Stay Tuned on the Issue of Broad Plan Release and Injunction Provisions in Bankruptcy
August 15, 2023
In a prior post in this blog we discussed the issue of whether a broad release and injunction provision in a chapter 11 debtor’s plan of reorganization as it relates to third parties is legally valid. We all know that a typical chapter 11 debtor’s plan of reorganization will include a release and injunction provision that tends to be extremely broad. Further, we all understand that, generally speaking, under the Bankruptcy Code the bankruptcy courts have fairly broad powers to deal with claims against debtors. The issue is – what is the limit of that power? Can a chapter 11 plan release and injunction provision release a claim of a third party against another third party? The issue can be significant for sureties because if the release and injunction provision is broad enough it may impact the surety’s subrogation and indemnity rights as well as the ability to pursue salvage against non-debtor entities. See Kimball Hill saga – United States Bankruptcy Court for the Northern District of Illinois, held Fidelity & Deposit Company of Maryland in contempt for an alleged violation of the injunction and release provision (In re Kimball Hill, 565 B.R. 878 (Bankr. N.D. Ill. 2017)), and subsequently imposed civil contempt sanctions of $9.5 million (595 B.R. 84 (Bankr. N.D. Ill. 2019)). F&D appealed and the District Court vacated and remanded (F&D v. TRG Venture II, LLC, 2019 WL 5208853 (N. D. Ill. Oct. 16, 2019)). On remand, the Bankruptcy Court, (In re Kimball Hill, 620 B.R. 894 (Bankr. N. D. Ill. 2020)), reinstated its original contempt findings and reimposed its sanctions award against F&D and F&D again appealed. The District Court affirmed the sanctions award (F&D v. TRG Venture II, LLC, 2022 WL 952737 (N.D. Ill. Mar. 30, 2022)). F&D appealed and the Seventh Circuit affirmed. In re Kimball Hill, Inc., 61 F.4th 529 (7th Cir. 2023).
On August 10, 2023, in the case of Harrington v. Purdue Pharma, L.P., No. 23-124, 2023 WL 5116031 (U.S. Aug. 10, 2023), the Supreme Court granted certiorari from an opinion of the United States Court of Appeals for the Second Circuit specifically to address the question of – “whether the Bankruptcy Code authorizes a court to approve, as part of a plan of reorganization under Chapter 11 of the Bankruptcy Code, a release that extinguishes claims held by nondebtors against nondebtor third parties, without the claimants’ consent.” The Supreme Court has stayed the Second Circuit’s decision until the Supreme Court issues its opinion. The case will be heard on the Supreme Court’s December docket.
This is significant because as we noted in our prior post, there is a split among the Circuits on the issue of whether bankruptcy courts can release third parties from claims held by other third parties in connection with a debtor’s reorganization plan. Some Circuits, such as the Fifth, Ninth, and Tenth Circuits, have held that third-party releases are categorically beyond the power of a bankruptcy court. See Bank of N.Y. Trust Co. v. Official Unsecured Creditors’ Comm. (In re Pac. Lumber Co.), 584 F.3d 229, 251-53 (5th Cir. 2009); Resorts International, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401 (9th Cir. 1995)(cert. den. 517 U.S. 1243 (1996); Landsing Diversified Properties-II v. The First National Bank and Trust Co. of Tulsa (In re Western Real Estate Fund, Inc.), 922 F.2d 592, 601-02 (10th Cir. 1990). Other Circuits, such as the Sixth, Second, Fourth, Seventh and Eleventh Circuits, have held that such plan releases are permissible under certain circumstances, recognizing that such provisions are only proper in unusual, extraordinary or rare circumstances. See Behrmann v. National Heritage Foundation, 663 F.3d 704, 712 (4th Cir. 2011); Airadigm Comm., Inc. v. Federal Comm. Commission (In re Airadigm Communications, Inc.), 519 F.3d 640 (7th Cir. 2008) (approving nondebtor release when release was necessary for the reorganization and appropriately tailored … affected only claims arising out of or in connection with the reorganization itself, not blanket immunity); In re Metromedia Fiber Network, Inc., 416 F.3d 136 (2d Cir. 2005); SE Prop. Holdings, LLC v. Seaside Eng’g 7 Surveying (In re Seaside Eng’g & Surveying, Inc.), 780 F.3d 1070, 1078 (11th Cir. 2015).
In the Second Circuit case at issue, In Re Purdue Pharma L.P., 69 F.4th 45 (2d Cir. 2023), the chapter 11 debtors are a privately-held pharmaceutical company and affiliated entities involved in the manufacture and promotion of proprietary prescription opioid pain relievers that were the subject of mass tort litigation. The debtors sought confirmation of a proposed plan of reorganization which, inter alia, contained broad releases of civil claims against non-debtor family members who owned and/or were directors and officers of debtors. The United States Trustee along with numerous states and municipalities, and others objected. The United States Bankruptcy Court for the Southern District of New York, (In re Purdue Pharma L.P., 633 B.R. 53 (Bankr. S.D.N.Y 2021)), entered an order confirming the plan, as modified to limit “shareholder release” of claims against family members. An appeal was taken from that order as well as two merged and related orders. The District Court, (In re Purdue Pharma, L.P., 635 B.R. 26 (S.D.N.Y. 2021)), vacated the confirmation order, ruling that the Bankruptcy Code does not permit nonconsensual releases of third-party direct claims against non-debtors. Debtors, various creditor and claimant groups, and certain family members appealed.
The Second Circuit held that a bankruptcy court has authority, including under the section of the Bankruptcy Code permitting the inclusion of “any other appropriate provision” in a Chapter 11 plan so long as it is “not inconsistent” with other sections of the Code, to approve a plan that includes nonconsensual third-party releases of direct claims against non-debtors. The Second Circuit stated that bankruptcy courts should look to the seven factors before imposing releases of such claims.
The “seven factors” were first set forth in the Sixth Circuit’s opinion in Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648, 658 (6th Cir. 2002). The Dow Corning court held that the factors are:
- There is an identity of interest between the debtor and the third-party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate;
- The non-debtor has contributed substantial assets to the reorganization;
- The injunction is essential to reorganization, namely the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor;
- The impacted class, or classes, have overwhelmingly voted to accept the plan;
- The plan provides a mechanism to pay for all or substantially all of the class or classes affected by the injunction;
- The plan provides an opportunity for those claimants who choose not to settle to recover in full; and
- The bankruptcy court made a record of specific factual findings that support its conclusions.
Despite the seemingly narrow circumstances under which broad release and injunction provisions are permitted, if permitted at all, it has become common place to find such provisions in reorganization plans. Accordingly, sureties should stay tuned to the Supreme Court’s consideration of this issue.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (email@example.com) or any member of the Surety and Fidelity Practice Group.
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