Bankruptcy courts across the United States continue to consider third-party releases and the circumstances under which they may be permissible, if any. The U.S. Court of Appeals for the Fifth Circuit has previously held that bankruptcy courts may not issue nonconsensual, third-party releases as part of a confirmed Chapter 11 plan of reorganization. See Bank of N.Y. Tr. Co. v. Official Unsecured Creditors’ Comm. (In re Pac. Lumber Co.), 584 F.3d 229, 251 (5th Cir. 2009). However, third-party releases also exist in the non-bankruptcy context. Two recent opinions from the Fifth Circuit shed light on the scope of permissible bar orders and third-party releases of claims in the receivership context. Such bar orders may provide an effective alternative to third-party releases in bankruptcy in resolving mass tort cases.

On June 17, 2019, the Fifth Circuit vacated a district court order approving a $65 million settlement payment by insurance underwriters to a receivership estate and an accompanying bar order enjoining third-party claims against the underwriters arising out of a bank Ponzi scheme. See S.E.C. v. Stanford Int’l Bank, Ltd., 927 F.3d 830 (5th Cir. 2019) (Jones, J.). The court found that the district court had lacked authority to approve a settlement that nullified claims of coinsured parties to policy proceeds, like those of the former employees, “without an alternative compensation scheme.” It also found that the non-consensual release of the claims of the former employees outside of the policy itself was an impermissible third-party release of direct claims that did not belong to the receivership.

Contrastingly, on July 22, 2019, the Fifth Circuit affirmed a district court’s approval of a bar order enjoining suits against two insurance brokers that agreed to pay $120 million in exchange for a settlement of all claims against them arising out of the same Ponzi scheme. See Zacarias v. Stanford Int’l Bank, Ltd., No. 17-11073, 2019 WL 3281687 (5th Cir. 2019) (Higginbotham, J.). In Zacarias, the question presented was whether a court has the authority to enter a bar order foreclosing suits against third-party defendants with whom a receiver is engaged in litigation, particularly when doing so is necessary to guarantee an equitable distribution of limited assets to similarly situated claimants. Faced with the prospect of losing their ability to potentially earn greater recoveries than those generated by the receivership process, a group of objectors sought to preserve their right to sue the settling defendants. After describing both the practical necessity and jurisdictional basis of the receivership process, the court identified the objectors’ efforts as the collective-action problem that the receivership scheme was intended to remedy. The court found that the bar orders fell within the broad jurisdiction of the district court to protect the receivership res.

Factual Background

Starting in the 1980s, Antigua-based Stanford International Bank (Stanford) and its predecessor issued certificates of deposit (SIB CDs) and marketed them throughout the United States and Latin America. Stanford’s financial advisors marketed the SIB CDs by assuring potential investors that its investments were highly liquid and achieved consistent double-digit annual returns. Stanford also purchased insurance through its insurance brokers, Bowen, Miclette & Britt (BMB) from the 1990s and Willis from 2004. In its marketing materials, Stanford assured investors that it subjected itself to rigorous independent audits and touted the insurance policies’ extensive coverage. These efforts proved central to Stanford’s success and its ability to issue more than $7 billion in SIB CDs to investors who were drawn in by the high rates of return and allegedly extensive insurance coverage.

As it turned out, Stanford redeemed maturing SIB CDs with new investors’ principal payments, and deposits were regularly commingled and allocated to illiquid investments. The bank’s finances were monitored by two of the bank’s principals, rather than professional analysts. BMB and Willis undertook insurance assessments of Stanford’s operations and learned that the SIB CDs were financing illiquid investments and that both the quality and lack of coverage for the underlying investments were not disclosed to investors.

The Ponzi scheme collapsed in the wake of the 2008 financial crisis. Stanford’s investors sought redemptions in large numbers while new sales slowed down, leaving the bank without sufficient liquidity to pay redemptions. $7 billion dollars in deposits were protected by only $50 million in coverage, and among the defrauded investors, 18,000 SIB CD holders lost approximately $5 billion. In February 2019, the U.S. District Court for the Northern District of Texas placed the bank into a federal receivership and approved a process by which investors could file claims against Stanford and receive pro rata distributions from recoveries generated by lawsuits brought by the receiver. The district court also held that the court would possess exclusive jurisdiction over a group of insurance policies and their proceeds and ruled that no claims could be brought against the proceeds in any other forum.

