by Chelsea Ire­land*

Every­body los­es in bank­rupt­cy, but the pur­pose of the Bank­rupt­cy Code is to appor­tion the loss in a sys­tem­at­ic man­ner. When an insol­vent enti­ty files for bank­rupt­cy, there are sev­er­al routes open to it. This dis­cus­sion will be restrict­ed to liq­ui­da­tion under Chap­ter 7 and reor­ga­ni­za­tion under Chap­ter 11. Chap­ter 7 liq­ui­da­tion is the most basic course of action allowed under the Bank­rupt­cy Code and requires that an appoint­ed trustee take con­trol of and sell the debtor’s prop­er­ty and dis­trib­ute the assets.2 Chap­ter 11 reor­ga­ni­za­tion pro­vides an alter­na­tive to liq­ui­da­tion.3 Rather than for­feit its assets, the debtor acts as its own trustee and becomes a debtor in pos­ses­sion.4 Sub­ject to the author­i­ty of the bank­rupt­cy court, the debtor in pos­ses­sion will nego­ti­ate with cred­i­tors and third par­ties in order to reor­ga­nize itself in such a way that it can emerge as a “prof­itable and pro­duc­tive mem­ber of its eco­nom­ic com­mu­ni­ty.”5


In Chap­ter 11 reor­ga­ni­za­tion, the debtor in pos­ses­sion con­tin­ues to oper­ate the busi­ness, while a com­mit­tee of cred­i­tors may begin to for­mu­late a reor­ga­ni­za­tion plan to restore the enti­ty to finan­cial health.6 If there is an oppor­tu­ni­ty for a merg­er with or acqui­si­tion by some third par­ty enti­ty, the reor­ga­ni­za­tion plan will pro­vide for that merg­er and lay out how the dif­fer­ent class­es of cred­i­tors will be treat­ed as a result of the merg­er.7 The terms of the merg­er, includ­ed in the reor­ga­ni­za­tion plan, must ulti­mate­ly be con­firmed by the bank­rupt­cy court.8

Con­cern aris­es, how­ev­er, when a poten­tial acquir­er seeks to include pro­vi­sions in the reor­ga­ni­za­tion plan that insu­late itself from lia­bil­i­ty to some class of cred­i­tors. While reor­ga­ni­za­tion plans com­mon­ly lim­it an acquir­ing company’s lia­bil­i­ty to the debtor’s cred­i­tors,9 a num­ber of Cir­cuit Courts of Appeals have con­firmed reor­ga­ni­za­tion plans that dis­charge an acquirer’s lia­bil­i­ty to a class of cred­i­tors, where that lia­bil­i­ty is unre­lat­ed to the debtor’s bank­rupt­cy. For exam­ple, in a recent Eleventh Cir­cuit case, a close­ly held civ­il engi­neer­ing firm, Sea­side, filed for Chap­ter 11 bank­rupt­cy.10 The firm pro­posed to reor­ga­nize and con­tin­ue oper­at­ing as a new enti­ty, Gulf, which would be man­aged by four of the five orig­i­nal share­hold­ers of Sea­side.11 The bank­rupt­cy court con­firmed and the Eleventh Cir­cuit affirmed a reor­ga­ni­za­tion plan that includ­ed a pro­vi­sion that effec­tive­ly insu­lat­ed the man­agers from any lia­bil­i­ty aris­ing out of the reor­ga­ni­za­tion process.12 Put sim­ply, by con­firm­ing the reor­ga­ni­za­tion plan, the Eleventh Cir­cuit allowed the four peo­ple who drove Sea­side into bank­rupt­cy to be pro­tect­ed from claims by Seaside’s cred­i­tors, which could arise out of the bank­rupt­cy process.13

Class­es of cred­i­tors vote on whether or not to accept a cer­tain reor­ga­ni­za­tion plan,14 and a major­i­ty of cred­i­tors in a class have the pow­er to bind a minor­i­ty.15 When a third par­ty dis­charge of lia­bil­i­ty is includ­ed in a reor­ga­ni­za­tion plan, and a major­i­ty of a cred­i­tor class votes in favor, the minor­i­ty is effec­tive­ly stripped of their claims with­out their consent.

