Nexpoint Advisors, L.P. v. Highland Capital Management, L.P. (In re Highland Capital Management, L.P.) (5th Cir.)

The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:

SUMMARY

The Fifth Circuit Court of Appeals (the “Circuit”) rejected an exculpation clause for certain non-debtors included in a bankruptcy court’s Chapter 11 confirmation order but approved a gate-keeping function which allowed that court to screen and bar bad-faith litigation against the reorganized debtor, its successors, and other bankruptcy participants that might disrupt the plan’s effectiveness. Nexpoint Advisors, L. P. v Highland Capital Management, L.P. (In re Highland Capital Management, L.P.), 2022 WL 3571094 (5th Cir. August 19, 2022).

To view the opinion, click here. 

FACTS

Highland Capital Management, L.P., (the Debtor) managed billion-dollar publicly traded investment portfolios for three decades, but it ran into financial distress caused by judgments and filed Chapter 11 in 2019 in Delaware (later transferred to Texas). The filing led to a “nasty breakup” between the Debtor and its co-founder James Dondero. The United States Trustee appointed a four-member Unsecured Creditors’ Committee (the Committee) which investigated the Debtor’s prior practices and oversaw its continuing operations. It also negotiated the plan of reorganization. During the negotiations for the plan, the Committee sought to displace Dondero, which the court approved in an agreed order, under which the Committee selected a board of three Independent Directors to act as a quasi-Chapter 11 trustee. The order also barred any claims against these Independent Directors without the bankruptcy court authorizing such claim as a “colorable claim [ ] of willful misconduct or gross negligence.” Later the Committee sought and obtained an extension of that bar order to the named Chief Restructuring Officer. These orders were not appealed.

In 2020 Dondero futilely proposed several plans. After these failures, he and other related creditors objected to multiple steps in the reorganization process and interfered with the Debtor’s operations, culminating in a string of unsuccessful interim appeals. Through mediation, the bankruptcy court ultimately confirmed a Chapter 11 plan amenable to most creditors except for Dondero and his cronies, who objected at every opportunity no matter what was proposed. The eventual confirmation order shielded the Debtor and bankruptcy participants from lawsuits through an exculpation provision to be enforced by an injunction and a gatekeeper provision. These protections extended to nearly all bankruptcy participants, including “related Persons”, which included “all former, present, and future officers, directors, employees, managers, members, financial advisors, attorneys, accountants, investment bankers, consultant, professionals, advisors, shareholders, principals, partners, heirs, agents, other representatives, subsidiaries, divisions, and managing companies.” The order specifically excluded Dondero and his related entities and professionals. The exculpation was broad, covering breach of contract and negligence claims, but excluding acts or omissions that constituted bad faith, fraud and other intentional misconduct. The gatekeeping provision forced a party seeking to bring a claim against any of the protected parties to ask the bankruptcy court to determine whether its claim was colorable before it could pursue such claim.

When the bankruptcy court approved the exculpation and gatekeeping protections, it concluded that the provisions were fair, equitable, and reasonable and were “integral elements” of the plan under the circumstances of the litigious nature of Dondero and his supporters. Dondero and others appealed the confirmation order, seeking a direct appeal to the Circuit. The Circuit accepted the direct appeal and, with the exception of exculpation of non-debtor parties, affirmed the confirmation order.

REASONING

The circuit addressed multiple issues, including equitable mootness, the Debtor’s right to a discharge, the satisfaction of the Absolute Priority Rule, and some technical procedural arguments, all determined in favor of the Debtor. This review will focus only on the validity of the protection provisions: the exculpation and gatekeeping aspects of the confirmation order.

Appellants’ arguments against the broad exculpation clause centered on whether the plan’s shield of non-debtors from breach of contract and negligence claims was a violation of § 524(e) of the Bankruptcy Code. Section 524(e) provides that in a Chapter 11 proceeding “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.” The Circuit recognized that the application of § 524(e) to exculpation clauses pertaining only to non-debtor post-petition liability– as opposed to outright releases of both pre- and post-petition claims against third parties – had created a circuit split. The Third and Ninth Circuits have found that such limited exculpation is not a violation of § 524(e), whereas this Circuit along with the Tenth Circuit have held that it “categorically bars third-party exculpations absent express authority in another provision of the Bankruptcy Code. In re Pacific Lumber Co., 584 F. 3d 229, 251-253 (5th Cir. 2009).

The Circuit saw no reason to challenge the reasoning of Pacific Lumber. When the decision was handed down, the Circuit was aware of the countervailing Third Circuit view (the Ninth Circuit did not so rule until Blixseth v Credit Suisse, 961 F. 3d 1074 (9th Cir. 2020)) and addressed it by looking at the exact language of the statute. Applying that precedent here, the Circuit ruled that the release of many of the “Related Persons,” which included unknown future professionals and entities, was beyond the jurisdiction of the bankruptcy court and therefore it reversed that part of the exculpation clause. However, it did allow the clause to protect the Independent Directors who acted as the quasi-Chapter 11 trustee throughout the reorganization process, as they were in essence an extension of the Debtor.

With regard to the gatekeeper provisions, the Circuit made comparison to the Barton doctrine which requires a party to obtain leave of the bankruptcy court before it can bring an action against a trustee or officer of the court for acts done in an official capacity. The necessity of that doctrine to efficient administration of a bankruptcy case could be analogized to the need here for the court to ensure that frivolous litigation did not disrupt the implementation of the plan. Rather than determine the bankruptcy court’s subject matter jurisdiction over any such potential claim, it ruled that the bankruptcy court should determine its own subject matter jurisdiction at the time its gatekeeping function was called into play. Those protections were allowed to stand.

AUTHOR’S COMMENTS

In light of the Fifth Circuit precedent, the reversal of the exculpation of third parties for even post confirmation claims is not surprising. As noted, we now have a significant circuit split which only the Supreme Court can resolve. Given that this issue has arisen several times in the past few years, perhaps it will grant certiorari in this case after rejecting it in Blixseth.

The opinion has an extensive discussion of Dondero and his cronies’ interference with not only the plan process but the bankruptcy court’s authority in general. The record recited shows that the bankruptcy court had made extensive findings implicating bad behavior by Dondero caused the entire reorganization process to be more lengthy and costly. In light of those facts, it is no wonder the gatekeeping provisions were upheld.

This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.