Several lawsuits ensued between the receiver and the underwriters as to the scope of the policies’ coverage. Concurrently, the receiver also pursued the policy proceeds indirectly against individual Stanford directors, officers, and employees, alleging fraudulent transfers, unjust enrichment, and/or claims for breach of fiduciary duty. The parties ultimately reached a settlement, with the underwriters agreeing to pay the receiver $65 million in exchange for a release of some of the insured parties’ obligations under the relevant policies and bar orders enjoining further action against the underwriters. The underwriters sought the accompanying bar orders because the release contemplated by the settlement only released the estate’s claims against 16 of its officers and directors, rather than all insureds. All other former Stanford employees, officers and directors would remain subject to ongoing litigation by the receiver and forced to bear any accompanying costs. The bar orders would prohibit these entities from suing the underwriters for their costs of defense and indemnity under the insurance policies, as well as for extra-contractual or statutory claims. The settlement was approved, with the district court finding that the agreement was the product of good-faith negotiations and that the disparity in treatment created by the bar orders was outweighed by their practical necessity.

A group of entities precluded from suing the underwriters in connection with their costs of defense under the insurance policies then objected to the bar orders and argued that the district court’s decision constituted an abuse of discretion. Such objection required the Fifth Circuit to address two issues. First, the court would need to address whether the district court’s broad power to fashion ancillary relief could be used to bar claims by insureds to proceeds of the underwriters’ policies—which the court acknowledged constituted property of the receivership estate. The second issue was whether the court’s equitable power could be used to enjoin third-party extra-contractual claims against the underwriters that were not otherwise connected to the receivership’s property.

The Fifth Circuit’s Opinions

Bar orders are impermissible where insured parties releasing claims do not share in settlement proceeds, and where such bar orders release claims that do not belong to the receivership estate. S.E.C. v. Stanford Int’l Bank, Ltd., 927 F.3d 830 (5th Cir. 2019) (Jones, J.)

The Fifth Circuit began by describing the statutory basis and operation of federal receiverships. Equity receiverships share many characteristics of bankruptcy liquidations, and federal district courts may similarly utilize the receivership mechanism in connection with a troubled entity that would otherwise be unable to satisfy its liabilities in a way that would ensure equal treatment of similarly situated creditors. The court then highlighted a broader principle of the receivership process that had been downplayed by the district court’s approval of the settlement and bar orders: that the receiver collects and distributes only assets of the entity in receivership. Accordingly, an equity receiver may only sue to redress injuries to the entity in the receivership—comparable to how a bankruptcy trustee may sue only to redress injuries to the debtor. A receivership also is restricted by limits on the district court’s in rem jurisdiction, and cannot exercise unbridled authority over assets belonging to third parties to which the receivership estate has no claim. Accordingly, the court cited to several decisions that have held that a bankruptcy court may not authorize a debtor to enter into a settlement with liability insurers that enjoin independent third-party claims against the insurers. Noting the shared legal roots of bankruptcy and equity receiverships, the court stated that such prohibition against enjoining unrelated, third-party claims extended beyond the bankruptcy context and applied equally to equity receiverships.

As authority for the proposition that the bar orders could properly extend to extra-contractual third-party claims unconnected to the receivership’s property, the receiver cited to S.E.C. v. Kaleta, 530 F. App’x 360, 362 (5th Cir. 2013) (unpublished), a decision in which the court approved bar orders enjoining claims by third parties not before the court. In Kaleta, the SEC initiated an enforcement action against Kaleta Capital Management and related entities and individuals, alleging a fraudulent scheme. A receiver was appointed by the district court to pursue third parties in order to recoup proceeds of Kaleta’s fraud, resulting in a settlement and bar order enjoining further claims arising out of the scheme. Turning back to the facts before the court, the opinion distinguished Kaleta, noting that the bar order in that case protected the assets of the receivership estate, whereas the bar orders at issue in the case at hand extended beyond the receivership assets. Accordingly, the court declined to find that a district court’s in rem jurisdiction over the receivership estate could be used to bar independent, non-derivative third-party claims that do not affect the res of the receivership estate.