Despite a bank­rupt­cy court’s “broad author­i­ty to mod­i­fy cred­i­tor-debtor rela­tion­ships,”16 the Code is ambigu­ous as to whether, and under what cir­cum­stances, a bank­rupt­cy court can dis­charge the lia­bil­i­ty of an enti­ty that is not a par­ty to the bank­rupt­cy pro­ceed­ings such as an acquir­er. Fed­er­al cir­cuits dis­agree as to whether a bank­rupt­cy court can dis­charge the lia­bil­i­ty of a third par­ty non-debtor. The Fifth Cir­cuit specif­i­cal­ly has opined that rec­og­niz­ing such author­i­ty would result in con­se­quences nev­er intend­ed by the leg­is­la­ture.17 That court’s jurispru­dence, how­ev­er, tends to dis­re­gard the gen­er­al lan­guage of the Bank­rupt­cy Code.

The dis­cre­tion that the Bank­rupt­cy Code grants to bank­rupt­cy courts indi­cates Congress’s con­fi­dence that the bank­rupt­cy courts are in the best posi­tion to deter­mine whether a third par­ty dis­charge (or any non-pro­hib­it­ed course of action) is nec­es­sary or appro­pri­ate in any spe­cif­ic instance. This con­tri­bu­tion will argue that not only does a bank­rupt­cy court have the author­i­ty to dis­charge the lia­bil­i­ty of a third par­ty, but that the abil­i­ty of courts to do so is in the best inter­est of cred­i­tors in general.


While on its face, the third par­ty dis­charge seems inequitable, bal­anc­ing inter­ests can jus­ti­fy its use. A bank­rupt­cy court has broad dis­cre­tion when con­firm­ing a prof­fered reor­ga­ni­za­tion plan.18 Yet dis­cre­tion is cab­ined in two ways. First, a court has no author­i­ty to con­firm a reor­ga­ni­za­tion plan that is “incon­sis­tent with the applic­a­ble pro­vi­sions” of the Bank­rupt­cy Code.19 Sec­ond, the Code lim­its dis­cre­tion grant­ed to the bank­rupt­cy court to “issue any order process or judg­ment” to those that are “nec­es­sary or appro­pri­ate to car­ry out the pro­vi­sions of [the Bank­rupt­cy Code].”20 There­fore, if not oth­er­wise for­bid­den by the Bank­rupt­cy Code, a court may dis­charge the lia­bil­i­ty of a third par­ty if doing so is “nec­es­sary or appro­pri­ate” in that instance.

Because the Bank­rupt­cy Code leaves the bank­rupt­cy courts open to con­firm any reor­ga­ni­za­tion plan that is not incon­sis­tent with the Bank­rupt­cy Code, objec­tions to the use of the third par­ty dis­charge have been ground­ed main­ly in tex­tu­al inter­pre­ta­tions of the rel­e­vant statu­to­ry pro­vi­sions. Sec­tion 524(e) of the Code states that the “dis­charge of a debt of the debtor does not affect the lia­bil­i­ty of any oth­er enti­ty on, or the prop­er­ty of any oth­er enti­ty for, such debt.”21 Both the Ninth and Tenth Cir­cuits have read sec­tion 524(e) of the Bank­rupt­cy Code to pro­hib­it the use of the third par­ty dis­charge.22 How­ev­er, giv­en that Con­gress chose the phrase “does not,” rather than “may not” or “must not,” it would be strange to read 524(e) as a restric­tion on the bank­rupt­cy court’s author­i­ty.23 When the Bank­rupt­cy Code is lim­it­ing the pow­er of the bank­rupt­cy courts, it does so explic­it­ly and with more def­i­nite lan­guage.24 The Sev­enth Cir­cuit, in In re Air­a­digm Com­muns., Inc., opined that sec­tion 524(e) is more nat­u­ral­ly read as a “sav­ings clause” which “pre­serves rights that might oth­er­wise be con­strued as lost.”25 Based on the use of the phrase “does not,” the Sev­enth Circuit’s inter­pre­ta­tion is high­ly per­sua­sive, and sec­tion 524(e) is most nat­u­ral­ly read to include the phrase “unless oth­er­wise pro­vid­ed for.”26 Impor­tant­ly, the Sec­ond, Third, Fourth, Sixth, and Eleventh Cir­cuits have all joined in Sev­enth Cir­cuit in indi­cat­ing that the use of a third-par­ty dis­charge is not pre­clud­ed by the Bank­rupt­cy Code.27

