Is a Legislative Crackdown Coming on Third Party Releases in Bankruptcy Plans?

One valuable tool in formulating a successful exit from chapter 11 via a confirmed plan is the use of third-party releases. Such releases can take many forms, but the basic idea is that a non-debtor third party contributes property, usually cash, to the debtor or a trust created under the plan, with the cash to be distributed to unsecured claim holders, in exchange for a release of asserted or potential claims those claim holders may assert against the third party (often where there is co-liability with debtor). Generally, the third party wants a blanket release of all claims held by all creditors, especially where those creditors may have a direct cause of action they could assert, in exchange for the cash or other consideration given by the third party. The scope of who can be bound by such a release by the creditors varies by jurisdiction, with some courts permitting such releases in the plan only where each creditor has affirmatively consented to the release, with other courts approving or allowing confirmation of plans that bind all creditors to the release regardless of whether each creditor affirmatively consented or not.

The Bankruptcy Code is silent on whether such releases are permitted, and because they are not expressly prohibited, such provisions are permissible in a plan so long as the provision is consistent with the Bankruptcy Code. See 11 U.S.C. § 1123(b)(6). The only other provision addressing such releases in the current Code (actually, injunctions against pursuit of claims against third parties) is in section 524(g). However, that section is limited by its terms to an injunction against bringing claims for wrongful death, bodily injury or property damage for asbestos exposure.

These releases have become widely used in chapter 11 and are necessary to resolve mass tort cases, like the clergy abuse cases, USA Gymnastics, the Purdue Pharma bankruptcy involving the opioid crisis, and even the pending Boy Scouts of America case. These releases can be very useful in generating recoveries for unsecured creditors who may otherwise be out of the money in more run-of-the-mill cases, such as cases involving officer and director breach of duty claims.

Use of these releases has proved to be controversial, especially with respect to the Purdue Pharma case. In that case, there has been much criticism leveled against the deal struck by the Sackler family to provide cash to Purdue Pharma’s opioid abuse victims over a ten-year period in exchange for a release to be imposed on consenting and non-consenting claimants.. While Bankruptcy Judge Drain has confirmed the plan, thereby approving the releases, there are likely to be appeals from his ruling.

As a direct result of Purdue Pharma case, Democratic members of the US House and Senate have introduced legislation intending to curb such releases. If passed into law, the legislation will have significant ramifications in many bankruptcy cases going forward. The Senate bill, S. 2497, was introduced by Sens. Warren, Durbin and Blumenthal on July 28, 2021. The Senate bill proposes to add a new section 113 to the Bankruptcy Code. In sum, section 113 would prevent the bankruptcy court from approving any provision of a plan of reorganization or otherwise for discharge, release or modification of the liability of a non-debtor party or the bankruptcy estate, and the court may not enjoin the commencement or continuation of any other proceeding to enforce the claim or cause of action, save for a short-term stay. Section (b) of the bill does provide that notwithstanding the prohibition of section (a), the prohibition does not prevent the court from authorizing a sale, transfer or other disposition of property free and clear of claims or interests, the court may continue to prevent third parties from exercising control over a right or interest that is property of the estate, and the prohibition is not a bar against any claim for indemnity, reimbursement or contribution that a non-debtor entity has against a third party once it has been released by the debtor or the estate. Finally, the proposed prohibition does not apply to court approval of a plan providing for the release of a non-debtor in circumstances where clear and conspicuous consent to the release is given by each creditor. But that consent must be individually given and cannot be inferred to be given by acceptance or failing to accept or reject a proposed plan. Moreover, the treatment of similar creditors cannot be different by reason of such entity’s consent or failure to consent.

At first blush, the Senate bill appears to be narrowly targeted to prohibit use of releases in mass tort cases. Among other things it will be impossible or impractical to solicit a release from each claimant. But, if enacted, the legislation could also prevent use of such releases in ordinary commercial cases, except those with only a handful of unsecured creditors. As a result it will be difficult to generate some recovery to otherwise out of the money creditors. Without the ability to deliver creditor releases, non-debtor third parties and their insurers will have no incentive to contribute to the creditor recovery. Moreover, the legislation likely increases the chances of liquidation or sale of assets under section 363, rather than use of a chapter 11 plan to reorganize, because the reorganization process cannot be used to fully implement a collective solution. Hopefully these considerations will be taken into account and the legislation modified to accommodate these concerns.