Third party releases are a controversial topic with Congress considering legislation to ban them. However, Judge Greg Costa, writing for the Fifth Circuit, has distinguished between an impermissible third-party release and a plan provision reducing a guarantor's liability in a new opinion. New Falls Corporation v. LaHaye (Matter of LaHaye), No. 19-30795 (5th Cir. 11/12/21) which can be found here.
What Happened
Mr. and Mrs. LaHaye owned an LLC named LaHaye Enterprises, LLC. The LLC owned a grocery store. To finance the business, the LaHayes pledged the grocery store and a house they owned to Regions Bank. The grocery store closed when a national chain came to town. The LLC tried to transfer its property to Regions Bank to reduce the debt. Instead, Regions Bank sold the debt to New Falls Corporation. When the LLC filed bankruptcy, New Falls filed a proof of claim valuing the property at $225,000. The LLC confirmed a plan which surrendered the grocery store to New Falls in return for a credit of $225,000. The Plan also provided that the LaHayes would only be liable for the remaining balance of $100,000.
New Falls then tried to foreclose on both the grocery store property and the house owned by the LaHayes. The LaHayes filed their own Chapter 11 bankruptcy. New Falls filed a proof of claim for the full amount of the debt without regard for the credit from the first bankruptcy. The Debtors objected to the claim which the Bankruptcy Court sustained. The LaHayes then confirmed a plan providing for payment of the $100,000 debt. New Falls appealed.
The Court's Ruling
On appeal, New Falls made two arguments. First, it argued that it was not required to give credit for the value of the grocery store until it received title to the property. At the time of the individuals' bankruptcy, New Falls still had not received title and the vacant property had gone down in value. The Court noted that a plan is effective upon confirmation under 11 U.S.C. Sec. 1141(a) but relied on the specific plan language that said:
The LaHayes shall be entitled to a partial release of the guaranties of the New Falls debt upon confirmation of this plan in an amount equal to the value of the property surrendered under the Plan. The LaHayes shall thereafter be liable only for the remaining balance of $100,000.00 as provided for above.
The plan did not leave any room for ambiguity. The individuals were entitled to credit upon plan confirmation not upon property transfer.
The second argument that the creditor made was that the plan provision was not binding on it vis a vis the guarantors. I am going to quote several pages of the opinion because it is extremely well-written and the court says it better than I could summarize.
Under the Bankruptcy Code, the “provisions of a confirmed plan bind the debtor . . . and any creditor.” 11 U.S.C. § 1141(a). Based on this provision, we have long understood a confirmed bankruptcy plan to have binding effect on subsequent proceedings that involve the same debt. (citations omitted). This binding effect extends to third parties. Indeed, a confirmation order binds every entity that holds a claim or interest in the planned reorganization, regardless of whether they assert those interests before the bankruptcy court. (citation omitted).
That being said, the “discharge of a debt of the debtor does not affect the liability of any other entity” for the debt 11 U.S.C. § 524(e). A debtor’s bankruptcy plan generally does not discharge its guarantors’ obligations, even if the plan reduces or restructures the debt itself. (citation omitted). After all, the reason a lender obtains a guaranty is to guard against the risk that the borrower will not repay the loan. If a borrower’s insolvency discharged even a guarantor’s liability, the guaranty would lose much of its force.
But discharge is not the issue here. The LLC’s bankruptcy plan does not discharge the New Falls debt or the LaHayes’ obligations under it. To the contrary, the plan provides that the LaHayes’ guarantees and mortgage “shall remain in force until the New Falls debt is paid in full.” The provision granting the LaHayes a partial release of liability for the secured portion of the debt is not a discharge. Rather, it requires New Falls to recover the secured debt from an asset—the Grocery Store—that is part of the LLC’s estate. The guarantee remains, with the LaHayes still owing the leftover balance.
This is not the first time we have recognized the distinction between erasing a guaranty (impermissible) and reducing a guarantor’s liability by ordering a debtor to surrender assets in satisfaction of the debt (permissible). (citations omitted). In Stribling, for example, the debtor’s bankruptcy plan did not discharge a guaranty; instead, it ordered asset transfers and payments that reduced the debt and, in tandem, the guarantors’ liability. (citation omitted). Applying the same logic, in Sandy Ridge, we approved a proposed Chapter 11 plan similar to the LLC’s. That debtor also offered to surrender some of its real estate in exchange “for a ‘credit on the indebtedness.’” (citation omitted). The bankruptcy court rejected the plan due, in part, to its concern that the credit would release the debtor’s guarantors from liability. (ctiation omitted). We reversed, explaining that the proposed plan would not “operate to release the nondebtor guarantors.” (citation omitted). The surrendered assets would satisfy the secured portion of the claim and, with the guaranty still in existence, the creditor “would then be able to pursue the guarantors” for the remaining unsecured sum (the total debt minus the credit). (citation omitted). The LLC’s plan operates the same way.
A simple way to frame the difference between discharging a debt and crediting an asset against its balance is to imagine that the bankruptcy court had ordered the LLC to turn over cash instead of real estate. No one would view an order requiring the LLC’s estate to pay New Falls $250,000 in cash as eliminating a guaranty. It would be a payment that reduced the debt—and thus the guarantee—to a $100,000 balance. The fact that the provision at issue contemplates an exchange of real property rather than cash does not make it any less binding. (citation omitted).
A bankruptcy plan, then, can limit a creditor’s claim against third-party guarantors—not by discharging the guaranty but by determining the source and value of payments satisfying the guaranteed debt. Indeed, the bankruptcy court has broad discretion to determine how a debt will be settled, including through the sale or transfer of “all or any part of the property of the [bankrupt entity’s] estate.” See 11 U.S.C. § 1123(a)(5)(A)–(D).
Opinion, pp. 7-9 (emphasis added). The opinion makes clear that this is not a Shoaf-type ruling where the creditor was bound due to failure to object. Rather, surrendering property to reduce the debt of both the debtors and the guarantor was permissible.
Why It's Important
This short opinion is important for several reasons. First, plans matter. When a debtor puts language in a plan, that language will bind the creditor even if the creditor doesn't like how the case turned out. Second, dirt for debt remains viable in the Fifth Circuit. In re Sandy Ridge Dev. Corp., 881 F.2d 1346, 1351 (5th Cir. 1989) was controversial at the time it was decided. However, today's Fifth Circuit regards it as settled law. I really liked the passage where Judge Costa compared paying a debt with real estate to paying with cash. Both types of property have value, although real estate is significantly less liquid than cash. Finally, it is permissible for a plan to impact the liability of a third party. While third party releases are impermissible, payments which benefit third parties are acceptable. Finally, although I omitted the citations in my lengthy quotation, the opinion is a veritable encyclopedia of Fifth Circuit bankruptcy opinions from the 80s and 90s which remain viable today.
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