The Ninth Cir­cuit relies on an expres­sio unius argu­ment for pro­hibit­ing the gen­er­al use of a third par­ty dis­charge. In the case of In re Lowen­schuss, the Ninth Cir­cuit assert­ed that because the Bank­rupt­cy Code specif­i­cal­ly pro­vides for the use of a third par­ty dis­charge in asbestos cas­es, Con­gress intend­ed asbestos cas­es to pro­vide the only cir­cum­stances where such a dis­charge can be used.28 Sec­tion 524(g) of the Bank­rupt­cy Code lays out a step-by-step process for the admin­is­tra­tion of asbestos cas­es, pro­vides that the court may per­ma­nent­ly enjoin plain­tiffs from fil­ing claims against that defen­dant debtor or a third par­ty.29 This is the only place in the Bank­rupt­cy Code where a third par­ty dis­charge is explic­it­ly authorized.

This expres­sio unius argu­ment does not pack its usu­al punch. Asbestos lit­i­ga­tion imposed an unpar­al­leled bur­den upon the courts, and a step-by-step process for the over­sight of bank­rupt­cy admin­is­tra­tion was nec­es­sary in order to effi­cient­ly wade through the ocean of asbestos-relat­ed claims. The speci­fici­ty of the require­ments laid out in sec­tion 524(g) there­fore indi­cate the need for a clear and spe­cif­ic process for orga­niz­ing and over­see­ing asbestos cas­es, rather than Congress’s inten­tion to dras­ti­cal­ly nar­row the cir­cum­stances under which a third par­ty dis­charge could be used.30 The inclu­sion of a third par­ty dis­charge as an avail­able option under sec­tion 524(g) was there­fore not meant to impose any addi­tion­al restric­tions on the bank­rupt­cy courts out­side of sec­tion 524(g).

The Fifth Cir­cuit’s jurispru­dence, which also “broad­ly foreclose[s] non-con­sen­su­al non-debtor releas­es and per­ma­nent injunc­tions,” rests on the broad pur­pos­es of the Bank­rupt­cy Code, specif­i­cal­ly equi­ty and the bur­den-ben­e­fit trade-off inher­ent in the bank­rupt­cy process.31 The Fifth Cir­cuit, in In re Pacif­ic Lum­ber Co., opined that there was “lit­tle equi­table about pro­tect­ing the released non-debtors.”32 Dis­charg­ing the lia­bil­i­ty of a non-debtor in order to facil­i­tate a reor­ga­ni­za­tion could poten­tial­ly result in the cred­i­tors of the debtor being pri­or­i­tized to the detri­ment of the cred­i­tors of the unre­lat­ed non-debtor. This sys­tem might reward an enti­ty for being the first to file for bank­rupt­cy. The Fifth Cir­cuit has also stressed the “pol­i­cy that bank­rupt­cy should ben­e­fit only the debtor,”33 and the Tenth Cir­cuit has sim­i­lar­ly sug­gest­ed that a per­ma­nent injunc­tion of a claim against a third par­ty affords that par­ty the ben­e­fits of the bank­rupt­cy process with­out requir­ing that par­ty to sub­mit itself to the bur­dens of the bank­rupt­cy process.34 This con­cern is derived from the pos­si­bil­i­ty that enti­ties might “push a fail­ing enter­prise into bank­rupt­cy not for the debtor’s sake, but for their own inter­ests,”35 which could turn bank­rupt­cies into a com­mod­i­ty and poten­tial­ly extin­guish extrin­sic lia­bil­i­ty.36 These pol­i­cy con­cerns assert­ed by the Fifth and Tenth Cir­cuits dras­ti­cal­ly under­es­ti­mate the apti­tude of the bank­rupt­cy courts to exer­cise dis­cre­tion in the inclu­sion of a third par­ty dis­charge in a reor­ga­ni­za­tion plan.

