April 09, 2020

Recent Delaware Decisions Show Divergent Views on Third-Party Release Procedures

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Two recent decisions from Delaware illustrate somewhat divergent views from the bankruptcy bench on the proper procedures for obtaining non-debtor releases in confirmed plans of reorganization. In both In re Emerge Energy Services LP, et al.1 and In re Cloud Peak Energy Inc., et al.2 the debtors’ initial, and then certain subsequent, efforts at plan confirmation were stymied by proposed opt-out procedures. Ultimately, both debtors were able to confirm their plans after adjusting the applicable release provisions, as described below. Collectively, these decisions demonstrate how closely many courts will scrutinize non-debtor releases and the importance of designing procedures for obtaining consent to such releases that demonstrate that they are procedurally fair.

In Emerge Energy Services, the debtors sought to provide for releases of claims against non-debtor parties by equity security holders and general unsecured creditors, among others, in their initial, first amended, and second amended plans of reorganization. Under each of the plans, consent would be deemed given unless: (1) as to equity security holders, a holder timely and properly completed and returned an opt-out form (since they were not voting on the plan) and, (2) as to general unsecured creditors, the creditor affirmatively opted out on their ballot voting on the plan. These provisions drew objections from the United States Trustee (“UST”)3 and the SEC,4 among others. Both the UST and SEC objected that it was procedurally improper to force stakeholder to opt out of, rather than opt in to or other affirmatively consent to, third-party releases.

The SEC’s objection also focused on the fairness of requiring equity security holders that received nothing under any of the proposed plans, and thus were not entitled to vote on the plans, to affirmatively opt out of the third-party releases. The SEC noted that “silence, or failure to opt out, cannot establish affirmative consent to the [r]elease” particularly because of the likelihood that many of the equity security holders were given either “no or insufficient notice of the opt-out procedure by their brokers.”5

The UST made a similar argument, also focusing on the specific procedural unfairness of requiring constituencies receiving no distribution under the plan (in this case, general unsecured creditors and equity security holders) to make the effort of opting out of third-party releases. To the UST, there was a disconnect between presuming consent based on inaction and the incentives of the equity security holders and general unsecured creditors to complete the necessary opt-out forms because, by virtue of receiving no distribution, the affected creditors may have believed that that they stood to gain little from taking the time to complete a ballot or opt-out form.

Judge Karen Owens sustained the UST’s and SEC’s objections in a December 5, 2019 order6 noting that, as to equity security holders and general unsecured creditors, the debtors’ second amended plan did not adequately account for whether such creditors affirmatively consented to provide third-party releases or, in the alternative, merely failed to understand that the actions they took in relation to the plan constituted consent to such a releases. As to general unsecured creditors, the court found that the second amended plan impermissibly sought to impose third-party releases on creditors that either returned a ballot and did not opt out of the third-party releases or failed to return a ballot. As to equity security holders, the court found that the Debtors’ second amended plan impermissibly sought to impose third-party releases on equity security holders that failed to submit an opt-out form.

To remedy these issues, the Debtors modified their second amended plan, which resulted in confirmation on December 18, 2019.7 As to equity security holders, the modifications provided that only those equity security holders who affirmatively consented to provide third-party releases would be deemed to have done so and that those equity security holders that failed to complete an opt-out form would not be considered to have consented to the third-party releases. As to general unsecured creditors, the plan modifications provided that only those general unsecured creditors that returned a ballot and did not affirmatively opt out of the third-party releases would be deemed to have consented to the third-party releases. As such, general unsecured creditors that failed to return a ballot would not be considered to have consented to the third-party releases.

In Cloud Peak Energy, the Delaware bankruptcy court addressed the propriety of opt-out provisions in a chapter 11 plan with respect to bondholders, who were entitled to vote on the plan, and equity security holders, who were not entitled to vote on the plan. As in Emerge Energy Services, the UST8 and SEC,9 among others, objected to the proposed third-party releases, arguing that the opt-out procedures set forth in the plan were insufficient indicators of the bondholders’ and equity security holders’ affirmative consent to grant the third-party releases.

