A Potential Alternative to Approving Consensual Third-Party Releases: § 1141(a) of the Bankruptcy Code

The approval of third-party releases in connection with the confirmation of a debtor’s chapter 11 plan before a bankruptcy court has become increasingly controversial and the subject of several recent district court decisions. [1] At the insistence of nondebtor parties, third-party releases are often included in a plan of reorganization or liquidation to shield such parties from claims — related to the debtor, its business and/or the restructuring — brought by the debtor’s creditors, equity securityholders and other stakeholders.

Historically, courts approve third-party releases in instances where the release is consensual. In considering these releases, courts apply traditional contractual principles to determine whether a creditor or interest-holder in fact “consented” to the third-party release. Over the last several years, courts even within the same district have had differing views as to what showing is required for a release to be deemed consensual. For example, several courts require creditors to affirmatively opt in to the third-party release, [2] while others conclude that opt-out provisions are satisfactory to manifest a creditor’s consent to be bound by the release. [3] As a result, there is a growing lack of clarity as to what is required to obtain the creditor or interest-holder’s consent.

An alternative framework relied upon by courts when analyzing the approval of consensual third-party releases appears to be emerging under § 1141(a) of the Bankruptcy Code. [4] On Oct. 27, 2021, the Delaware Bankruptcy Court in In re AH Liquidation Inc. approved a third-party release over objections filed by the U.S. Trustee and another creditor. [5] In approving the third-party release containing an opt-out mechanism, Judge Goldblatt concluded that the applicable standard for approval is included in § 1141(a) of the Bankruptcy Code rather than the contractual standard of consent. [6]

In making such a determination, Judge Goldblatt relied on recent decisions by Judge Silverstein and Judge Drain applying the same standard. These courts focus on the binding nature of a plan in approving the release provisions, rather than relying on whether the release is itself consensual. [7]

Specifically, in connection with the approval of the disclosure statement in In re Tops Holdings II Corp., Judge Drain stated that finding that a third-party release is consensual requires a determination that the affected party merely had an opportunity to object to the release. [8] In addition, § 1141(a) binds all parties to the terms of a confirmed plan irrespective of whether they individually consent. Section 1141(a) provides, in pertinent part: “[T]he provisions of a confirmed plan bind the debtor, any entity issuing securities under the plan, any entity acquiring property under the plan, and any creditor, equity security holder, or general partner in the debtor, whether or not the claim or interest of such creditor, equity security holder, or general partner is impaired under the plan and whether or not such creditor, equity security holder, or general partner has accepted the plan.” [9]

As such, § 1141(a), among other things, imposes on all parties in interest a duty to speak and a duty to object to relief being sought by a debtor in a bankruptcy case, and therefore elevates a chapter 11 plan to a “supercontract” status, binding parties that have not executed a chapter 11 plan, including releasing parties that did not check a box to opt in or opt out of a third-party release. [10]

Judge Drain observed that Congress’s intent underlying § 1141(a) is solely to ensure that parties receive disclosure and notice of a chapter 11 plan, but after that, it is entirely up to the impacted parties to affirmatively object if they disagree with its terms, including the third-party releases. Thus, confirmation of a chapter 11 plan binds all parties that receive proper notice to all provisions of a plan, including third-party releases. This includes parties who are not scheduled, have not filed a claim, are not receiving a distribution, and are not retaining any interest under the plan.

The In re Melinta Therapeutics Inc. court agreed with the Tops analysis and reliance on § 1141(a), finding that where creditors fail to speak up and/or object to a chapter 11 plan’s third-party release provisions (just like any other plan provision), they are bound by the terms of the plan. [11]

Whether the § 1141(a) argument will withstand scrutiny from one or more appellate courts remains to be seen. Further, the recent Purdue and Ascena district court decisions have called into question a bankruptcy court’s statutory authority and/or jurisdiction to approve nonconsensual third-party releases without considering § 1141. However, until the Supreme Court rules, or Congress takes some definitive action on this issue, third-party releases may continue to be permissible under this relatively new avenue: § 1141(a) of the Bankruptcy Code. Because of this, creditors and interest-holders must continue to be vigilant and carefully read chapter 11 plans to ensure that their rights and interests are not being impacted by third-party releases contained in a plan.