The Eleventh Circuit Court of Appeals recently issued an opinion in In re Centro Group, LLC, No. 21-11364, 2021 WL 5158001 (11th Cir. Nov. 5, 2021), in which it clarified the two separate and distinct standards for approving third party releases (or “bar orders” as the Eleventh Circuit termed them) in chapter 11 cases. According to the court, one standard applies in the context of settlement agreements and the other in the context of plan confirmation. Before delving into the recent opinion, a brief discussion of the two Eleventh Circuit cases that preceded Centro Group is appropriate.
The Munford Standard
In the Eleventh Circuit, the authority and standards for approving a settlement that incorporates a third-party release or bar order were first established in In re Munford, Inc., 97 F.3d 449 (11th Cir. 1996). The court in Munford approved a bar order to effectuate a settlement and held that section 105(a) of the Bankruptcy Code and Federal Rule of Civil Procedure 16 authorized bankruptcy courts to enter bar orders to facilitate settlements. The bar order in Munford extended to non-settling defendant claims for contribution and indemnification against a settling defendant, both non-debtors. Id.
On appeal to the Eleventh Circuit, the non-settling defendants attacked the bankruptcy court’s authority to approve the bar order. Id. at 452–53. The court found that bankruptcy courts can “enter bar orders where such orders are integral to settlement in an adversary proceeding.” Id. at 455. The court also provided that certain factors should be assessed to reasonably determine whether a bar order is fair and equitable, including: (1) “the interrelatedness of the claims that the bar order precludes”; (2) “the likelihood of the non-settling defendants to prevail on the barred claim”; (3) “the complexity of the litigation”; and (4) “and the likelihood of depletion of the resources of the settling defendants.” Id. The court concluded that the bar order was necessary because at least one of the parties “would not have entered into the settlement agreement” without it, and as such, it was “integral” to the settlement. Id.
The Seaside Standard
Nearly 20 years later in In re Seaside Engineering & Surveying, Inc., 780 F.3d 1070 (11th Cir. 2015), an engineering firm filed for Chapter 11 bankruptcy and submitted a reorganization plan which proposed that the firm reorganize and continue operations under a new name. Id. at 1075. The plan also included a bar order that prohibited lawsuits against the company (pre- or post-reorganization) and the company’s officers related to or arising out of the bankruptcy. Id. The bankruptcy court approved the settlement containing the bar order and a creditor appealed. Id. at 1075–76. On appeal to the Eleventh Circuit, the court explained that the case was factually distinguishable from Munford because the cases considered non-comparable bar orders. Id. at 1076–77. The court upheld the bar order in Munford because it was integral to reaching a settlement agreement between the parties. Id. at 1066. Different from the settlement context in Mumford, the bar order at issue in Seaside was upheld because it was deemed necessary for the reorganized entity to succeed. Id. at 1077 (“Instead of the settlement context in Munford, here the releases prevent claims against non-debtors that would undermine the operations of, and doom the possibility of success for, the reorganized entity”). The court looked to other circuits for guidance regarding treatment of bar orders in reorganization plans and adopted a seven-factor test used by the Fourth and Sixth Circuits to assess whether such a bar order is appropriate. Id. (citing In re Dow Corning Corp., 280 F.3d 648, 658 (6th Cir. 2002) (listing the seven factors)). After reviewing the bankruptcy court’s application of these seven factors, the court held that the bankruptcy court did not abuse its discretion in approving the bar order. Id. at 1079–81.
The Centro Group Opinion
The Centro Group opinion involved chapter 11 petitions filed by two companies that had entered into a merger agreement prior to the bankruptcy filings.
After completion of the merger, the surviving company discovered through a whistleblower that Centro had been misappropriating client funds. An investigation revealed that Centro officers and directors had misappropriated money from its clients’ escrow accounts which held payroll taxes resulting in over $1.7 million in tax liability Both companies later ended up in chapter 11 with a creditors’ committee.
The two companies, the committee and the defendants worked out a settlement, which included a bar order which prevented anyone from suing the defendants.
The buyer’s dominant shareholder unsuccessfully objected to the settlement and appealed. The district court affirmed. In the Eleventh Circuit, the shareholder contended that the bankruptcy court had applied the wrong standard for imposing a bar order.
In Centro Group, the Eleventh Circuit held that two separate standards apply for approval of bar orders depending on the circumstances under which the bar order is entered. According to the court, “[t]he Munford factors apply to bar orders assessed in the settlement context. Such a bar order is appropriate where the parties would not have entered into a settlement agreement without it, and thus it is ‘integral” to the settlement. The Seaside factors apply to bar orders that are specifically within the reorganization context and assessing whether ‘an order is necessary for the success of the reorganization.’” Centro Group, 2021 WL 5158001, at *3.
After discussing the two different standards, the Eleventh Circuit held that the bankruptcy court did not err in applying the Munford standard to approval of the bar order:
The record demonstrates that this case is more like Munford than Seaside because the Bar Order under review was integral to settlement. Although reorganization may have been on the table at some point, the purpose of the Bar Order differs from the factual context under Seaside because neither ProHCM nor Centro sought to reorganize and continue operations. As such, the purpose of the Bar Order is not to ensure success for a reorganized entity by eliminating liability against third parties but is instead to facilitate a settlement agreement. Because Munford controls and Markland did not preserve the argument of whether the bankruptcy court properly applied the Munford factors, the analysis stops here.
Centro Group, LLC, 2021 WL 5158001, at *3.
