Avoid Post-Confirmation Headaches; How Indenture Trustees and Agents Can Achieve Finality and Closure and Limit Risk in the Event Exculpation and/or Releases are Not Available

Indenture trustees and agents are also required to take affirmative steps to aid a debtor in implementing a chapter 11 plan, including providing appropriate notices to holders and facilitating distributions. Thus, indenture trustees work with debtors to ensure a chapter 11 plan provides for, among other things, appropriate treatment of debt holders, coordination with DTC, proper distribution mechanics, and modification or cancellation of the indenture. The primary reason for such involvement is because the indenture and the obligations of the indenture trustee, debtor and other parties to the indenture ride through a chapter 11 case absent treatment under a chapter 11 plan. Indenture trustees often take the position that an indenture is not an executory contract and falls outside the parameters of Bankruptcy Code § 365 and even if executory, is a financial instrument, rendering Bankruptcy Code § 365 inapplicable. Thus, the only way to modify or cancel an indenture is pursuant to the indenture itself or under Bankruptcy Code § 1123(a)(5)(F).[1]  In other words, through confirmation of a plan.

During a chapter 11 case, a majority of holders frequently direct an indenture trustee to take action or refrain from taking action and provide an indemnity or other protection to the indenture trustee. This is not always the case. In many situations the indenture trustee will not receive indemnity for their work or actions and an indemnity from a debtor may have little or no value. For example, even where an indenture trustee has been successful in ensuring a debtor’s indemnification obligation continues post-petition and post-effective date notwithstanding the cancellation of the indenture, such indemnity may be limited in scope and value. To limit exposure, an indenture trustee will almost always attempt to be covered by a plan’s release and exculpation provisions. Such success often depends on the jurisdiction where the chapter case is pending.

Many courts limit exculpatory provisions to apply solely to the post-petition actions of estate fiduciaries, including debtors, examiners, committees, committee members, debtors’ officers and directors, and their respective professionals and not indenture trustees. Courts have found that estate fiduciaries may be exculpated under a plan for their actions in the bankruptcy case except for willful misconduct or gross negligence because such a provision merely restates the standard to which such estate fiduciaries are held. See In re Washington Mutual Inc., 442 B.R. 314, 350 (D. Del. 2011) (citing In re PWS Holding Corp., 228 F.3d 224, 246 (3d Cir. 2000)). Immunity beyond such exculpation would be covered by third-party releases – meaning that exculpation provisions that cover non-estate fiduciaries are, in essence, disguised as or duplicative of third-party releases and must be analyzed as such. See Id. Thus, courts have found that “the practical effect of a proper exculpation provision is not to provide a release for any party, but to raise the standard of liability for fiduciaries for their conduct during the case.“ In re Health Diagnostic Laboratory, Inc., 551 B.R. 218, 233 (E.D. Va 2016).  

In some jurisdictions, non-consensual releases of indenture trustees are available but only under limited or narrow circumstances. See e.g. In re SunEdison Inc., 576 B.R. 453, 462 (Bankr. S.D.N.Y. 2018) (reiterating the standard set in In re Metromedia Fiber Network Inc., 416 F.3d 136, 141 (2d Cir 2005) that third party releases are only proper in rare and unique circumstances)[2]; see e.g. In re Continental Airlines, 203 F.3d, 203, 212(3d Cir. 2000) (“non-consensual releases by a non-debtor of other non-debtor third parties are to be granted only in ‘extraordinary cases.’”); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002) (articulating a multi-factor test); In re Aradigm Commc’n Inc., 519 F.3d 640 (7th Cir. 2008) (finding the third-party releases must be narrowly tailored, not provide blanket immunity and be necessary and essential to the reorganization); see also In re Ingersoll, Inc., 562 F.3d 856 (7th Cir. 2009); see also Natl. Heritage Found., Inc. v. Highbourne Found., 760 F.3d 344 (4th Cir. 2014); SE Prop. Holdings, LLC v. Seaside Eng’g & Surveying, Inc. (In re Seaside Eng’g & Surveying, Inc.), 780 F.3d 1070 (11th Cir. 2015).[3]

Even in situations where certain third-party releases are permitted, the chapter 11 plan may not always provide for the release of the indenture trustee or agents.

