November 17, 2022

Third-Party Releases in Chapter 11 Bankruptcy

Historically, a business (known as a debtor) filed for chapter 11 to restructure its debts owed to creditors through a plan of reorganization. The debtor would receive a discharge of any debts not required to be repaid under the plan. Only the debtor would receive a discharge (or release) of certain debts, after creditors received notice and had a meaningful opportunity to object to the plan and participate in the process.

In recent years, plans have provided for the release of various non-debtor third parties, including lenders, officers, professionals and other individuals and entities. The releases were approved by the bankruptcy court and imposed on parties who never consented to the releases.  These third-party releases have been a condition of approval of a debtor’s plan of reorganization and have been deemed ‘necessary’ to implement a plan and permit a debtor to emerge from chapter 11.

Over the past several years, third-party releases in plans have become a more common tool used by businesses in chapter 11. Recently, however, non-consensual third-party releases have come under more scrutiny, especially in bankruptcy cases filed by debtors to stay litigation filed by tort claimants.

The Boy Scouts of America (BSA) filed for chapter 11 due to numerous lawsuits filed by victims of alleged sexual abuse. The BSA filed a plan seeking approval of releases of various non-debtor parties who had not filed for bankruptcy, including local scouting councils, chartered organizations (like churches or religious organizations) who sponsor scout troops and insurance companies. Some of the contemplated release parties agreed to contribute significant funds in a trust to satisfy claims of victims. Many of these release parties were also subject to actual or potential lawsuits by the victims.

In its opinion supporting approval of the plan, the court held that non-consensual third-party releases were both fair and necessary to the plan where holders of abuse related claims were receiving payment toward 100% of their claims and the releases were necessary to the BSA reorganization. Insurance claimants and other third parties made their financial contributions contingent upon receiving such releases. The BSA plan is awaiting further rulings by the U.S. District Court before it receives final approval.[1] 

In the Purdue Pharma case[2], the Bankruptcy Court for the Southern District of New York confirmed a plan that contained releases of insiders (including the Sackler family, owners of Purdue Pharma) who paid more than $4 billion into a settlement trust for claimants relating to Purdue’s marketing and sale of the opioid, OxyContin. On appeal, the U.S. District Court vacated the order confirming the plan and ruled that the releases were improper. The U.S. District Court found that there was no express, implied or residual authority in the Bankruptcy Court to approve releases. The dispute was ultimately resolved at mediation.

Legislation has been introduced in Congress to prevent third parties from using the bankruptcy process to obtain releases from non-debtors without their express consent. Even if the legislation does not pass, courts will continue to view third-party releases with increased scrutiny.

Debtors seeking third-party releases should be cognizant of the following:

  • Releases should be narrowly drafted to achieve plan approval.
  • Released parties should be limited to those individuals/entities who are critical to the reorganization (e.g., an entity contributing capital to the company to fund operations and pay creditors).
  • Debtors should understand the opinions of prospective judges in their circuit and district on third-party releases while contemplating the filing of a bankruptcy case.

[1] In re Boy Scouts of America, 2022 WL 3030138 (Bankr. D. Del. July 29, 2022)

[2] In re Purdue Pharma L.P., 633 B.R. 53 (Bankr. S.D.N.Y. 2021)

About the author:

Jason W. Bank is the chair of the firm’s Bankruptcy and Restructuring Practice Group. He focuses his practice in the areas of commercial bankruptcy, out-of-court workouts, corporate restructuring and creditors’ rights. Jason has successfully guided numerous businesses through out-of-court restructurings and Chapter 11 reorganizations. He has negotiated resolutions of complex financial issues and debtor-creditor disputes and achieved consensual restructurings while avoiding bankruptcy or litigation.

Other posts to consider:

Attorneys

Jason W. Bank