National Heritage Foundation, Inc. v. Highbourne Foundation: Fourth Circuit Rejects Plan's Non-consensual Third-party Release | Practical Law

National Heritage Foundation, Inc. v. Highbourne Foundation: Fourth Circuit Rejects Plan's Non-consensual Third-party Release | Practical Law

The US Court of Appeals for the Fourth Circuit, in National Heritage Foundation, Inc. v. Highbourne Foundation, affirmed a decision of a bankruptcy court which held that a non-consensual third-party release provision contained in a Chapter 11 plan of reorganization was invalid due to the debtor's failure to provide evidence establishing that the facts and circumstances of the case justified the release.

National Heritage Foundation, Inc. v. Highbourne Foundation: Fourth Circuit Rejects Plan's Non-consensual Third-party Release

by Practical Law Finance
Published on 29 Jul 2014 • USA (National/Federal)
The US Court of Appeals for the Fourth Circuit, in National Heritage Foundation, Inc. v. Highbourne Foundation, affirmed a decision of a bankruptcy court which held that a non-consensual third-party release provision contained in a Chapter 11 plan of reorganization was invalid due to the debtor's failure to provide evidence establishing that the facts and circumstances of the case justified the release.
On June 27, 2014, the US Court of Appeals for the Fourth Circuit in National Heritage Foundation, Inc. v. Highbourne Foundation affirmed a bankruptcy court's decision which held that a non-consensual third-party release provision contained in a plan of reorganization was invalid due to the debtor's failure to provide evidence establishing that the facts and circumstances of the case justified the release (National Heritage Found., Inc. v. Highbourne Found., No. 13-1608, (4th Cir. June 27, 2014)).

Background

In 2009, National Heritage Foundation, Inc. (NHF), a non-profit organization that administers and maintains donor advised funds, filed for Chapter 11 bankruptcy after a state court entered a multimillion dollar judgment against it. The bankruptcy court confirmed NHF's plan of reorganization which included a non-debtor release provision (Release Provision) that released NHF, the Official Committee of Unsecured Creditors (Committee) and its members, any designated representative of the Committee and any officers, directors or employees of NHF, the Committee or their successors and assigns (Released Parties) from:
"any claim, obligation, cause of action, or liability to any party in interest who has filed a claim or was given notice of the Debtor's Bankruptcy Case . . . for any act or omission before or after the Petition Date through and including the Effective Date in connection with, relating to, or arising out of the operation of the Debtor's business, except to the extent relating to the Debtor's failure to comply with its obligations under the Plan."
Certain NHF donors challenged confirmation of the plan on the ground that the Release Provision was invalid. The district court affirmed the bankruptcy court's confirmation of the plan. On appeal, the Fourth Circuit vacated the portion of the district court's judgment affirming the Release Provision. The Fourth Circuit remanded with instructions to the bankruptcy court to make specific factual findings supporting the conclusion that the Release Provision was essential by considering the six substantive factors enumerated in Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.) (see 280 F.3d 648 (6th Cir. 2002)). These factors consider whether:
  • There is an identity of interests between the debtor and the third party, usually an indemnity relationship, such that a suit against the third party is, in essence, a suit against the debtor or will deplete assets of the estate.
  • The non-debtor has contributed substantial assets to the reorganization.
  • The injunction is essential to reorganization.
  • The impacted class, or classes, has overwhelmingly voted to accept the plan.
  • The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction.
  • The plan provides an opportunity for those claimants who choose not to settle to recover in full.
A different bankruptcy judge considered the case on remand and made factual findings concerning each of the Dow Corning factors. The bankruptcy court reversed, ruling that the Release Provision was unenforceable after concluding that only the first factor was clearly satisfied. The district court affirmed and NHF appealed to the Fourth Circuit.

Outcome

The Fourth Circuit reviewed each of the six substantive Dow Corning factors and concluded that:
  • NHF established an identity of interests between itself and the Released Parties because under its by-laws, it was required to advance legal expenses and indemnify its officers and directors.
  • None of the Released Parties made any financial contributions to the reorganization. NHF argued that its officers and directors made a substantial contribution to the reorganization by promising to continue serving NHF. However, the Court found no evidence to support this assertion and did not consider this meaningful consideration in any case because NHF's officers and directors were either paid or had a fiduciary obligation to perform their duties.
  • NHF failed to show that the release was "essential" to its reorganization because it did not provide evidence regarding the number, nature or potential merit of any donor claims. Further, the Court reasoned that the plan's severability clause, which provided that the plan would remain in effect "should any provision in this Plan be determined to be unenforceable," suggested that the plan would remain viable without the Release Provision.
  • It need not resolve whether deemed acceptance of the plan by the class most affected by the Release Provision (the donor class), who, as an unimpaired class was not entitled to vote on the plan, is the same as an overwhelming vote in favor of the plan for purposes of the Dow Corning test. The Court declined to rule on this issue because even if presumed acceptance satisfies this factor of the Dow Corning test, it would not outweigh the other factors that weighed against enforcing the Release Provision.
  • NHF failed to provide evidence that its plan created a mechanism, such as a channeling trust, to pay all or substantially all of the claims of the affected class, nor did it provide any evidence that the notice it provided to affected creditors adequately protected their interests.
  • NHF failed to provide evidence that its plan included a mechanism to pay the affected creditors' claims outside of the bankruptcy proceeding.
Because the Fourth Circuit found that only one Dow Corning factor was clearly satisfied, it agreed with the district court that NHF failed to provide adequate factual support to demonstrate that the circumstances justified enforcing the Release Provision.

Practical Implications

This decision reaffirms that non-consensual third-party releases are permissible in the Fourth Circuit, but should be granted cautiously, infrequently and only when they are supported by specific factual findings. The Fourth Circuit emphasized that a "debtor need not demonstrate that every Dow Corning factor weighs in its favor to obtain approval of a non-debtor release," and that its decision was "rooted in NHF's failure of proof rather than circumstances alone." This case serves as a reminder that courts closely scrutinize these releases when determining whether they are appropriate under the circumstances.
For more information on third-party releases in Chapter 11 plans, see Practice Note, Third-party Releases in Bankruptcy Plans.