restructuring, Directors and Officers, Insolvency/Bankruptcy, Insurance Laws and Products
• Law Firm: Goodwin Procter LLP
• Author: Mr Michael Goldstein, Debora Hoehne and Sari Rosenfeld

The Sixth Circuit's recent decision in Digital Media Solutions v. South Univ. of Ohio, 59 F.4th 772 (6th Cir. 2023)provides a cautionary tale about the limitations of federal equity receiverships as a restructuring tool. It serves as a reminder that the law and the judicial landscape governing restructuring proceedings are not static.

Background

Digital Media involved a California nonprofit (the Foundation) that formed a subsidiary (the Dream Center) to purchase three university systems (including certain Art Institutes) to turn them into nonprofits. 59 F.4th at 774. The Dream Center struggled to operate the university systems and faced mounting lawsuits from unpaid creditors, including students from one of the Art Institutes (the Art Students), who brought a class-action lawsuit in state court against the Dream Center, the Foundation, and their directors and officers for allegedly hiding the loss of the institute's accreditation. Id. at 775. The Art Students contended the loss of accreditation impaired the value of their degrees and harmed their employment prospects. Id. at 783.

A bankruptcy filing was not a viable option as it would render the Dream Center ineligible for federal student loans or aid (its main source of funding). Id. at 776.In contrast,a federal receivership did not trigger this ineligibility. The Dream Center consented to its placement in a federal equity receivership, and the federal court appointed a receiver (the Receiver) to operate the Dream Center and its subsidiaries. Id. at 775. The receivership estate included insurance policies protecting directors and officers against liabilities in connection with their oversight of the Dream Center and defense costs related to covered claims. Id. at 776. The Receiver negotiated a settlement with the directors and officers, the Foundation, and the insurance company to bring proceeds from the policies into the Dream Center's receivership estate. The settlement included releases by the Receiver from claims against directors and officers, and the directors and officers likewise released any claims against the Dream Center and the Receiver. Id. The settlement was contingent on the district court's entry of an order (the "Bar Order") that would bar non-settling third parties (including parties like the Art Students) from pursuing claims against not just the Dream Center, but also the Foundation, the directors and officers of the Dream Center and the Foundation, and the insurance company. Id.

The...