There are situations where the bankruptcy court extends protections to nondebtor parties, either in the form of a release of claims or a stay of litigation, to facilitate the restructuring of a debtor. Driven in part by the social media coverage of Purdue Pharma[1] and other mass tort bankruptcy cases (e.g., Boy Scouts of America), legislation in the form of the Non-Debtor Release Prohibition Act of 2021 (NRPA)[2] has been introduced in Congress. The NRPA focuses on the protections sometimes extended to parties that did not seek bankruptcy protection but are affiliated with a debtor.[3]
Nondebtor releases relieve nondebtors of claims and liabilities owed to third parties, such as creditors of the debtor. The releases are generally provided in consideration for a substantial contribution of money or other resources that facilitate a debtor’s reorganization. Such releases may either be consensual, with the creditor’s knowledge and consent, or nonconsensual and approved over the creditor’s objection.[4]
There is a split among the courts as to whether nonconsensual nondebtor releases are permissible, with some courts concluding that such releases may be authorized under the equitable powers of the Bankruptcy Code, specifically 11 U.S.C. § 105,[5] while others have found that the Bankruptcy Code prohibits any discharge or release in favor of a nondebtor party.[6]
The NRPA seeks to resolve this circuit split by introducing § 113 to chapter 1 of the Bankruptcy Code. The new section would add significant changes to the Code: Section 113(a) would restrict a bankruptcy court from approving any provision of a plan of reorganization or otherwise that discharges or modifies the liability of a nondebtor entity, but § 113(b)(5) includes a carve-out to subsection (a) wherein the bankruptcy court is reserved the power to approve “disposition of a claim or cause of action” of a nondebtor to the extent each nondebtor affected by the proposed release consents in writing to the release, and the consent or lack thereof does not affect its treatment under the plan. As drafted, the NRPA bill eliminates the ability to offer the incentive of improved creditor returns.
While nondebtor releases are the focus of the NRPA, the legislation includes another provision that could affect bankruptcy proceedings. Specifically, bankruptcy courts have the discretion, under the equitable provisions of Bankruptcy Code § 105, to temporarily enjoin or stay litigation against a nondebtor party. These nondebtor stays are sometimes granted where the continued prosecution of litigation may impair a debtor’s ability to reorganize. Section 113(c) limits the effect of any order staying the continuation of a proceeding against a nondebtor to 90 days except on the affected creditors’ consent.
As proposed, the NRPA would preserve only expressly[7] consensual third-party releases and thus does not impact releases of bankruptcy estate claims. A probable result of the legislation would be to substantially curtail bankruptcy restructurings as a paradigm for resolving mass tort litigation because tort defendants would be less likely to contribute substantial funds in settlement under a fact pattern where they might still be liable to tort plaintiffs outside of bankruptcy.
The NRPA could provide certainty and uniformity to treatment of third-party releases and may result in less forum-shopping since the law would be uniform across jurisdictions. The probability of the NRPA’s passage is uncertain, but should it pass in its current form, it may create meaningful changes in chapter 11 reorganization cases.
[1] The plan in In re Purdue Pharma contained broad nondebtor releases in § 10.7(b), as well as broad definitions of “releasing parties” and “shareholder released parties.” Interestingly, from 1995-2007, Purdue only “upstreamed” enough money to the Sacklers to allow them to pay taxes and retain a relatively modest dividend for themselves. According to information provided by the debtor, the Sacklers used 90 percent of Purdue’s upstreamed earnings to pay taxes, while the family retained 10 percent of those distributions. From 2008-18, this changed: During that period, only 44 percent of the money that Purdue upstreamed to the Sacklers was needed to pay taxes on Purdue’s earnings. Fifty-six percent of those distributions were retained by the family. This change resulted in Purdue’s having far less in its treasury when it declared bankruptcy than would have been the case had the family adhered to the prior distribution pattern. In re Purdue Pharma L.P. 7:19-bk-23649 (Sept. 15, 2019). On Dec. 16, 2021, U.S. District Court Judge Colleen McMahon of the Southern District of New York overturned the confirmation of Purdue Pharma’s chapter 11 plan of reorganization. Judge McMahon concluded in her 142-page opinion that “the Bankruptcy Code does not authorize such non-consensual non-debtor releases.” In re Purdue Pharma L.P. 7:21-cv-07532-CM (12/10/2021).
