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Third Circuit Enforces Plan Releases Against Later-Purchasing Shareholders Bringing Claims Concerning Post-Confirmation Conduct

Bankruptcy plans often include provisions releasing debtors and their officers and directors from certain potential liability. In Zardinovsky v. Arctic Glacier Income Fund, No. 17-2522 (3d Cir. Aug. 20, 2018), the United States Court of Appeals for the Third Circuit held that such a provision bound shareholders who purchased the shares after confirmation, as to post-confirmation claims including securities fraud and breach of fiduciary duty. Because this decision was at the motion to dismiss stage, what follows are the court’s characterization of the facts as alleged in the complaint.

Arctic Glacier Income Fund is a Canadian income trust. In 2012, it filed for bankruptcy in Canada, and ultimately confirmed a Plan. Because Arctic Glacier also filed a chapter 15 case in the United States, and received recognition of its Canadian case, its Plan has full effect in the United States.

The Plan called for sale of Arctic Glacier’s assets and distribution of the proceeds to creditors, and ultimately, at the lowest level of priority, to shareholders. The Plan did not greatly constrain the discretion of the Monitor (the Canadian equivalent of a trustee) on when or how much to distribute to shareholders, though 21 days’ notice of a distribution was required. The Plan also included liability releases insulating Arctic Glacier and its officers from any claim “in any way related to, or arising out of or in connection with” the bankruptcy.

The assets were sold and the creditors were repaid in full. Arctic Glacier then announced, on December 11, 2014, that shareholders as of December 18 would be entitled to receive a dividend to be distributed at a later point. The Financial Industry Regulatory Authority (“FINRA”), a self-regulatory organization that, inter alia, regulates distributions, has a detailed set of rules for which dates count for receiving a dividend and which dates count for being entitled to dividend funds. The Plan did not reference these rules and Arctic Glacier did not inform FINRA of its planned distribution. After December 18 passed, Arctic Glacier shares continued to trade at the same price, even though the shares no longer carried with them the right to receive the distribution. Arctic Glacier noticed this discrepancy but did not take steps to clarify the timing of and rights to the dividends.

Plaintiffs purchased 12,600,000 shares of Arctic Glacier stock between December 16 and January 22. The distribution took place on January 22 and went only to the shareholders as of December 18. Plaintiffs argued that had Arctic Glacier notified FINRA and complied with its rules, they would have been entitled to the distribution payments for shares bought through January 22. They brought claims in the United States for negligence, breach of fiduciary duty, and securities fraud against Arctic Glacier and four of its officers. The bankruptcy court and the district court dismissed the claims on the grounds that the confirmed plan was res judicata and the releases barred the claims. Plaintiffs then appealed.

Plaintiffs made three arguments to escape the releases. First, plaintiffs argued that a plan cannot bar liability for post-confirmation conduct. They pointed to the Supreme Court’s decision in Holywell Corp. v. Smith, 503 U.S. 47, 58 (1992), which stated that “we do not see how [a confirmed plan] can bind the United States or any other creditor with respect to post-confirmation claims.” Second, plaintiffs argued that they were not transferees for purposes of taking on the same limitations as the previous holders of the shares. Third, plaintiffs argued that enforcing the releases against them would violate due process.

The Third Circuit rejected all three arguments. As to the argument that the Plan could not bar liability for post-confirmation acts, the Third Circuit distinguished Honeywell, noting that in that case, where the government sought to collect taxes on the income generated by a liquidation, the government was not directly challenging plan implementation. The court reasoned that a debtor can only implement a plan post-confirmation, so not permitting confirmed plans to bar liability for post-confirmation acts would generally undermine the preclusive effect of plan confirmation. As to the argument that the purchasing shareholders are not transferees, the court rejected this argument entirely, noting that a purchase is clearly a transfer, and that as a transfer of a bankruptcy claim, it comes with the same limitations the transferor had previously. As to the due process argument, the court noted that the original shareholders were represented in the bankruptcy proceeding, and the plaintiffs had notice by publication of the terms of the Plan. The Third Circuit affirmed the dismissal of the claims.