Having established the scope of the receivership’s authority, the court first held that the district court abused its discretion by not only foreclosing the objectors’ ability to share in the insurance policy proceeds of which they were coinsureds, but also preventing them from filing claims against the receivership estate. Whereas Kaleta expressly permitted those affected by the bar order to pursue their claims by participating in the claims process for the receiver’s ultimate plan of distribution, the bar orders contemplated by the present settlement cut off the objectors from participating in the claims process altogether. Accordingly, the only remaining avenue of recovery for the objectors would be through direct claims against the underwriters. The court acknowledged that some settlement with the underwriters was necessary because the sheer magnitude of claims far exceeded the policies’ coverage. Nevertheless, the court held that barring the objectors’ claims to coverage under the insurance policies by claiming the proceeds thereunder as property of the receivership, while simultaneously preventing the objectors from accessing even a portion of the proceeds through the receivership process, undermined the settlement’s fairness. Accordingly, the court found that the settlement was not consistent with the court’s duty to assure that all claimants against the receivership would be given a reasonable opportunity to share in the estate’s assets.

The court also found that the bar orders improperly extinguished the objectors’ ability to pursue extra-contractual claims for bad faith breach of duty and claims under the Texas Insurance Code against the underwriters. These claims against the underwriters existed independently and bore no connection to the receivership estate, and constituted property rights that could not be extinguished by the bar orders contemplated by the settlement. The court sympathized with the need to settle difficult issues of insurance coverage and avoid the gradual dissipation of limited receivership assets through protracted litigation, but found that the settlement and bar orders nonetheless violated limits on the authority of the receivership process and fundamental notions of fairness.

Bar orders are permissible where they enjoin claims by individuals sharing in settlement proceeds. Zacarias v. Stanford Int’l Bank, Ltd., No. 17-11073, 2019 WL 3281687 (5th Cir. 2019) (Higginbotham, J.)

In a separate litigation arising out of the Stanford Ponzi scheme, the Fifth Circuit affirmed the district court’s approval of a bar order releasing claims through a different insurance settlement. Four years after the district court appointed a receiver, the receiver sued BMB and Willis, the bank’s insurance brokers. In an effort to negotiate for complete peace, the insurance brokers agreed to a settlement that was conditioned on bar orders enjoining further suits arising out of the Ponzi scheme. After the district court gave notice of the settlement to interested parties and entered the bar orders in August 2017, certain objectors brought an appeal challenging the district court’s jurisdiction and discretion to enter the bar orders.

The Fifth Circuit’s Majority Opinion. The majority opinion described the statutory basis and operation of federal receiverships. Pursuant to federal securities law, federal district courts may utilize the receivership mechanism in connection with a troubled entity that would otherwise be unable to satisfy its liabilities in a way that ensures equal treatment of similarly situated creditors. The majority emphasized that central to the success of a receivership is its ability to prevent third-party creditor-claimants from jumping the queue and recovering beyond their pro rata share, a function facilitated by a court’s ability to issue “orders preventing interference with its administration of the receivership property.” As authority, the majority cited to several decisions in which courts approved bar orders enjoining claims by third parties not before the court, and using Kaleta as an example of one such opinion that drew “upon principles so commonplace that it was not published.” The majority emphasized the realities of Stanford’s receivership process: Willis and BMB insisted on bar orders as preconditions of their respective settlements, an incentive that would be otherwise eliminated if each holder of SIB CDs could still sue the insurance brokers in subsequent lawsuits. Furthermore, additional litigation would deplete the limited assets available to the investor claimants, and there was no guarantee that continued prosecution of these claims would result in a greater recovery for the receiver.

The majority then noted that its decision was consistent with its previous opinion in S.E.C. v. Stanford Int’l Bank, Ltd., 927 F.3d 830 (5th Cir. 2019), discussed above. Although in that opinion the Fifth Circuit had vacated district court approval of the settlement between the receiver and the bank’s insurance underwriters and the accompanying bar order because the bar order impermissibly discharged the Stanford officers’ non-investment-related claims, the court emphasized that the receivership afforded defrauded investors the opportunity to file claims and participate in the distribution process, and that doing so did not improperly extinguish those investors’ rights.

The majority also observed that the objectors’ effort to retain their ability to pursue piecemeal litigation against the insurance brokers would give them the benefits of the receivership process without its burdens. The objectors had submitted proofs of claims and received the benefits of the receiver’s pursuit of claims on their behalf, which would provide them with a pro rata distribution of associated recoveries. But given the prospect of losing their ability to potentially earn greater recoveries than those generated through the receivership process, the objectors sought to jump the queue at the expense of similarly situated claimants. The court noted that the objectors’ effort was an example of the collective-action problem that the receivership process was intended to address, and accordingly found that the bar orders fell well within the district court’s broad jurisdiction to protect the receivership res.