In confirming the Debtors’ plan, Judge Kevin Gross effectively opted to strike the plan provision that sought third-party releases from equity security holders by finding that the equity security holders did not qualify as “Releasing Parties” under the plan because they received nothing and they were not given the opportunity to vote.10 As to the bondholders, Judge Gross determined that the plan’s opt-out procedures, which required bondholders to affirmatively opt out of third-party releases in connection with completing their ballot, were consensual, specific, and integral to the plan and that, as such, bondholders would be bound by the releases unless they opted out in connection with submitting their ballot.11 Though not explicitly addressed at the confirmation hearing or in the subsequent confirmation order, the release procedures approved by Judge Gross with respect to the bondholders bound those that failed to return a ballot in addition to the consenting bondholders.

The Emerge Energy Services and Cloud Peak Energy confirmation fights illustrate the contours of how Delaware bankruptcy courts may address third-party releases in relation to various stakeholder constituencies. In particular, courts’ reticence to impose releases on equity holders that are not entitled to vote on a plan nor receive any distribution without assurance that such equity holders affirmatively consented to the release is an important through-line between both decisions. But perhaps more notable is the divergence between Judges Gross and Owens with respect to the effect of failure to return a ballot by a party entitled to vote on a plan. This divergence may require debtors, particularly those in Delaware bankruptcy courts, to carefully consider how they design solicitation procedures where third-party releases are a material provision of a reorganization plan.

1 In re Emerge Energy Services LP, et al., No. 19-11563 (KBO).

2 In re Cloud Peak Energy Inc., et al., No. 19-11047 (KG).

3 Obj of the U.S. Trustee to Confirmation of Debtors’ First Amended Joint Plan of Reorganization for Emerge Energy Services LP and its Affiliated Debtors under Ch. 11 of the Bankr. Code, In re Emerge Energy Services LP., et al., No. 19-11563 (KBO) (Bankr. D. Del. Oct. 17, 2019), ECF No. 514;

4 Obj, of the Securities and Exchange Comm. to Approval of the Disclosure Statement and Confirmation of the Debtors’ Joint Ch. 11 Plan, In re Emerge Energy Services LP., et al., No. 19-11563 (KBO) (Bankr. D. Del. Aug. 24, 2019), ECF No. 255.

5 Supp. Obj, of the Securities and Exchange Comm. to Confirmation of the Debtors’ Joint Ch. 11 Plan, In re Emerge Energy Services LP., et al., No. 19-11563 (KBO) (Bankr. D. Del. Oct. 3, 2019), ECF No. 424.

6 Opinion, In re Emerge Energy Services LP, at al.. No. 19-11563 (KBO) (Bankr. D. Del. Dec. 5, 2019), ECF No. 671.

7 Findings of Fact, Concl. Of Law and Order Confirming the Second Am. Joint Plan of Reorganization for Emerge Energy Services LP and its Affiliate Debtors Under Ch. 11 of the Bankr. Code, In re Emerge Energy Service LP, et al., No. 19-11563 (KBO)(Bankr. D. Del. Dec. 18, 2019), ECF No. 721.

8 U.S. Trustee’s Obj. to Confirmation of the Rev. First Am. Joint Ch. 11 Plan of Cloud Peak Energy Inc. and Certain of its Debtor Affiliates, In re Cloud Peak Energy Inc., et al., No. 19-11047 (KG) (Nov. 18, 2019), ECF No. 840.

9 Obj, of the Securities and Exchange Comm. to Confirmation of the First Am. Join. Ch. 11 Plan of Cloud Peak Energy Inc. and Certain of its Debtor Affiliates, In re Cloud Peak Energy Inc., No. 19-11047(KG) (Nov. 26, 2019), ECF No. 825.

10 Findings of Fact, Concl. Of Law, and Order (I) Approving the Debtors’ Disclosure Statement and (II) Confirmation the Rev. First Am. Joint Ch. 11 Plan of Cloud Peak Energy Inc. and Certain of its Debtor Affiliates, In re Cloud Peak Energy Inc., No. 19-11047(KG) (Dec. 5, 2019), ECF No. 868.

11 Id.

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