Supreme Court’s denial of cert on third party releases argued as “radically expansive” may assist commercial real estate debtors seeking relief from springing guaranties.
On May 26, 2020 the U.S. Supreme Court denied the petition for a writ of certiorari on a case involving the ability of a bankruptcy court to confirm a plan of reorganization that provides for releases of non-debtor parties. ISL Loan Trust v. Millennium Lab Holdings II, LLC (Case No. 19-1152). The effect of the denial is to leave intact a decision by the Third Circuit that may be more liberal in permitting a debtor’s plan to provide for a release of non-debtor parties. The case did not involve a third party guaranty, but it did involve a structure in the plan that could be readily be adopted to the typical fact pattern in a commercial real estate bankruptcy.
Petitioners were lenders of approximately $106.3 million to the Debtors, which was part of a larger credit facility with other lenders, totaling $1.825 billion. The credit facility was issued as part of a “dividend recapitalization” transaction for the benefit of non-debtor stockholders; approximately $1.3 billion of the credit facility was paid as a “special dividend” to the non-debtor shareholders.
The Petitioners claimed that they were defrauded into entering into the credit facility because they were told that Millennium was not involved in any government investigation that would have a material adverse effect on the company. However, at the time Millennium was said to be a knowing target of such an investigation by the Department of Justice. The Petitioners alleged that the non-debtor equity holders who received the special dividend “participated in the fraud” which permitted the funds to be siphoned off. (Cert. pet. 6-7).
The Debtors then filed for bankruptcy and proposed a plan in which the non-debtor shareholders would obtain full releases and discharges of all claims against them, including Petitioners’ common law fraud counts. The third parties agreed to make a significant contribution to the bankruptcy estate of over $300 million provided that the plan granted them a full release. The bankruptcy court confirmed the plan and the Third Circuit affirmed.
The Petitioners sought review by the Supreme Court. The Petitioners tried to persuade the Court that this was a “radically-expansive” view of permitting third party releases. Seeking to demonstrate just how “radically-expansive” this was, the Petitioners argued that under the Third Circuit ruling a third party release could become valid where the release is desired by someone whose money is necessary to fund the reorganization plan, and that person refused to provide the money unless the release or adjudication he or she wants is made part of the plan. “That is a radically-expansive view of a bankruptcy court’s adjudicatory authority that would authorize releases of entirely unrelated claims if tactically demanded by parties willing to fund a plan of reorganization.” (Cert. pet. 23.).
The argument did not persuade the Court to review the case. This so-called radically expansive view might work well in a typical commercial real estate bankruptcy case. One possible application of this ruling is as follows: An owner of a commercial office building, might seek relief under Chapter 11 because of the temporary loss of tenants due to the COVID-19 pandemic. An owner/guarantor might agree to provide a capital contribution to the debtor entity in order to retrofit the building and provide infrastructure to provide social distancing, add additional elevators and restrooms, better ventilation, and other changes to provide better protection against the virus.
The COVID-19 crisis has created economic hardship for both commercial tenants and landlords. One of the key issues will be whether the bankruptcy courts can fulfill their goal of providing the best solution for all constituents—one that balances the rights of both creditor and debtor. One of the largest deterrents to permitting the bankruptcy courts to function to their optimal level are contractual devices known as “springing guaranties.” These are contractual promises, usually required by CMBS lenders as a condition to a mortgage loan, and which impose full guaranty liability on the owner/guarantor if, among other acts, the owners decide to file for relief under Chapter 11.
The springing guaranty proven to decidedly effective in blocking the filing of bankruptcy for those in the real estate industry. To date, there is no reported bankruptcy case decision which has found the springing guaranty to be unenforceable as against public policy. But, it may be possible to argue that a guaranty can be released as part of a confirmed plan of reorganization, provided certain requirements are satisfied and the guarantor is making a significant contribution to the reorganization. The argument is difficult, but the Supreme Court’s denial of certiorari is still helpful. The case might also be seen, in its broadest context as part of the arc of bankruptcy law as moving against notions of “remoteness” and all devices which restrict bankruptcy jurisdiction, rather than enlarging it.