With Blixseth, the Ninth Circuit Relaxes Its Grip on Third-Party Releases

For the last 25 years, third-party releases in chapter 11 plans were thought to be categorically prohibited in the Ninth Circuit. With its recent decision in Blixseth v. Credit Suisse, however, the Ninth Circuit Court of Appeals walked that prohibition back by affirming confirmation of a plan that released third parties from liability for actions taken during the bankruptcy case.[2] Blixseth may affect where large financially distressed companies located within the Ninth Circuit decide to file for bankruptcy.

The goal for the debtor in most every chapter 11 case is to confirm a plan. The plan sets forth the treatment creditors receive on account of their pre-petition claims. Following confirmation of the plan, the Bankruptcy Code expressly provides that a chapter 11 debtor receive a discharge of pre-confirmation debt.[3] This debt discharge is a key benefit of the chapter 11 process to the debtor.

However, there are statutory limitations to the debtor’s ability to discharge pre-confirmation debt. Section 524(e) of the Bankruptcy Code limits the scope of the discharge by providing that the “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”[4] Nevertheless, for reasons that depend on the facts of the case, debtors sometimes seek to extend the discharge to third parties, such as directors, officers, or guarantors, in the form of releases contained in the plan for actions they took prior to and during the bankruptcy case.

Most jurisdictions allow third-party releases with varying degrees of limitation on their scope.[5] Courts in these jurisdictions find statutory support in section 105(a) of the Bankruptcy Code, which provides that a court has discretion to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”[6] For these courts, their equitable powers under § 105 of the Bankruptcy Code trump the prohibition under § 524(e). But in the Ninth Circuit prior to Blixseth, third-party releases were disallowed on their face.[7]

In its In re Lowenschuss opinion in 1995, the Ninth Circuit Court of Appeals effectively banned third-party releases in the circuit. The court stated that “without exception … Section 524(e) precludes bankruptcy courts from discharging the liabilities of nondebtors.” The court determined that the release proposed by the debtor was too broad to meet § 524(e)’s requirements because it “released the debtor and all connected persons or entities … from all claims[.]”[8] Although the court considered the argument that § 105(a) permitted third-party releases, it ultimately found that the prohibition contained in § 524(e) controlled.[9] Lowenschuss remained the law on third-party releases in the Ninth Circuit until the Blixseth decision in June 2020.

Blixseth v. Credit Suisse

In 2000, Timothy and Edra Blixseth founded the Yellowstone Club, an exclusive ski and golf community located in Big Sky, Mont.[10] The Blixseths obtained $375 million in loans from a group of lenders, including Credit Suisse. The loans were secured by the assets of the Yellowstone Club and various related companies.[11] By 2008, misuse of the loan proceeds had led to the financial demise of the Yellowstone Club. Around that time, Timothy and Edra divorced. Edra took control of the Yellowstone Club as part of the divorce. Finding that it would be impossible to pay off the loans, she put it into chapter 11 bankruptcy.[12]

Yellowstone Club’s bankruptcy was contentious, and heavy litigation ensued around confirmation of the debtor’s plan, including proposed releases to several of the warring factions. Credit Suisse, however, was not given a release and objected to the plan. Timothy joined in the objection. Ultimately, the debtor and the other parties reached a global settlement that included an exculpation clause for Credit Suisse covering Credit Suisse’s acts during the bankruptcy case. But the global settlement left out Timothy, who thus objected to the settlement on several grounds, but importantly because he didn’t receive an exculpation clause. The court overruled his objection and confirmed the plan.

After several appeals and remands, the Ninth Circuit in June 2020 held that the third-party release was permissible as it applied to Credit Suisse because it “focused on actions of various participants in the [Third Amended Joint Plan] approval process and relat[ed] only to that process.”[13] The Court noted that “[t]he liability release here is narrow in both scope and time … limited to releasing the parties from liability for any act or omission in connection with, relating to, or arising out of the Chapter 11 cases or bankruptcy filing.”[14]

Central to the court’s opinion was that the third-party release for actions taken during the bankrutpcy case did not run afoul of the prohibition in § 524(e) because it didn’t impact the “liability for any other entity … for the discharged debt.”[15] Whereas the court found the release in Lowenschuss impermissible for its broadness, it accepted the Blixseth release because of its narrowness.

Conclusion

Third-party releases can be advantageous for a debtor to include in its chapter 11 plan for several reasons. Certain parties, such as co-debtors, parent companies, guarantors, lenders, sureties and the like, may require a release to support the plan and that without these certain parties, the plan may be unconfirmable. Those parties may have indemnification claims against the debtor, or they may be a source of post-petition funding for the debtor; further, they may require the releases to waive the claims or fund the debtor’s plan.

The Blixseth decision is significant because debtors in the Ninth Circuit now can confirm plans with third-party releases for post-petition conduct. It may impact where insolvent businesses located within the Ninth Circuit decide to file for bankruptcy, making filing in their home state more attractive.

The Ninth Circuit has joined the majority of appellate courts in allowing debtors to confirm plans with third-party releases. The U.S. Supreme Court has yet to address the legality of third-party releases in chapter 11 plans, and recently denied a petition for writ of certiori on the issue.[16] For now, Blixseth is the law of the land in the Ninth Circuit.

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[1] The authors thank Trevor Wainfeld, Arizona State University School of Law Class of 2021, for his terrific work on this article.

[2] ___ F.3d ___ (9th Cir. 2020).

[3] 11 U.S.C. § 1141.

[4] 11 U.S.C. § 524(e).

[5] In re A.H. Robins Co. Inc., 880 F.2d 694 (4th Cir. 1989); In re Drexel Burnham Lambert Grp. Inc., 960 F.2d 285 (2d Cir. 1992); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002); In re Airadigm Commc’ns Inc., 519 F.3d 640 (7th Cir. 2008); SE Prop. Holdings LLC v. Seaside Eng’g & Surveying Inc. (In re Seaside Eng’g & Surveying Inc.), 780 F.3d 1070 (11th Cir. 2015); In re Millennium Lab Holdings II LLC, 945 F.3d 126 (3d Cir. 2019).

[6] 11 U.S.C. § 105(a).

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

[8] Id. at 1401.

[9] Id. at 1402.

[10] Blixseth, ___ F.3d ___.

[11] Id.

[12] Id.

[13] Id.

[14] Id. (quotation omitted).

[15] Id.

[16] See ISL Loan Trust, et al. v. Millennium Lab Holdings II LLC, et al., (Supreme Court Case No. 19-1152).