In circumstances where an indenture trustee or agent cannot be included as an exculpated party under a chapter 11 plan and cannot obtain a third party release, there is inherent risk of future litigation and costs and uncertainty for the indenture trustee. Even where indemnification has been preserved by the debtor, the indemnification provisions may be worthless. In other situations, the liability may be passed on to holders through the charging lien used to satisfy the indenture trustee’s fees and expenses which are entitled to priority distribution under the indenture and which would otherwise be lost after funds or other value are distributed to the holders. More often than not, this exposure will delay or reduce distributions and make the process more cumbersome.

Recently, indenture trustees have successfully limited or even prevented trustee litigation risk and exposure through specific findings and conclusions of law incorporated into confirmation orders. In several cases over the past few years, Arent Fox has successfully negotiated and courts have approved  such findings and conclusions of law. The negotiated language provides that based on the record, the indenture trustee and agent diligently and in good faith discharged their duties and obligations pursuant to the applicable indenture and conducted themselves with respect to all matters in any way related to the notes claims with the same degree of care and skill that a prudent person would exercise or use under the circumstances in the conduct of his or her own affairs. The provision also includes a finding that the indenture trustee and agent have discharged their duties fully in accordance with the applicable indenture. See e.g., In re R.E. Gas Development, LLC, et al., Case No. 18-22032 (JAD) [ECF] at ¶ II; In re Claires Stores Inc., et al., Case No. 18-10584 (MFW)[ECF No 1040] at ¶ 22.; In re Cenveo Inc., et al., Case No. 18-22178 (RDD) [ECF No. 685] at ¶ 57; In re 21^st Century Oncology Holdings, Inc., et al., Case No. 17-22770 (RDD) [ECF No. 915] at ¶ 53; In re Offshore Investment Group Limited, et al., Case No. 15-12422 [ECF No. 166] at ¶ LL.

A bankruptcy court is able to make such findings based upon the record of the proceedings and by judicial notice of the filings in the case. Often these create a sufficient record, without the need for additional evidence from the indenture trustee and agent or otherwise, to support the findings in a confirmation order. If a court is uncertain or uncomfortable with the record before it, the debtor or indenture trustee or agent can submit additional evidence, which may include documentary evidence or testimony. The court’s recognition of an indenture trustee’s actions and its compliance with the indenture and its duties under the law in connection with a chapter 11 case prevents or limits the exposure for an indenture trustee. Such findings and conclusions of law also benefit noteholders and the debtor. Indeed, debtors, noteholders and other interested parties seeking to implement a chapter 11 plan often support the inclusion of such findings when warranted by the facts and circumstances of the case because they ensure timely distributions to holders without the need for reserves or holdbacks. 

While not yet battle tested in litigation, these findings and conclusions will, at a minimum, serve as a deterrent for future potential litigants who would need to address them in any subsequent claim. We expect to continue to see such findings and conclusions incorporated into confirmation orders as a useful and practical way of achieving the much desired finality and closure of a chapter 11 case and indenture-related issues without implicating the exculpation provisions.

[1] Section 1123(a)(5)(F) provide that “[n]otwithstanding any otherwise applicable nonbankruptcy law, a plan shall – provide for the adequate means for the plan’s implementation such as – cancellation or modification of any indenture or similar instrument.”

[2] In SunEdison, the Court stated that “[i]n deciding whether a third party release is appropriate, courts may consider whether the estate has received a substantial contribution, whether the enjoined claims are channeled to a settlement fund rather than extinguished, whether the enjoined claims would indirectly impact the debtor's reorganization through claims of indemnity or contribution, whether the plan otherwise provides for payment in full of the enjoined claims and whether the creditor has consented. Nevertheless, the test is not ‘a matter of factors and prongs,’ and a third party release will not be tolerated ‘absent findings of circumstances that may be characterized as unique.’”). Id. at 462.

[3] The Fifth, Ninth and Tenth Circuits on the other hand have held that Bankruptcy Code §524(e) prohibits non-consensual third party releases.  See e.g. Pacific Lumber Co., 584 F.3d 229, (5th Cir. 2009); Resorts Intl. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394 (9^th Cir. 1995); In re W. Real Estate Fund, Inc., 922 F.2d 592 (10th Cir. 1990).