When it comes to limiting creative uses of chapter 11, the Fifth Circuit is on a roll.

On December 31, the Fifth Circuit barred so-called uptier financings that utilized creative drafting to evade provisions in bond indentures that demand “ratable treatment” whenever a debtor is paying some holders but not others. Excluded Lenders v. Serta Simmons Bedding LLC (In re Serta Simmons Bedding LLC), 125 F.4th 555 (5th Cir. Dec. 31, 2024). To read ABI’s report, click here.

In the reorganization of Highland Capital Management LP, the Fifth Circuit for the second time wrote an opinion on a direct appeal from confirmation. The circuit’s first opinion in August 2022 authorized bankruptcy judges to be gatekeepers with power to stop groundless lawsuits aimed at people or entities involved in the reorganization. NexPoint Advisors LP v. Highland Capital Management LP (In re Highland Capital Management LP), 48 F.4th 419, 424 (5th Cir. Aug. 19, 2022). To read ABI’s report, click here.

In the second confirmation opinion on March 18, the Fifth Circuit said that gatekeeping “is patently beyond the power of an Article I court under § 105” if it protects anyone other than the debtor, independent directors, the creditors’ committee and committee members for conduct within the scope of their duties.

In this writer’s view, gatekeeping no longer has much practical significance in the Fifth Circuit, because those protected by gatekeeping are even better protected by exculpations.

The bigger question is this: After Serta Simmons and the new Highland Capital opinion, is the Fifth Circuit sending a message to bankruptcy judges about reining in exotic features of chapter 11 plans beyond uptier financings and gatekeeping?

In the Fifth Circuit’s new Highland Capital opinion on March 18, only one circuit judge from the first panel was on the panel in the new case. One of the circuit judges from the Serta Simmons panel also was on the new Highland Capital panel.

Exculpations and Gatekeeping

In both Highland Capital opinions, the Fifth Circuit noted the “continued litigiousness” expected after confirmation from the debtor’s former chief executive, who was forced out during the chapter 11 case. To head off continual litigation, the chapter 11 plan as originally confirmed included both exculpations and gatekeeping.

The exculpations, which might be viewed as equivalent to releases, were conferred on the debtors and its successors, the debtor’s general partner, independent directors, the creditors’ committee and its members, the professionals retained by the debtor and the committee, the debtor’s new chief executive, and persons related to the foregoing.

The gatekeeping provisions were broader. No one could sue a “Protected Party” unless the bankruptcy court had first authorized the suit after deciding it made a “colorable claim.”

The Protected Parties were broader than those receiving exculpations and included the debtor’s subsidiaries, the reorganized debtor, the trust created by the plan, the trustees for the trust, and the creditors’ oversight committee.

Entities related to the ousted chief executive took a direct appeal from confirmation of the plan containing exculpations and gatekeeping. In the 2022 opinion, the panel “reverse[d] only insofar as the plan exculpates certain non-debtors in violation of 11 U.S.C. § 524(e), str[uck] those few parties from the plan’s exculpation, and affirm[ed] on all remaining grounds.” Highland Capital, supra, 48 F.4th at 424. Specifically, the Fifth Circuit limited the exculpations to cover only the debtor, a trustee, the creditors’ committee and committee members.

Following a motion for rehearing after the first opinion, Circuit Judge Jennifer Walker Elrod said in the new March 18 opinion that the appeals court granted panel rehearing and modified the original opinion. In the modified opinion, she said,

We granted panel rehearing and made one substantive change to the opinion: deleting the sentence, “The injunction and gatekeeper provisions are, on the other hand, perfectly lawful,” and replacing it with the sentence, “We now turn to the Plan’s injunction and gatekeeper provisions.” Id. at 438.

On remand in bankruptcy court, the debtor proposed amending the exculpations as directed by the Fifth Circuit. Over objection by entities related to the ousted chief executive, the bankruptcy court did not narrow “Protected Parties” to line up with those receiving exculpations. See In re Highland Capital Management LP, 2023 BL 66255 (Bankr. N.D. Tex. Feb. 27, 2023). To read ABI’s report, click here.

For a second time, the Fifth Circuit accepted a direct appeal of the chapter 11 plan as modified.

Limits on Gatekeeping Power

On the second appeal, Judge Elrod stated the question as being “whether the bankruptcy court erred in failing to narrow the definition of ‘Protected Parties’ used in the Gatekeeper Clause coextensively with its narrowing of the definition of ‘Exculpated Parties.’”

Citing Fifth Circuit authority, Judge Elrod said that Section 105(a) does not give a bankruptcy court a “roving commission to do equity.” She added, “[W]e have always recognized and enforced limitations on bankruptcy courts’ power to shield non-debtors from liability.”

Citing the Supreme Court’s Purdue opinion last term and the Fifth Circuit’s opinions in In re Pac. Lumber Co., 584 F.3d 229 (5th Cir. 2009), and In re Zale Corp., 62 F.3d 746 (5th Cir. 1995), Judge Elrod said that the two courts “have definitively held that bankruptcy courts may not approve a confirmation plan that non-consensually releases non-debtors from liability related to a bankruptcy proceeding.”

Taking a victory lap given that Zale and Pacific Lumber anticipated Purdue by decades, Judge Elrod said,

[T]his court had held the same [as Purdue]: . . . any provision that non-consensually releases non-debtors from liability for debts and/or conduct, and any injunction that acts to shield non-debtors from such liability, must be struck from a bankruptcy confirmation plan.

Although the Fifth Circuit “recognized that bankruptcy courts have some power to perform gatekeeping functions,” Judge Elrod said, “they nonetheless do not have unrestricted power to protect non-debtors from liability via a pre-filing injunction.” She added, “[W]e have never extended the Barton doctrine to give bankruptcy courts gatekeeping power over claims against non-debtors.”

The Holding

Drawing from the 2022 opinion in Highland Capital and the revised opinion after rehearing, Judge Elron held:

The clear weight of Supreme Court and Fifth Circuit precedent dictates our holding: that a proper reading of Highland I requires that the definition of “Protected Parties” used in the Plan’s Gatekeeper Clause be narrowed coextensively with the definition of “Exculpated Parties” used in the Exculpation Provision. Any other reading of Highland I would improperly grant the bankruptcy court authority to enforce what is perhaps the broadest gatekeeper injunction ever written into a bankruptcy confirmation plan. Such authority is patently beyond the power of an Article I court under § 105. [Emphasis added.]

To ensure there would be no mistake, Judge Elrod reversed and remanded for the district to:

revise the Plan’s definitions of both “Exculpated Parties” and “Protected Parties” to read simply: “collectively, (i) the Debtor; (ii) the Independent Directors, for conduct within the scope of their duties; (iii) the Committee; and (iv) the members of the Committee in their official capacities, for conduct within the scope of their duties.”

Observations

In the comment box below, we invite readers to offer their views on questions like the following:

1.     Are Serta Simmons and the new Highland Capital opinions remarkable, or are they nothing more than reflections of the Fifth Circuit’s longstanding prohibition of nondebtor releases?

2.     Do Serta Simmons and Highland Capital have significance beyond uptier financings and gatekeeping?

3.     In Serta Simmons and Highland Capital, is the Fifth Circuit sending a message to bankruptcy judges in the Fifth Circuit to be leery about exotic features chapter 11 plans?

4.     Do the two opinions suggest anything about how the Fifth Circuit will rule should opt in vs. opt out come up on appeal?