Although bankruptcy filings have been rare in the two years since the emergence of COVID-19, deposits are expected to start rising again as government pandemic assistance and financial buffers, such as forbearance agreements, are lifted. Despite the current lull in bankruptcy filings, bankruptcy law has continued to evolve in recent years with the passage of the Small Business Reorganization Act 2019, which created Sub-Chapter V for small business restructurings, as well as temporary changes to the bankruptcy code included in the CARES Act and the Consolidated Credits Act of 2021. The current bankruptcy buzz involves the possibility of new common law rulings regarding third-party non-consensual releases.
To fully understand the landscape of these releases, let’s first look at the Chapter 11 planning process. Most businesses choose to file for Chapter 11 receivership. In this chapter, a debtor will propose a â planâ which deals with its debt through restructuring and reorganization, liquidation, sale or a combination of the three. While Chapter 12 and 13 plans are generally court-approved form plans that include minimal variations from case to case, Chapter 11 plans are uniquely tailored to the particular needs of the debtor. so that it can successfully emerge from bankruptcy and continue to operate in the future. . As a result, debtors and creditors in Chapter 11 cases benefit from a great deal of creativity in negotiating Chapter 11 plans.
Essentially, Chapter 11 plans are complete changes in terms agreements or loan modifications between the debtor and all of their creditors. As with typical change of terms agreements and loan modifications, release clauses are often included in Chapter 11 plans. The most common types of releases included in these plans are indemnity and exculpation clauses, which provide releases for officers, employees and agents of the debtor for conduct related to the bankruptcy case. Bankruptcy courts generally require these provisions to be narrowly tailored, but they are generally permitted.
However, another type of release is frequently found in Chapter 11 mega-bankruptcy case plans: non-consensual third-party releases. These waivers provide protection to non-debtor third parties for conduct that is generally unrelated to the bankruptcy case. For example, in In re Drexel Burnham Lambert Group, Inc.the directors and officers of the debtors, who did not themselves file for receivership, received a discharge in the confirmed Chapter 11 plan from their liability for certain securities actions. In In re Millennium Lab Holdings II, LLCafter the debtor paid a special pre-bankruptcy dividend to its shareholders using the proceeds of a major credit agreement with lenders, the bankruptcy court upheld the Chapter 11 plan, which released the shareholders from the claims asserted by Millennium’s lenders. Significantly, although some of Millennium’s lenders opposed the confirmation, their claims against nondebtor shareholders were nevertheless released when the plan was confirmed. Often, in plans confirmed with non-consensual third-party releases, the released non-debtors contribute capital to the plan or accept legal harm in exchange for the release, and the plan would not be feasible or operate without these contributions.
The controversy surrounding third-party releases stems from whether a bankruptcy court has the power to confirm a plan that includes a non-debtor release. As a general rule (and by the express language of the Bankruptcy Code), only a debtor is entitled to a bankruptcy discharge. However, bankruptcy courts have found the power under other sections of the code, combined with the silence of the code as to whether a non-debtor can receive a discharge, to give authority to third-party non-consensual discharges.
The issue of a bankruptcy court’s authority to uphold a plan with non-consensual third-party releases recently came to the fore with the 142-page opinion of Judge McMahon of the Southern District of New York setting aside the order of confirmation from the bankruptcy court in In re Purdue Pharma LP. In Purdue Pharma, the debtor filed for bankruptcy in response to litigation regarding its product, OxyContin. Purdue Pharma’s proposed plan included a waiver of liability from existing and future opioid-related lawsuits for the people who founded and operated Purdue Pharma, namely members of the Sackler family. Such a release would have been burdensome not only to current opioid lawsuit plaintiffs, but also future plaintiffs who may not have voted on the plan, as well as state attorneys general who actively opposed the confirmation. The Second Circuit has agreed to expedite the appeal of Judge McMahon’s decision with closing arguments to be heard on April 25, 2022.
In her extensive opinion, Justice McMahon held that the Bankruptcy Code grants express authority under Section 524(g) to bankruptcy courts to uphold plans with non-consensual releases by third parties only in bankruptcy cases. ‘asbestos. The fact that Congress added this particular provision to Section 524 indicated Congress’ intent that the authorization of non-consensual third-party broadcasts in this context was an exception, not the norm permitted by the code.
Judge McMahon went on to identify the circuit’s current division on the matter. Plans with third-party non-consensual releases are upheld in the Second Circuit, but it’s unclear where the bankruptcy courts get their authority to uphold those plans. The Fourth and Eleventh Circuits find their authority under Section 105(a) alone, and the Sixth and Seventh Circuits find authority under Section 105(a) in conjunction with Section 1123(b)(6). Conversely, the Fifth, Ninth, and Tenth Circuits do not allow non-consensual releases from third parties other than in cases of asbestos. In light of Judge McMahon’s opinion, the upcoming decision of the Second Circuit in appealing his opinion, and the circuit’s ongoing split, this issue may finally find its way to the Supreme Court in the near future.
In the meantime, clients will benefit from keeping tabs on mega-bankruptcy records and their proposed plans. Customers’ legal rights may be affected as a result of a confirmed Chapter 11 plan. For example, if a debtor files for bankruptcy to deal with widespread litigation of which the customer may be a co-defendant, the customer may find themselves liable for greater liability if the debtor, its affiliates, companies insurance or any other co-defendants have communicated received. Similarly, if the customer is engaged in litigation against an entity and an affiliate of the entity files for bankruptcy, the entity may also receive a release, ending the customer’s litigation or decreasing the number of defendants the client could recover from. On the other hand, clients can benefit from active participation in Chapter 11 plans where the client can negotiate their own discharge even if they themselves have not filed for bankruptcy.
 To see Wave of corporate bankruptcies turns to dust, defying expectationsBloomberg Law (January 5, 2022), available at https://news.bloomberglaw.com/bankruptcy-law/corporate-bankruptcy-wave-turns-to-dust-defying-expectations.
 Chapter 11 plans are âconfirmedâ when the plan sponsor meets the requirements of Section 1129 of the Bankruptcy Code and after bankruptcy court approval. Once a plan is confirmed and a corresponding confirmation order is entered, the plan becomes the operational agreement between the debtor and its creditors.
 To see In re Purdue Pharma LP635 BR 26, 37 (SDNY 2021) “Almost every proposed Chapter 11 outline I receive includes proposed versions.” (emphasis omitted) (quoting In re Aegean Marine Petroleum Network Inc.599 BR 717, 726 (SDNY 2019))).
 To see In re Drexel Burnham Lambert Group, Inc.130 BR 910, 914 (SDNY 1991).
 To see In re Millennium Lab Holdings II, LLC, et al.575 BR 252 (Bankr. D. Del. 2017).
 This is an example of a not consensual third-party version.
 See 11 USC Â§Â§ 524 and 1141. But see 11 USC Â§ 524(g) providing for the release of non-debtors in asbestos cases.
 See 11. USC Â§Â§ 105(a), 1123(a)(5), 1123(b)(6), and 1129(a)(1).
In re Purdue Pharma LP635 BR 26 (SDNY 2021).
 To see identifier. at 54 years old.
 To see identifier. at 104.
 To see identifier. at 105.
 To see identifier.
 To see identifier. at 104. These circuits have held that, pursuant to Section 524(e) of the Bankruptcy Code, a discharge from bankruptcy applies only to the debtor and “does not affect the liability of any other entity on , or the property of any other entity for such debt.11 USC Â§ 524(e).
See also Patterson v. Mahwah Bergen Retail Group, Inc.2021 WL 2653732 (ED Va. 2021 Jun 28).