Fifth Circuit Restricts Scope of Highland Plan Injunction’s ‘Protected Parties’ to Permissible Exculpated Parties, Reiterates Bankruptcy Court’s Limited Authority to Grant Nondebtor Relief 

Relevant Document:
Opinion

The U.S. Court of Appeals for the Fifth Circuit issued an opinion today, limiting the scope of “protected parties” under the Highland Capital Management plan’s injunction and gatekeeper provisions to be coextensive with the list of permissible exculpated parties – the debtor, the official committee of unsecured creditors and its members, and independent directors that acted as the bankruptcy trustee – as set forth in its earlier 2022 Highland I decision.

The opinion reverses in part the bankruptcy court’s interpretation of Highland I, which in turn originates from an arguable ambiguity in the Highland I decision as to whether “impermissible exculpated parties” are similarly struck from the plan’s injunction and gatekeeper provisions. The injunction and gatekeeper provisions enjoin parties from pursuing litigation against protected parties unless the bankruptcy court affirmatively greenlights the litigation.

In the Fifth Circuit’s original Highland I decision issued on Aug. 19, 2022, the court struck the plan’s exculpation provision, except with respect to the debtor, the UCC and its members, and the independent directors. CLO funds affiliated with former Highland President and CEO James Dondero petitioned for a panel rehearing to clarify the scope of the ruling relative to the injunction and gatekeeper provisions.

Although the Fifth Circuit granted the petition, it did so without a rehearing or further briefing, and instead issued an amended opinion on Sept. 7, 2022. The amended opinion – nearly identical to the original one – replaced only the first sentence of its analysis of the injunction and gatekeeper provisions, by substituting the sentence: “The injunction and gatekeeper provisions are, on the other hand, perfectly lawful” for the following: “We now turn to the Plan’s injunction and gatekeeper provisions.”

On the debtor’s motion to conform the plan to the Highland I decision (as amended), Bankruptcy Judge Stacey Jernigan found that Highland I required only the plan’s definition of “exculpated parties” be narrowed to the debtor, the UCC and its members, and the independent directors. Judge Jernigan rejected objecting CLO funds and advisors’ argument that the plan’s injunction and gatekeeper provisions should likewise be limited in scope.

CLO advisors affiliated with Dondero directly appealed the matter to the Fifth Circuit. The circuit court heard oral argument in February 2024, taking the matter under advisement.

According to today’s opinion issued by a three-judge panel of Chief Judge Jennifer Walker Elrod and circuit Judges Stuart Kyle Duncan and Don R. Willett, the bankruptcy court “failed to properly implement our instructions in Highland I when it declined to narrow the definition of ‘Protected Parties’” to include only the debtor, the independent directors for conduct within the scope of their duties, and the committee and its members for conduct within the scope of their duties. As a result, the bankruptcy court exceeded its power under the Bankruptcy Code by allowing the plan to improperly protect nondebtors from liability, says the panel.

Citing circuit case law on the limitations of the bankruptcy court’s equitable powers under section 105(a) of the Bankruptcy Code, the panel writes that even before the Supreme Court’s Purdue decision barring nonconsensual nondebtor releases, the circuit court has held that bankruptcy courts may not confirm a plan that nonconsensually releases nondebtors from liability related to a bankruptcy proceeding; likewise, any plan injunction – albeit not releases themselves – may not shield nondebtors not legally entitled to releases. The fresh start under Bankruptcy Code section 524(e) for debtors is not intended to release nondebtors, reiterates the panel.

In addition, the bankruptcy court’s power to issue gatekeeping orders is restricted, says the panel. Under the Supreme Court’s Barton doctrine, an individual may be required to seek leave of the bankruptcy court before pursuing a claim against the trustee or another bankruptcy court-appointed officer for acts in their official capacity, says the panel.

The rationale behind the Barton doctrine, continues the panel, includes preventing interference with the performance of duties exclusive to the appointing bankruptcy court to distribute trust assets to creditors and the bankruptcy court’s interest in protecting a bankruptcy trustee – a court-appointed officer – from unjustified personal liability. “Beyond these” nondebtor individuals, “we have never extended the Barton doctrine to give bankruptcy courts gatekeeping power over claims against non-debtors,” observes the panel.

“As it must,” writes the panel, “Highland I obeys these bedrock principles concerning bankruptcy courts’ power to protect non-debtors.” The proper reading of Highland I therefore requires the bankruptcy court to narrow the definition of “protected parties” coextensively with the definition of “exculpated parties.”

The panel then dives into a detailed discussion of why Highland I’s plain language and the amended opinion “elucidate” this holding, ultimately concluding that the “clear weight” of Supreme Court and Fifth Circuit precedent requires this result. Any other reading would improperly grant bankruptcy court authority to enforce “what is perhaps the broadest gatekeeping injunction ever written into a bankruptcy confirmation plan,” says the panel, which would be “patently beyond the power of an Article I court under § 105.”

The panel remands the matter to the district court to revise the plan’s definitions in accordance with the opinion.