Caselaw Update on Third Party Releases in Bankruptcy Plans

In the Summer 2021 edition of the Restructuring Report, I wrote about legislative efforts to reform the Bankruptcy Code to place limits on the use of third party releases in bankruptcy plans of reorganization. The legislation is being proposed in Congress in reaction to prominent use of involuntary third-party releases in cases such as Purdue Pharma, involving a release of the Sackler family for liability for the opioid crisis. Such releases have become widely used in larger cases to provide a release from creditors to third parties usually affiliated with the debtor, in exchange for consideration provided by the third party to the reorganization plan. Now there have been important developments in Purdue Pharma and in the retail case of the parent company of Ann Taylor on use of such releases.

In Purdue Pharma, Chief Judge Carol McMahon of the United States District Court for the Southern District of New York reversed the bankruptcy court’s order confirming a plan including broad releases of opioid abuse victims of claims against members of the Sackler family. In this same edition, Emily McAdam writes about the recent decision in the Purdue Pharma case. In subsequent proceedings, Judge McMahon authorized Purdue Pharma and members of the family to appeal her decision to the Second Circuit Court of Appeals and Purdue will undoubtedly seek an expedited resolution on appeal.

The Southern District of New York is not the only court to recently reject use of non-consensual third-party releases in bankruptcy plans. On January 13, 2022, the District Court for the Eastern District of Virginia overturned the confirmation order in the Mahwah Bergen Retail Group bankruptcy case. However, the District Court did not go as far as the Purdue Pharma decision in holding that non-consensual releases are never permitted; instead, the District Court ruled that such releases should be granted only cautiously and infrequently, in accordance with existing Fourth Circuit precedent.

The District Court decision arose from the Ascena Retail Group bankruptcy. Ascena owned several retail brands such as Ann Taylor, LOFT and Lane Bryant. At the time it filed for bankruptcy relief in 2020, there was pending a securities class action lawsuit against certain of its pre-petition executives. The bankruptcy plan provided for broad third-party releases that covered any type of claim against Ascena’s officers and certain other parties. Importantly, the plan provided that the releases bound only those who did not affirmatively opt out of the release on the creditor’s confirmation ballot. Anyone who did not submit a ballot or did not opt out on the ballot was deemed bound by the release. Thus, the effect of the release would have eliminated the claims of all the securities class action parties unless they affirmatively opted out. The plan also contained a very broad exculpation provision.

The District Court opinion is a lengthy discussion of third-party plan releases and exculpation provisions and is well worth reviewing. At base, the District Court concluded the Bankruptcy Court had erred in considering the release to be consensual, and therefore the Bankruptcy Court did not analyze the release in accordance with binding precedent. The opinion begins with an analysis about whether the Bankruptcy Court has the power under Stern v. Marshall to issue a final decision confirming the plan with non-consensual releases, as the non-consensual releases at issue were found to be non-core matters. As a result, the District Court concluded, a confirmation order need not be treated as a final order because the releases exceeded the authority of the Bankruptcy Court to issue a final order. This conclusion may be controversial because confirmation of a plan has long been seen as a core proceeding in bankruptcy, and therefore confirmation orders are final orders of the bankruptcy court.

As to the merits, the District Court concluded that the release and exculpation were inconsistent with existing Fourth Circuit precedent for approval of such releases. The District Court voided the third-party release and ordered that the exculpation provisions be redrafted consistent with Fourth Circuit caselaw. Under that law, courts are to employ a seven factor analysis in scrutinizing releases. The factors require consideration of such things as whether the released parties made a substantial contribution to the plan in exchange for the release, whether the releases were essential to the success of the reorganization, whether affected classes voted in favor or against the plan, and whether such classes will receive substantial consideration under the plan.

Aside from the merits, the District Court ordered relief for the remand of the case is interesting in and of itself. The District Court made note of the fact that a practice of routine approval of third-party releases in the Richmond division of the Bankruptcy Court for the Eastern Division of Virginia contributes to why major companies file there and noted that the bankruptcy court is one of four bankruptcy courts nationally where 91 percent of “mega” cases are filed. (The others are Delaware, the Southern District of New York and the Southern District of Texas). This contributed to an unusual portion of the relief ordered by the District Court. The District Court ordered that on remand the Chief Bankruptcy Judge reassign the case to a different bankruptcy judge outside the Richmond division for further proceedings consistent with the court order.

Neither of these opinions will be the last word on third party plan releases. But drafters of plans should take note of these opinions and stay tuned for additional developments in this area of bankruptcy practice.

  • Clinton E. Cutler

    Clint is a shareholder and former Chair of Fredrikson’s Bankruptcy, Restructuring & Workouts Group, practicing in the areas of debtor/creditor law, bankruptcy and complex commercial litigation. Clint has represented clients ...

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