A recent decision by Bankruptcy Judge Stuart Bernstein, made in connection with plan confirmation in the SunEdison bankruptcy case, strikes down non-consensual third-party releases on a variety of bases. The decision analyzes issues regarding subject matter jurisdiction, the circumstances of deemed consent, and the applicable substantive requirements for a non-consensual release.

In their plan of reorganization, SunEdison and various affiliates included a broad release of a variety of third‑party claims. The releases extended to claims against (i) the debtors’ officers, directors, employees, financial advisors, attorneys and professionals, (ii) the DIP lenders, (iii) many of the debtors’ prepetition lenders, and (iv) each of those parties’ affiliates, advisors, principals, members, and professionals. The release purported to cover not only creditors voting in favor of the plan, but also those who were silent and neither objected nor voted. 

Perhaps the most far-reaching aspect of the court’s decision is in the area of subject matter jurisdiction. Parties cannot confer subject matter jurisdiction on a court by their conduct. Accordingly, to the extent that there is no subject matter jurisdiction, the other elements examined in the SunEdison decision would be of only theoretical import. In addition, the court found that it had a duty to consider its subject matter jurisdiction even in the absence of any objection by a party in interest.

The court cited earlier decisions from the Madoff and Quigley bankruptcy cases for the proposition that “the touchstone for bankruptcy jurisdiction [over a non-debtor’s claim] remains whether its outcome might have any ‘conceivable effect’ on the bankruptcy estate.” The court acknowledged that claims against parties having indemnification rights against the debtors could provide support for the existence of subject matter jurisdiction. However, the court went on to note that the release in the debtors’ plan “is much broader than the indemnification obligations the debtors contend support it.” This conclusion was bolstered by the expansive language of the release, which seemingly covered claims against released parties relating to almost any activity prior to the effective date of the plan.

The court expressed concern that the scope of the releases extended well beyond the potential indemnified parties. The court noted that it included the debtors’ retained professionals in the cases, the creditors’ committee and its members, as well as a variety of other agents employed in connection with the bankruptcy case. Finally, the court listed the extensive categories of additional released parties defined only by their relationship to the primary parties released. This included affiliates, advisors, employees, officers, representatives, consultants, and agents of the listed categories of released parties. In the absence of an identified indemnification obligation, the court concluded it did not have subject matter jurisdiction to enforce releases with respect to third-party claims against those parties.

Even for parties for whom subject matter jurisdiction existed, the court’s decision offers no comfort. The decision takes a narrow view of the legal implications of a creditor’s silence in the face of a purported release. Although acknowledging some seemingly contrary authority, the court held that, unless a creditor had a duty to speak, their silence could not be construed as consent.

Thirdly, the court also challenged the substantive justification for the purported releases. The court concluded that third-party releases are proper only in “rare and unique circumstances.” The court did not find such circumstances in the present case.

Finally, the court noted an additional concern whether it would have the judicial authority to enjoin pursuit of the released claims in light of the Stern v. Marshall decision. However, since the court was not approving the releases on other grounds, it found it unnecessary to reach the constitutional issue.

The SunEdison decision continues the recent trend toward narrowing the permissible scope of third‑party releases in bankruptcy cases. The portion of the decision narrowly construing the court’s subject matter jurisdiction may be the aspect that presents the greatest challenges to practitioners. It seems a long reach to conclude that only claims against parties with direct indemnification rights against the debtors “might have any conceivable effect on the bankruptcy estate.” The words “might,” “any,” and “conceivable effect” all suggest a fluid and far-reaching scope. One can imagine that claims against a creditors’ committee, its members, or its professionals could conceivably impact the bankruptcy estate. Moreover, by focusing on subject matter jurisdiction, neither consent by the parties nor the absence of objection would save a release otherwise suspect.

The decision grants the SunEdison debtors the opportunity to recast the proposed releases in light of the court’s decision. It remains to be seen how much of the original scope can actually be preserved.