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Third-Party Releases: Mirage or Reality?

Published August 4, 2014 by Sasser Law Firm

Small-business owners are routinely required to co-sign on loans obtained by their companies. That makes perfect sense from the lender’s perspective (after all, the more people responsible for a loan, the more likely it is that the loan will be repaid), but it can create some real inefficiencies in the event that a company needs to reorganize in a chapter 11 case. In those situations, the business owner often has to follow his company into bankruptcy to deal with the guarantee of the loan. And this doesn’t just happen to mom-and-pop restaurants; it happens to the big guys, too.

In some situations, bankruptcy courts have allowed a business’s chapter 11 plan to release the company’s owners from their debt, too. It happens just frequently enough to keep the idea rattling around in everyone’s brain as a possible end-run around the two-bankruptcy-case conundrum, but not so often that it actually materializes. Here are the requirements for a business chapter 11 plan obtaining the release or a non-debtor, as expressed by the 6th Circuit Court of Appeals in In Re Dow Corning Corp.:

The bankruptcy court may enjoin a non-consenting creditor’s claims against a non-debtor when

  1. There is an identity of interest between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debt is, in essence, a suit against the debtor or will deplete the assets of the estate;
  2. The non-debtor has contributed substantial assets to the reorganization;
  3. The injunction is essential to reorganization, namely, the reorganization hingers on the debtor being free from indirect suits against parties who would have indemnity or contributions claims against the debtor;
  4. The impacted class, or classes, has overwhelmingly voted to accept the plan;
  5. The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction;
  6. The plan provides an opportunity for those claimants who choose not to settle to recover in full and;
  7. The bankruptcy court made a record of specific factual findings that support its conclusions.

As you can see, the stars have to be aligned in a pretty spectacular way to pull off a third-party release, and when it does happen, the court’s eye is always on what is best for the debtor-company, not what’s best for the non-debtor owner. In the meantime, business owners will often continue to have to file two bankruptcy cases to resolve the issues created by co-signing their business loans.

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