The Bottom Line

The Honorable Karen B. Owens, sworn in as a Delaware Bankruptcy Judge on June 17, 2019, recently ruled that the third-party releases contained in Emerge Energy Services LP’s Chapter 11 plan were not consensually granted, given that creditors and equity holders were required to affirmatively opt out of granting such releases in an “Opt-Out Form” or a plan voting ballot. In re Emerge Energy Services LP, et al., Case No. 19-11563 (Bankr. D. Del. 2019) [Dkt. No. 671] (the Decision). Judge Owens concluded that inferring affirmative consent on the part of creditors and equity holders through their failure to “opt out” of granting a release was improper.

What Happened?

Emerge Energy Services LP (Emerge) was in the business of mining, processing and distributing sand products used in hydraulic fracking. The Debtors, who operated through a publicly traded partnership (the Partnership), were borrowers under a revolving loan facility and a notes purchase facility.  

Facing an industry downturn, increased transportation costs, and a catastrophic levee breach, Emerge and certain affiliates (the Debtors) filed for bankruptcy in July 2019.

Pursuant to a deal negotiated with certain of its creditors, the Debtors proposed a plan of reorganization that satisfied the Debtors’ revolving loan facility with new borrowings and gave the Debtors’ noteholders equity in the Partnership’s interest in the going concern operation. The proposed plan also contained a “death trap” — general unsecured creditors in Class 6 were entitled to receive 5% of the reorganized Partnership’s ownership interests, along with certain warrants for additional equity, if Class 6 voted in favor of the plan; if Class 6 voted against the plan, Class 6 would receive nothing. Importantly, the Debtors’ proposed plan also provided that certain creditors and interest holders would provide third-party releases to a number of non-debtor parties, including the Partnership’s general partner, unless those third parties “opted out” of granting such releases.

Class 6 voted against the plan and stood to receive nothing. The Official Committee of Unsecured Creditors, along with the Securities and Exchange Commission and the United States Trustee (together, the Objectors), objected to the plan, arguing, among other things, that the plan contained nonconsensual third-party releases which the Debtor had not justified with evidence or argument on the record. See Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203, 214 (3d Cir. 2000) (analyzing the more stringent factors required for approval of nonconsensual third-party releases). Specifically, the Objectors argued that the plan, as proposed, did not actually contain “consensual” third-party releases given that the failure to return an Opt-Out Form or a ballot cannot constitute affirmative consent.

The Debtors, on the other hand, maintained that the third-party releases contained in the Plan were consensual given that creditors and equity holders were made aware of the fact that if they did not want to grant a release, they would simply need to opt out of granting such release. This construct, according to the Debtors, conveyed the creditors’ and equity holders’ consent and therefore the Debtors were not required to satisfy the more stringent factors necessary for nonconsensual releases.

The Court ruled in favor of the Objectors. Judge Owens explained that the Court couldn’t conclude “the failure of a creditor or equity holder to return a ballot or Opt-Out Form manifested their intent to provide a release. Carelessness, inattentiveness, or mistake are three reasonable alternative explanations.” Decision at 23. Pointing to the “conspicuous notice of how to opt-out and the implication of the failure to do so,” Judge Owens conveyed that the third-party release provision would need to be revised in order for plan confirmation to go forward. Id.

Why This Case Is Interesting

The Court candidly noted that “its position is a minority amongst the judges” of the Delaware Bankruptcy Court. And to be sure, a number of recent decisions have approved of third-party releases as consensual under an opt-out construct similar to that in the Debtors’ plan.[1] Judge Owens, however, also pointed to several past decisions similarly critical of the opt-out provision present in the Debtors’ plan.[2]

The Decision serves as an important data point in the case law regarding the use of opt-out procedures in connection with consensual third-party releases. It also highlights what appears to be an intra-district split on this issue in the Delaware Bankruptcy Courts. Practitioners should be mindful of this split in connection with plan confirmation matters in Delaware.[3]


[1] See In re Gen. Wireless Ops., Inc., 2017 WL 5461361 at *10 (Bankr. D. Del. Oct. 26, 2017) (confirming plan with opt-out third-party releases and concluding that such releases were consensual); In re Abeinsa Holding, Inc., 562 B.R. 265, 285 (Bankr. D. Del. 2016) (same); In re Indianapolis Downs, LLC, 486 B.R. 286, 306 (Bankr. D. Del. 2013) (rejecting United States Trustee’s argument that affirmative consent, rather than deemed consent in an opt-out structure, is required for a consensual release); In re Spansion, Inc., 426 B.R. 114, 144 (Bankr. D. Del. 2010) (noting that “[c]ourts have determined that a third party release may be included in a plan if the release is consensual and binds only those creditors voting in favor of the plan”).

[2] See, e.g., In re Chassix Holdings, Inc., 553 B.R. 64 (Bankr. D. Del. 2015) (“Finding ‘consent’ in these circumstances [i.e., an opt-out provision] is to some extent a legal fiction. We know from experience that many creditors and interest holders who receive disclosure statements and solicitation materials simply will not respond to them, either because they elect not to read them at all or for other reasons.”).

[3] Two weeks after the Decision was issued, the Debtors presented and Judge Owens approved a modified plan with scaled-back release language in line with Judge Owens’ previous Decision.