The bank­rupt­cy code restricts the bank­rupt­cy court’s dis­cre­tion to those cours­es of action which are “nec­es­sary or appro­pri­ate” in any giv­en cir­cum­stance.37 With­in the adver­sar­i­al envi­ron­ment of con­fir­ma­tion hear­ings, a bank­rupt­cy court will be able to enter­tain and chal­lenge the argu­ments for or against any pro­vi­sion with­in a reor­ga­ni­za­tion plan. A third par­ty dis­charge may be inap­pro­pri­ate where it is clear that some third par­ty is sole­ly seek­ing to insu­late itself from lia­bil­i­ty, and the court may refuse to allow the dis­charge in such an instance. Like­wise, sev­er­al cir­cuits have deter­mined that such a dis­charge is unac­cept­able where the lia­bil­i­ty to be dis­charged arose as a result of “will­ful mis­con­duct.”38 The Sixth Cir­cuit has devel­oped a mul­ti-fac­tor test for deter­min­ing whether a third par­ty dis­charge is appro­pri­ate, and sev­er­al cir­cuits have adopt­ed this test or some ver­sion of it.39 The test requires that a court deter­mine, among oth­er things, that “the non-debtor has con­tributed sub­stan­tial assets to the reor­ga­ni­za­tion,” and that “[t]he injunc­tion is essen­tial to reor­ga­ni­za­tion, name­ly, the reor­ga­ni­za­tion hinges on the debtor being free from indi­rect suits against par­ties who would have indem­ni­ty or con­tri­bu­tion claims against the debtor,” and that “[t]he impact­ed class, or class­es, has over­whelm­ing­ly vot­ed to accept the plan.”40 The court goes on to list oth­er fac­tors which it requires for approval, but the point is that courts are already comb­ing through the facts in each rel­e­vant case to deter­mine whether the use of a third par­ty dis­charge is appropriate.

If prop­er­ly eval­u­at­ed for appro­pri­ate­ness, a third par­ty dis­charge pro­vides a use­ful incen­tive to would-be financiers, which pro­vides a ben­e­fit to cred­i­tors as a whole. In some sit­u­a­tions “absent [the third party]’s involve­ment, the reor­ga­ni­za­tion sim­ply would not have occurred.”41 If dis­charg­ing the lia­bil­i­ty of a non-debtor is enough to pre­vent the fail­ing of a reor­ga­ni­za­tion plan, then it is gen­er­al­ly ben­e­fi­cial to cred­i­tors that such a dis­charge be imple­ment­ed. Under a Chap­ter 11 reor­ga­ni­za­tion, cred­i­tors must be treat­ed at least as well as they would have been treat­ed in a Chap­ter 7 liq­ui­da­tion,42 and so a Chap­ter 11 reor­ga­ni­za­tion is finan­cial­ly prefer­able. A cred­i­tor pre­vent­ed from fil­ing a claim against a third par­ty non-debtor is still ben­e­fit­ing from a sys­tem that aims to facil­i­tate Chap­ter 11 bank­rupt­cies in gen­er­al. If a major­i­ty of the class of cred­i­tors affect­ed by the third par­ty dis­charge has vot­ed in favor of the dis­charge, it would be inequitable to allow one por­tion of one cred­i­tor class to hold out and cause the entire reor­ga­ni­za­tion to fail.

There­fore, because the Bank­rupt­cy Code does not pro­hib­it the use of a third par­ty dis­charge, and because the bank­rupt­cy courts are qual­i­fied to exer­cise dis­cre­tion con­cern­ing whether a dis­charge would be nec­es­sary or appro­pri­ate in any giv­en sit­u­a­tion, the law should per­mit third par­ty discharges.

* Chelsea Ire­land is a 2L at New York Uni­ver­si­ty School of Law. This piece is a com­men­tary on the 2017 Prob­lem at the Duber­stein Moot Court Com­pe­ti­tion held in Queens, New York at St. John’s Uni­ver­si­ty School of Law. There were two issues pre­sent­ed in the Duber­stein Prob­lem. This piece is restrict­ed to the issue con­cern­ing whether bank­rupt­cy courts have the author­i­ty to dis­charge the lia­bil­i­ty of a non-debtor to a non-con­sent­ing cred­i­tor. Cyrus Korn­feld, also a 2L at New York Uni­ver­si­ty School of Law, briefed the sec­ond issue, which con­cerned the appli­ca­tion of the equi­table moot­ness doctrine.

2. See 11 U.S.C. §§ 701–84; Col­lier on Bank­rupt­cy ¶ 1.07(1) (Alan N. Resnick & Hen­ry J. Som­mer eds., 16th ed.).

3. See 11 U.S.C. §§ 1101–74.

4. See 11 U.S.C. § 1101(1).

5. 1–1 Col­lier on Bank­rupt­cy ¶ 1.07(3) (Alan N. Resnick & Hen­ry J. Som­mer eds., 16th ed. 2017).

