* Trustee says third party releases may be improper
* Dynegy, Dynegy Holdings to combine
* Sept. 5 hearing to approve Chapter 11 plan
Aug 28 (Reuters) - The U.S. government is opposing the effort by Dynegy Inc and its Dynegy Holdings LLC unit to emerge from Chapter 11 bankruptcy, saying their reorganization plan may improperly limit the ability of third parties to bring liability claims.
U.S. Trustee Tracy Hope Davis, whose office is a component of the Department of Justice, filed an objection to the plan on Monday in the U.S. bankruptcy court in Poughkeepsie, New York, nine days before a Sept. 5 hearing in which Dynegy hopes to win court approval of its reorganization.
Dynegy this week said its plan had won overwhelming support from creditors holding about $3.5 billion of claims.
But Davis, whose office oversees bankruptcy cases in the New York area, said the power producer has not shown that its proposed "broad, non-consensual third party releases of liability" comply with bankruptcy law, and that such releases are proper only in rare circumstances.
"A nondebtor release is a device that lends itself to abuse," Davis wrote, quoting a 2005 decision by the federal circuit court of appeals in New York. "Unless and until the debtors meet their burden by demonstrating compliance with the law of this circuit and the bankruptcy code, the court should decline to confirm the plan as proposed."
Katy Sullivan, a Dynegy spokeswoman, said, "Our plan received widespread support from creditors and we will respond to the U.S. Trustee's objections through the established legal processes."
Dynegy Holdings filed for Chapter 11 last November amid a dispute over control of some coal-powered plant assets.
The Houston-based parent filed for bankruptcy in July as part of a reorganization that calls for creditors to take a 99 percent stake in a combined Dynegy and Dynegy Holdings, with shareholders getting a claim for the remainder plus warrants.
Dynegy is the same company that in 2001 canceled plans to buy larger rival Enron Corp, which later collapsed. Shares of Dynegy closed Monday at 41.6 cents on the Pink Sheets.
The cases are In re: Dynegy Holdings LLC, U.S. Bankruptcy Court, Southern District of New York, No. 11-38111; and In re: Dynegy Inc in the same court, No. 12-36728.