In In re Hal Luftig Company, Inc., the U.S. District Court for the Southern District of New York (Judge Denise L. Cote), denied confirmation of a Subchapter V plan of reorganization that contained a nonconsensual release of a non-debtor party.

Background

The debtor was a theatrical production corporation. One of the debtor’s investors initiated an arbitration against the debtor and its president and sole shareholder, generally alleging that the investor did not receive income to which it was entitled from the Broadway productions of Kinky Boots and Elephant Man. The arbitrator found the debtor and shareholder liable. As a result, the debtor filed for bankruptcy. The individual shareholder did not.

In the bankruptcy, the debtor proposed a plan, which provided a release of all claims that the investor had against the debtor’s shareholder (who had not filed for bankruptcy). The Bankruptcy Court would have confirmed the plan with the release, subject only to certain modifications.

However, the District Court found that releases of claims held by non-debtors against other non-debtors is a “dramatic remedy to be used cautiously” and is only proper “in rare cases.” The District Court observed that “there is nothing unique about this small business bankruptcy that would set it apart from many others in which the debtor entity is closely connected to a non-bankruptcy principal.” The court found “[t]here is a great danger that ordering nonconsensual releases of liability to such principals would undermine the carefully balanced structure of the Bankruptcy Code.”

Additionally, the District Court found that the sixth Purdue Pharma factor—that the impacted class of creditors “overwhelmingly voted in support of the plan with the releases”—was not satisfied. The District Court noted that this factor required “approval by a minimum of 75% of voting creditors in favor of the plan,” which was “the bare minimum.” That was not satisfied in this case.           

Takeaways

Hal Luftig shows the hesitance that courts in the Second Circuit have to granting involuntary third-party releases in a bankruptcy case absent “overwhelming” creditor support. While the District Court affirmed the application of the Purdue Pharma factors to a Subchapter V case, the District Court decision may create a new factor to consider in the context of Subchapter V cases or cases involving closely held corporations: whether there is anything different or special that warrants granting a non-consensual third party release in such a case. Further case law will resolve this question.