[2] Recently, the House Judiciary Committee voted 23-17 to recommend that the NRPA (H.R. 4777) be considered by the full House of Representatives. A full House vote has not yet been scheduled. The analogous Senate version of the NRPA (S. 2497) is still being considered by the Senate Judiciary Committee.
[3] H.R. 2096, introduced on March 19, 2021, and S. 2472, introduced on July 26, 2021, and referred to as the “Stop Shielding Assets from Corporate Known Liability by Eliminating Non-Debtor Releases” or the “SACKLER Act,” are like the NRPA but narrower in scope in that they prohibit bankruptcy courts from releasing claims brought by states, tribes, municipalities or the federal government against nondebtors. The bankruptcy court may issue a stay not exceeding 90 days regarding such a claim by those parties.
[4] Nonconsensual releases require a showing of one or more factors, such as whether (1) the enjoined claims would indirectly impact the debtor’s reorganization by way of indemnity or contribution; (2) the enjoined claims were channeled to a settlement fund rather than extinguished; (3) the plan otherwise provided for the full payment of the enjoined claims; and/or (4) the estate received substantial consideration from the party to be released. In re Metromedia Fiber Network Inc., 416 F.3d 136, 142 (2d Cir. 2005).
[5] In In re Metromedia Fiber Network Inc., 416 F.3d 136 (2d Cir. 2005), the Second Circuit clarified the standard under which it is appropriate to grant nondebtor releases. The court identified two factors that are necessary for court approval of a nondebtor release: (1) The release must itself be important to the plan; and (2) the scope of the release must be necessary to the plan. Id. at 143. Thus, a nondebtor release is not justifiable simply on the ground that it was offered in exchange for a monetary contribution. Id. In Munford v. Munford Inc. (In re Munford Inc.), 97 F.3d 449 (11th Cir. 1996), the Eleventh Circuit laid out three justifications for such a bar order: (1) Public policy strongly favors pretrial settlement of all types of litigation; (2) litigation costs are particularly burdensome on a bankruptcy estate given the financial instability of the estate; and (3) bar orders play an integral role in facilitating settlement. Id. In Class Five Nevada Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648 (6th Cir. 2002), the Sixth Circuit provided that third-party releases are where (1) there is an identity of interests between the debtor and the third party, usually an indemnity relationship, such that a suit against the nondebtor is, in essence, a suit against the debtor or will deplete the assets of the estate; (2) the nondebtor has contributed substantial assets to the reorganization; (3) the injunction is essential to reorganization — namely, the reorganization hinges on the debtor being free from indirect suits against parties that would have indemnity or contribution claims against the debtor; (4) the impacted class or classes have overwhelmingly voted to accept the plan; (5) the plan provides a mechanism to pay for all or substantially all of the class or classes affected by the injunction; (6) the plan provides an opportunity for those claimants who choose not to settle to recover in full; and (7) the bankruptcy court made a record of specific factual finding that support its conclusions.
[6] The Tenth Circuit rejected a nondebtor release in Landsing Diversified Pro. v. First National Bk. and Trust Co. of Tulsa (In re Western Real Estate Fund), 922 F.2d 592 (10th Cir. 1990). In American Hardwoods Inc. v. Deutsche Credit Corp., 885 F.2d 621 (9th Cir. 1989), the Ninth Circuit affirmed the bankruptcy court’s denial of a permanent injunction against a creditor for the benefit of third-party nondebtor principals of the debtor for debts they personally guaranteed. The court held that the bankruptcy court has no power to discharge the liabilities of a debtor’s guarantor.
[7] The legislation would bar third-party releases that are consensual only because of “opt-out” provisions.