Dynegy: Third Party Releases and the Use of the Written Opt Out
Although often controversial, releases of non-debtor parties are sometimes authorized pursuant to a Chapter 11 plan of reorganization. It is more unusual, however, that a court would deem equity holders to have consented to the releases when the releasing parties (a) were not receiving distributions on account of their interests under the plan and (b) were required, if they wished not to release, to affirmatively “opt out” of the releases by writing a letter to the voting agent rather than simply checking a box on a ballot or notice. But, these types of releases are exactly what the court did approve in the Chapter 11 cases of Dynegy Holdings, LLC (“DH”) (Case No. 11-38111) and Dynegy Inc. (“DI” and, together with DH and their subsidiaries and affiliates, “Dynegy”) (Case No. 12-36728) in the Southern District of New York in confirming a joint DH-DI plan (the “Plan”) on September 5, 2012.1 The approval of the releases in the context of these particular Chapter 11 cases – where many of the third-parties who received the releases were determined by the examiner appointed in the cases to have engaged in improper acts – is an important development in the law regarding third-party releases.2
Background of the Plan and Releases
Prior to the commencement of the Dynegy Chapter 11 cases, DI, DH, and certain other affiliates engaged in a series of transactions to reorganize Dynegy’s businesses and restructure its debt (the “Prepetition Transactions”). The Prepetition Transactions included the transfer of Dynegy’s valuable coal assets from DH to DI in exchange for a highly speculative “undertaking” by DI to make a stream of payments to DH over time (the “CoalCo Transaction”). Following the commencement of the Chapter 11 cases, the court appointed an examiner to investigate the Prepetition Transactions and prepare a report regarding their propriety. On March 9, 2012, the examiner filed his report (the “Examiner Report”), which concluded, among other things, that:
(i) the CoalCo Transaction was an actual fraudulent transfer with intent to hinder and delay creditors;
(ii) the CoalCo Transaction was a constructive fraudulent transfer;
(iii) the officers and directors of DH breached fiduciary duties to creditors, assuming DH was insolvent at the time of the CoalCo Transaction; and
(iv) though it would be possible for DH to confirm a plan of reorganization, any such plan needed to provide for the appointment of a board of directors consisting of different non-officer members than those that approved the CoalCo Transaction, because such appointment would be inconsistent with the interests of creditors and with public policy.
Following the issuance of the Examiner Report, the court ordered the various parties to participate in mediation under the auspices of the examiner (in his role as mediator) to resolve the major contentious issues in these cases, including those addressed in the Examiner Report. The mediation resulted in a settlement that was approved by the court on June 1, 2012 and paved the way for the confirmation of the Plan. The Plan contemplates that: (a) DH and DI will merge prior to emergence from bankruptcy; (b) unsecured creditors of DH will receive 99% of the equity in the post-emergence, merged entity; and (c) all equity interests in DI will be cancelled and their holders will receive no recovery on account of those interests. In addition, the Plan provides a mechanism for releases from any claims and causes of action arising from prepetition conduct (including the Prepetition Transactions) for a number of non-debtor parties, including the directors, officers, and shareholders of DI. As a result, if approved, these non-debtor releases would release claims that could accrue to the benefit of, among others, shareholders of DI who may have been injured by the conduct of DI’s directors and officers, and who are otherwise receiving nothing on account of their equity interests under the Plan.
To be clear, for the non-debtor releases in the Plan to apply to any stakeholder, the stakeholder must have “consented” to such releases. Specifically, creditors who were entitled to vote on the Plan were able to check a box to “opt out” of the third-party releases. Shareholders of DI, however, who did not receive a copy of the Plan and who only received a notice of the confirmation hearing and a notice explaining the releases, and who were not entitled to vote on the Plan because they were receiving no consideration and therefore were deemed to reject the Plan, could only opt out by writing a letter to the voting agent asserting their intention to “opt out.”
The Bankruptcy Court’s Approval of the Releases
In determining the propriety of third-party releases under a plan, courts in the Second Circuit look to Deutsche Bank AG v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136 (2d Cir. 2005). This standard requires that non-debtor, third-party releases may only be granted in “truly unusual” circumstances where the trial court makes detailed findings that the release itself is important to the success of the plan. Id. at 143. Factors that may be relevant in determining if such a release is appropriate include whether: (i) the estate receives substantial consideration; (ii) the enjoined claims are channeled to a settlement fund rather than extinguished; (iii) the enjoined claims would indirectly impact the debtor’s reorganization by way of indemnity or contribution; (iv) the plan otherwise provides for the full payment of the enjoined claims; or (v) the affected creditors consent. Id. at 142. Moreover, before deciding on the issue of third-party releases, a court must first determine whether it has subject matter jurisdiction to grant such releases.
Here, the court confirmed the Plan, including the third-party releases, over the objection of the Office of the United States Trustee, after a hearing at which DI and DH presented evidence in support of confirmation and that the releases met the applicable standard. With respect to the releases, the court first found that it had subject matter jurisdiction to grant the third-party releases where the releases directly affected the res of the estate. The court stated that the res was the insurance policies and cash belonging to the debtors and the reorganized entity that would be required to defend against actions brought by claimants and shareholders against DI’s directors and officers. The court then found that the third-party releases were appropriate under Metromedia because the opt-out mechanism allowed such releases to be consensual – and, in fact, the court did not make any specific findings that the releases met any of the other so-called Metromedia factors.
Implications of the Court’s Approval of the Releases
The decision by the bankruptcy court to approve the third-party releases in this specific case is a particularly noteworthy result in light of the fact that DI’s shareholders were found to have consented to the release where they (i) are receiving nothing on account of their equity interests and (ii) would have had to write a letter to the voting agent to opt out of the releases rather than merely checking a box on a ballot. It is also a noteworthy ruling in light of the serious conclusions of the Examiner Report regarding the Prepetition Transactions and the impropriety of appointing any of the non-officer directors to the new board of the post-emergence, reorganized entity.
The following conclusions may be drawn from the findings described above. Under the right circumstances:
1. a court can find that an interest holder may consensually release third-parties under a plan regardless of whether it is entitled to vote on such a plan; and
2. an interest holder’s consent to a release can be found even if the plan mechanism for such releases requires the interest holder to (a) actively opt out of such releases and (b) write a letter to opt out of the releases, instead of simply checking a box on a notice or ballot.
1 Akin Gump Strauss Hauer & Feld LLP serves as counsel to the Official Committee of Unsecured Creditors in the Dynegy Chapter 11 cases. 2 To be clear, one party – Stephen Lucas, the lead plaintiff (the “Lead Plaintiff”) in the securities class action entitled Charles Silsby, individually and on behalf of all others similarly situated v. Carl C. Icahn, Dynegy Inc., Robert C. Flexon, and Clint Freeland, Case No. 12-cv-02307 (JGK) pending in the United States District Court for the Southern District of New York – filed an objection to the Plan based on the propriety of the third-party releases in the Plan. The Lead Plaintiff agreed to defer litigation regarding his objection – including with regard to his ability to “opt out” on behalf of the entire class of plaintiffs he purported to represent – until after the confirmation hearing and the court’s approval of these releases. Therefore, while the Lead Plaintiff may be able to re-raise his objection, it is unclear whether the bankruptcy court would entertain such objection and even less clear whether it would reverse the findings it made at the confirmation hearing.
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