Finally, the majority determined that the bar orders did not violate the provisions of the Anti-Injunction Act. Federal injunctive relief is often deemed “necessary to prevent a state court from so interfering with a federal court’s consideration or disposition of a case as to seriously impair the federal court’s flexibility and authority to decide that case.” Atl. Coast Line R.R. Co. v. Bhd. of Locomotive Eng’rs, 398 U.S. 281, 295 (1970). Clarifying the scope of the receivership process’s jurisdiction with reference to a nineteenth-century decision, the majority noted that when the district court originally took the receivership estate into its custody, the res “[wa]s as much withdrawn from the judicial power of the other [courts], as if it had been carried physically into a different territorial sovereignty.” Covell v. Heyman, 111 U.S. 176, 182 (1884). Consequently, to the majority, the use of bar orders is a time-honored judicial practice, necessitated by the practical realities of distributing limited assets to similarly situated claimants. Accordingly, the court found that the bar orders were justified by the need to prevent ancillary state court proceedings from interfering with the district court’s exclusive authority to distribute the receivership estate’s assets.

The Dissent. In his dissent, Judge Don Willett argued that the district court lacked authority to grant the bar orders, despite sharing the majority’s belief in the settlement’s practical value. Whereas the receiver asserted breach of fiduciary duty and negligence claims against the insurance brokers, the objectors sought to bring causes of action for fraud and negligent misrepresentation on account of letters they received misrepresenting the true scope of Stanford’s insurance coverage. Judge Willett therefore declined to find that the objectors’ alleged injuries were the same as those being remedied by the receivership’s suit. Rather, to Judge Willett, the district court had no authority to enforce the bar orders and enjoin the objectors’ claims. Finally, Judge Willett declined to find that the bar orders were within the district court’s in rem jurisdiction—which extended to Stanford’s assets but did not similarly include the victims’ claims.

Conclusion

Much as insurance was key to the Stanford Ponzi scheme, it is also key to the resolution of mass tort cases. As seen in the Stanford and Madoff cases, fraud can drive massive amounts of litigation. Likewise, mass torts may generate extensive litigation in multiple forums. There may be multidistrict litigation panels for pretrial proceedings in the federal system. Operating businesses may be crippled by mass tort liability. A collective settlement that frees the business operations from continuing contingent and unliquidated liability is the rational objective. However, achieving that objective—often for the benefit of a purchaser or investor of the defendant business—requires an understanding of the efficacy of bar orders and their impact on third parties. Because there may be agreements as among the insurers and state law claims against the insurers, maximizing the value of insurance assets is often a predicate to resolution in a mass tort situation, including any sale of the business. If insurers cannot obtain relief from continuing contingent and unliquidated liability, the efficacy of a collective settlement is open to question.

Just as insurers seek certainty and final resolution of massive litigation, the same is true for indemnitors. The Stanford cases demonstrate that jurisdiction is a key consideration. Indeed, in both cases, jurisdiction was premised upon in rem jurisdiction displacing state courts in favor of federal courts. Most interesting, however, is the Fifth Circuit’s analogizing to the extent of bankruptcy jurisdiction as the source of authority to enter a bar order, even when it effects a third-party release. The key to the court’s reasoning seems to be the ability of those barred to make a claim against the proceeds of the settlement. While that factor assists reconciling the two decisions, the impact on the claims not owned by the estate (whether bankrupt or federal receivership) and raised by those objecting to the bar order is not as easily reconciled. The impact of a bar order is to protect the settling parties from any additional exposure, which sounds fairly close to a nonconsensual third-party release. Practicality was a consideration in Judge Higginbotham’s opinion in Zacarias, but was not an influencing factor in Judge Jones’s opinion in the SEC action, where the objectors were not participants in the distribution of the settlement proceeds.

Given the Fifth Circuit’s prohibition on non-consensual third party releases, investors should be cognizant of taking full advantage of a bar order protecting settling defendants as a potential predicate for protecting themselves as a subsequent purchaser or investor in a sale. This is particularly important in jurisdictions such as the Fifth Circuit and the Ninth Circuit, where “free and clear” sales are generally impermissible. The reorganization and purchase of Takata out of Chapter 11 is a good example of effectively using a settlement with a bar order to facilitate a subsequent investor-driven sale. While Takata was a case in the Third Circuit, where third-party releases are permitted under certain circumstances, the importance of effecting protection for settling insurers and indemnitors, as well as successors in interest cannot be underestimated in a mass tort scenario.

Corinne Ball is a partner at Jones Day.