Releases, injunctions and exculpations make big news these days following Harrington v. Purdue Pharma L.P., 219 L. Ed. 2d 721 (Sup. Ct. June 27, 2024), where the Supreme Court categorically barred nondebtor, nonconsensual releases in chapter 11 plans.

On narrow grounds, Bankruptcy Judge Michael E. Wiles of New York excised releases in a chapter 11 plan that would have been given to corporate officers who qualify as “insiders.” He based his decision on Section 503(c), not on an expanded reading of Purdue. Releases are sometimes called exculpations.

Indeed, bankruptcy courts are reading Purdue narrowly. In the last week, we reported decisions where bankruptcy judges in Delaware and Virginia both decided that Purdue did not preclude the issuance of preliminary injunctions to stop lawsuits against corporate officers who are no longer eligible for protection with permanent injunctions as part of chapter 11 plans. To read the stories, click here and here.

In the case before Judge Wiles, the insiders were promised releases months before the plan was filed because the insiders had threatened to resign if they were not released from claims the estate might have against them.

The Threats to Quit

The debtor was a Dutch company with operations outside the U.S. The Netherlands has not adopted the equivalent of U.S. chapter 15. The company filed a chapter 11 petition in the U.S. in December and proceeded to sell the assets. The plan was a liquidating plan.

As Judge Wiles said in his July 19 opinion, the debtor had promised “several months ago” to give releases to its officers and directors “in response to threats by a number of officers and directors to terminate their employment and as inducements to continue their employment.”

After detailed analysis of the evidence and the arguments by the debtor and others, Judge Wiles found as a fact “that the sole consideration for the proposed releases in favor of the insiders was their agreement to remain in the Debtors’ employment, and that the other parties had agreed to seek such releases in order to induce such continued employment.” He concluded that the debtor had not conducted an investigation sufficient to establish that claims against the releasees would have no merit.

The releases were limited, to a degree. The releases would have meant that neither the debtor nor its successors could sue officers or directors based on claims that the debtor might have against them. The releases would have likewise barred “derivative” claims.

The releases would have allowed suits against the officers and directors to the extent of available insurance. The releases would only pertain to claims in excess of insurance. Naturally, the releases would not bar claims for “fraud, gross negligence or willful misconduct.” The releases would not preclude claims by third parties, except to the extent that the claims would be derivative.

Not all creditor classes had accepted the plan, so Judge Wiles was confronted with cramming down the plan under Section 1129(b). Aside from the U.S. Trustee, the creditors’ committee and everyone else was on board with the releases. The releases were the topic of briefing conversation at several hearings. Judge Wiles sustained the U.S. Trustee’s objection to the releases.

Section 503(c)

To Judge Wiles’ way of thinking, the propriety of the leases was governed by Section 503(c). The subsection bars the allowance or payment of an administrative expense claim that would be

(1) a transfer made to . . . an insider of the debtor for the purpose of inducing such person to remain with the debtor’s business, absent a finding by the court based on evidence in the record that —

(A) the transfer . . . is essential to retention of the person because the individual has a bona fide job offer from another business at the same or greater rate of compensation;

(B) the services provided by the person are essential to the survival of the business; and

(C) either—

(i) the amount of the transfer made to . . . the person is not greater than an amount equal to 10 times the amount of the mean transfer or obligation of a similar kind given to nonmanagement employees for any purpose during the calendar year in which the transfer is made or the obligation is incurred; or

(ii) if no such similar transfers were made to, or obligations were incurred for the benefit of, such nonmanagement employees during such calendar year, the amount of the transfer or obligation is not greater than an amount equal to 25 percent of the amount of any similar transfer or obligation made to or incurred for the benefit of such insider for any purpose during the calendar year before the year in which such transfer is made or obligation is incurred;…

The Releases Were ‘Transfers’ Under Section 503(c)

On the merits, Judge Wiles decided that some of the releasees were not “insiders” as defined in Section 101(31). He permitted the release as to the non-insiders and proceeded to decide whether releases could be given to insiders.

As to the insiders, Judge Wiles described the debtor as contending “that section 503(c) only applies to the allowance and payment of administrative expenses and that the grant of a release is not the payment of an administrative expense.”

Judge Wiles rejected the argument, deciding that the subsection “applies to post-petition ‘transfers’ and ‘obligations’ generally, not just to cash payments.” Citing Section 101(54) and its definition of “transfer,” he held that the “grant of a release is a disposition of a party’s interest in property (legal claims) and therefore is a ‘transfer.’”

The debtor next argued that “section 1123(b)(3) and Rule 9019 generally permit the settlement of claims that belong to Debtors.” Judges Wiles did not buy the argument, finding “no suggestion in sections 1123(b)(3) or Rule 9019 that a Debtor’s general authority to seek the approval of a compromise can be used to circumvent the far more specific provisions of section 503(c).”

Judge Wiles sustained the objection to the releases running in favor of the insiders, saying he had “sympathy for the insiders, who did good work and who did in many cases face[] hardships and personal risks. But I am constrained by the terms of the Bankruptcy Code and I am not free to ignore its relevant provisions.”

Observations

Prof. Anthony J. Casey agreed with Judge Wiles. He told ABI:

This seems exactly right to me. It is a very narrow holding. The judge is applying Section 503(c) because Debtors conceded that they didn’t get anything other than continued services in exchange. He is right that releases count under Section 503(c) if they are given to induce continued service, as they were here.

Furthermore, the Debtors concede that they wouldn’t be able to meet the requirements of 503(c). To me that makes it straightforward.

Judge Wiles clearly leaves open the possibility of releases based on other justifications.

Prof. Casey is the Donald M. Ephraim Professor of Law and Economics at the University of Chicago Law School.

Prof. Bruce A. Markell had problems with the statute, not with the decision. The professor told ABI:

I don’t think Judge Wiles went too far; it is the statute that’s broken, not his reading of it.  

If you accept the fact that a release is a transfer of a claim, then § 503(c) applies. But if it applies, then you can never give releases, since I don’t know how an insider receiving a release can obtain “a bona fide job offer from another business at the same or greater rate of compensation.” Congress apparently did not appreciate the scope of “transfer.”

As to releases of insiders, normally referred to as exculpations, I’m on record that it is usually a bad thing to the extent that lawyers are being released (not the case here, I understand). I wrote on the topic in the June 2022 edition of Bankruptcy Law Letter in a piece entitled, “Examining Exculpations’ Ethics: Rethinking the Ethical Duties of a Debtor’s Attorney in Reorganization.”

I am now working on a broader piece (to be published in Emory’s Bankruptcy Developments Journal), which will explain that they are generally a bad thing, at least for tort liability.

Prof. Markell is the Professor of Bankruptcy Law and Practice at the Northwestern University Pritzker School of Law.