6. See 11 U.S.C. § 1103(c).

7. See 11 U.S.C. § 1123(a)(5)(C).

8. See 11 U.S.C. § 1129.

9. See 11 U.S.C. § 363(f).

10. See In re Sea­side Eng’g & Sur­vey­ing, 780 F.3d 1070, 1075 (11th Cir. 2015).

11. Id.

12. Id. at 1076 (“[N]one of the Debtor, … Reor­ga­nized Debtor, Gulf Atlantic … (and any offi­cer or direc­tors or mem­bers of the afore­men­tioned [enti­ties]) and any of their respec­tive Rep­re­sen­ta­tives (the “Releasees”) shall have or incur any lia­bil­i­ty to any Hold­er of a Claim against or Inter­est in Debtor, or any oth­er par­ty-in-inter­est … for any act, omis­sion, trans­ac­tion or oth­er occur­rence in con­nec­tion with, relat­ing to, or aris­ing out of the Chap­ter 11 Case, the pur­suit of con­fir­ma­tion of the Amend­ed Plan as mod­i­fied by the Tech­ni­cal Amend­ment, or the con­sum­ma­tion of the Amend­ed Plan as mod­i­fied by this Tech­ni­cal Amend­ment, except and sole­ly to the extent such lia­bil­i­ty is based on fraud, gross neg­li­gence or will­ful misconduct.”).

13. Id. at 1081 (“We con­clude that the bank­rupt­cy court did not abuse its dis­cre­tion in approv­ing the non-debtor releas­es. The releas­es are fair and equi­table, and whol­ly nec­es­sary to ensure that Gulf may con­tin­ue to oper­ate as an enti­ty. This case has been a death strug­gle, and the non-debtor releas­es are a valid tool to halt the fight.”).

14. See 11 U.S.C. § 1129(a)(8).

15. See 11 U.S.C. § 1126(c).

16. Unit­ed States v. Ener­gy Res. Co., 495 U.S. 545, 549 (1990) (not­ing the tra­di­tion­al role of bank­rupt­cy courts as courts of equity).

17. See In re Zale Corp., 62 F.3d 746, 757 n.28 (5th Cir. 1995) (explain­ing that such author­i­ty would incen­tivize cred­i­tors to push debtors into bank­rupt­cy for cred­i­tors’ own sake).

18. 11 U.S.C. § 105(a) autho­rizes a bank­rupt­cy court to “issue any order, process, or judg­ment that is nec­es­sary or appro­pri­ate to car­ry out the pro­vi­sions of this title.” A bank­rupt­cy court bears the respon­si­bil­i­ty of con­firm­ing a reor­ga­ni­za­tion plan, and under 11 U.S.C. § 1123(b)(6), the court may con­firm a plan that includes “any oth­er appro­pri­ate pro­vi­sion not incon­sis­tent with the pro­vi­sions of this title.”

19. 11 U.S.C. § 1123(b)(6).

20. 11 U.S.C. § 105(a).

21. 11 U.S.C. § 524(e); A num­ber of Cir­cuits refer to third par­ty dis­charge as a “non-debtor release.” See, e.g., In re Metro­me­dia Fiber Net­work, Inc., 416 F.3d 136, 142 (2d Cir. 2005); In re Sea­side Eng’g & Sur­vey­ing, 780 F.3d 1070, 1077 (11th Cir. 2015). Call­ing the dis­charge a release dis­tances this activ­i­ty from the lan­guage of 11 U.S.C. § 524(e), which refers specif­i­cal­ly to a dis­charge, not a release. Such clas­si­fi­ca­tion is a mis­nomer, and unper­sua­sive. A release indi­cates con­sent by the cred­i­tor, where­as the third par­ty dis­charge is con­tro­ver­sial because it is involuntary.

