On July 3, 2014, the US Court of Appeals for the Third Circuit issued a non-precedential opinion in In re Lower Bucks Hospital affirming a decision denying approval of a non-consensual third-party release contained in a plan of reorganization because the release was not adequately disclosed to affected creditors in the disclosure statement or in the plan (No. 13-1311, (3d Cir. July 3, 2014)).

In 1992, Lower Bucks Hospital (Debtor) issued bonds, which were secured by its gross revenues. An indenture trustee (Trustee) was appointed to maintain perfection of the bondholders' security interest.

In 2010, the Debtor filed a Chapter 11 bankruptcy petition. At the time of the filing, the Debtor owed about $26 million of principal and interest to the bondholders, which should have been a secured claim. However, the Debtor filed an adversary proceeding against the Trustee, alleging that it failed to maintain a correct financing statement to secure the debt when the Debtor changed its name in 1997 and 2006. The parties eventually settled, agreeing that:

The Bankruptcy Court approved the settlement, clearly unaware of the Third-party Release. The Debtor later filed a disclosure statement and a plan of reorganization, which only included references to the Third-party Release on pages 42 (out of 47) and 55 (out of 62), respectively, and did not use any typeface that emphasized or highlighted the disclosure, such as italics, bold or underline. The Bankruptcy Court approved the disclosure statement and the plan, still unaware of the Third-party Release.

One of the bondholders challenged the Third-party Release by filing:

The Bankruptcy Court subsequently amended its approval of the settlement to clarify that it did not limit the bondholders' ability to bring claims against the Trustee. At the confirmation hearing, the parties jointly requested that the Court sever the Third-party Release from the proposed plan and consider it separately at a later date. The Bankruptcy Court agreed and confirmed the plan without the Third-party Release.

Ultimately, the Bankruptcy Court denied the Third-party Release, noting that:

The Trustee appealed to the District Court, which affirmed the Bankruptcy Court's decision. The Trustee then appealed to the Third Circuit, arguing that:

The Third Circuit affirmed, holding that:

Section 1125 of the Bankruptcy Code requires that a disclosure statement contain "adequate information" which is information sufficient in detail to enable a hypothetical investor to make an informed decision about the plan. In addition, Federal Rule of Bankruptcy Procedure 3016 states that "[i]f a plan provides for an injunction..., the plan and disclosure statement shall describe in specific and conspicuous language (bold, italic, or underlined text) all acts to be enjoined and identify the entities that would be subject to the injunction."

Here, the Court noted that the Third-party Release acted as an injunction by prohibiting bondholders from bringing suit against the Trustee. The Court held that the disclosure was inadequate in presentation and placement because the reference to the Third-party Release:

Next, the Third Circuit turned to the Bankruptcy Court's ability to revisit its initial approval of the disclosure statement. Under Federal Rule of Bankruptcy Procedure 9024, which incorporates Federal Rule of Civil Procedure 60(b), a court may reconsider earlier orders in the case of "mistake, inadvertence, surprise, . . . excusable neglect," or "any other reason that justifies relief." Here, because the Third-party Release was not brought to the attention of the Bankruptcy Court by the parties, the Court held that it was within the Bankruptcy Court's discretion to revisit its approval of the disclosure statement in light of the new information. The Court noted that any other rule would encourage debtors to obscure information in their disclosure statements.

Finally, the Third Circuit agreed that approval of the Third-party Release should be withheld. Under the Third Circuit's standard in pronounced in In re Continental Airlines, a non-consensual third-party release may be upheld if specific factual findings support that it is:

(203 F.3d 203, 213-14 (3d Cir. 2000)).

Applying this standard, the Third Circuit held that in the absence of adequate disclosure, it could not conclude that the Third-party Release was exchanged for adequate consideration or was otherwise fair to the bondholders. Therefore, the Third Circuit affirmed the lower courts' decision denying approval of the Third-party Release.

Although this decision is nonprecedential, it serves as a reminder of the importance of fully, clearly and adequately disclosing all key terms of a settlement agreement and a plan of reorganization, particularly non-consensual, non-debtor releases. Failure to do so may lead to litigation and increases the risk that a court will not enforce the disputed provision.

For more information on third-party releases in Chapter 11 plans, see Practice Note, Third-party Releases in Bankruptcy Plans.