22. See In re Lowen­schuss, 67 F.3d 1394, 1402 (9th Cir. 1995) (“[Sec­tion] 524(e) pre­cludes bank­rupt­cy courts from dis­charg­ing the lia­bil­i­ties of non-debtors.”); In re W. Real Estate Fund, 922 F.2d 592, 600 (10th Cir. 1990) (inter­pret­ing sec­tion 524(e) to mean that “it is the debtor, who has invoked and sub­mit­ted to the bank­rupt­cy process, that is enti­tled to its pro­tec­tions” and that “Con­gress did not intend to extend such ben­e­fits to third-par­ty bystanders.”).

23. See In re Air­a­digm Com­muns., Inc., 519 F.3d 640, 656 (7th Cir. 2008) (“The nat­ur­al read­ing of this pro­vi­sion does not fore­close a third-par­ty release from a creditor’s claims.”).

24. See e.g., 11 U.S.C. § 105(b) (“[A] court may not appoint a receiv­er in a case under this title.”) (empha­sis added).

25. In re Air­a­digm Com­muns., Inc., 519 F.3d at 656.

26. Id.

27. See In re Metro­me­dia Fiber Net­work, Inc., 416 F.3d 136, 142 (2d Cir. 2005) (“The Bank­rupt­cy Code does not explic­it­ly pro­hib­it or autho­rize a bank­rupt­cy court to enjoin a non-con­sent­ing creditor’s claims against a non-debtor.”) (cit­ing In re Dow Corn­ing Corp., 280 F.3d 648, 656 (6th Cir. 2002)); In re Con­ti­nen­tal Air­lines, 203 F.3d 203 (3d Cir. 2000) (declin­ing to adopt a rule pro­hibit­ing the use of third par­ty dis­charges); In re A.H. Robins Co., 880 F.2d 694, 702 (4th Cir. 1989) (opin­ing that sec­tion 524(e) does not have to be “lit­er­al­ly applied in every case as a pro­hi­bi­tion on the pow­er of the bank­rupt­cy courts.”); In re Sea­side Eng’g & Sur­vey­ing, 780 F.3d. 1070 (11th Cir. 2015) (adopt­ing the read­ing of the Sev­enth Circuit).

28. See In re Lowen­schuss, 67 F.3d 1394, 1402 n.6 (9th Cir. 1995) (assert­ing that a third par­ty dis­charge was “specif­i­cal­ly designed to apply in asbestos cas­es only.”).

29. See 11 U.S.C. § 524(g)(4)(A).

30. Sec­tion 524(g) neces­si­tates that a num­ber of require­ments be met before an asbestos defen­dant can take advan­tage of the ben­e­fits of 524(g). Some of these require­ments include the estab­lish­ment of a trust that assumes the lia­bil­i­ty of the debtor and is fund­ed by the debtor, that the debtor is like­ly to be sub­ject to sub­stan­tial future lit­i­ga­tion, and that the actu­al amounts and tim­ing of future claims can­not be deter­mined. See 11 U.S.C. § 524(g)(1)(B).

31. See In re Pacif­ic Lum­ber Co., 584 F.3d 229, 252 (5th Cir. 2009).

32. Id.

33. In re Zale Corp., 62 F.3d 746, 757 n.28 (5th Cir. 1995).

34. See In re W. Real Estate Fund, 922 F.2d 592, 600 (10th Cir. 1990) (“the debtor, who has invoked and sub­mit­ted to the bank­rupt­cy process … is enti­tled to its pro­tec­tions; Con­gress did not intend to extend such ben­e­fits to third-par­ty bystanders.”).

35. In re Zale Corp., 62 F.3d at 757 n.28.

36. See id., (cit­ing Zerand-Bernal Group, Inc. v. Cox, 23 F.3d 159, 163 (7th Cir.1994)).

37. 11 U.S.C. § 105(a).

38. See e.g., In re Air­a­digm Com­muns., Inc., 519 F.3d 640, 657 (7th Cir. 2008); In re Sea­side Eng’g & Sur­vey­ing, 780 F.3d 1070, 1081 (11th Cir. 2015).

39. See gen­er­al­ly, Nat’l Her­itage Found., Inc. v. High­bourne Found., 760 F.3d 344, 347 (4th Cir. 2014); In re Sea­side Eng’g & Sur­vey­ing, 780 F.3d at 1079.

40. In re Dow Corn­ing Corp., 280 F.3d 648, 658 (6th Cir. 2002).

41. In re Air­a­digm Com­muns., Inc., 519 F.3d at 657.

42. See 11 U.S.C. § 1129(a)(7).