Nonconsensual third-party releases in bankruptcy are the hot topic of debate recently. Even though there is no provision of the Bankruptcy Code that expressly authorizes these releases, no Code provision prohibits them, either. Therefore (drumroll), different circuits have different views on third-party releases, and because Congress is not always hot and heavy on the Bankruptcy Code, these splits tend to slowly get worked out in the appellate court process. But in what seems to be a reaction to some high-profile cases, some legislators have made efforts to ban nonconsensual third-party releases.
Circuit Split and Recent High-Profile Cases Involving Third-Party Releases
Not surprisingly, the circuit courts disagree on whether a bankruptcy court has the authority to approve a chapter 11 plan that releases nondebtors from liability without the consent of all parties in interest. The Fifth, Ninth and Tenth Circuits hold the minority view that bans nonconsensual releases as being prohibited by § 524(e) of the Bankruptcy Code, which provides generally that “discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.”
The Second, Fourth, Sixth, Seventh and Eleventh Circuits hold the majority view that such releases and injunctions are permissible under certain circumstances, relying on § 105(a) of the Bankruptcy Code, which authorizes a court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code].” The First and D.C. Circuits have suggested that they agree with the “pro-release” majority, and the Third Circuit declined to decide the issue in In re Continental Airlines, 203 F.3d 203 (3d Cir. 2000).
Nonconsensual third-party releases are extensively used in chapter 11 and are necessary to resolve mass tort cases, like the clergy abuse cases, In re USA Gymnastics [1] and In re Purdue Pharma LP, [2] involving the opioid crisis. Use of these releases has been controversial, especially with respect to the release provided in a confirmed plan to the Sackler family in Purdue Pharma in exchange for what was seen as a nominal payment to the debtors’ alleged opioid abuse victims over a 10-year period. Moreover, the release in this case was to be imposed on consenting and nonconsenting claimants. While the Sackler release saga continues to play out in the appellate process, the media coverage of these releases painted the process as an opportunity for billionaires to obtain lifetime immunity for engaging in deceptive practices that contributed to a national epidemic.
Proposed § 113 to the Bankruptcy Code
The Purdue Pharma plan sparked public debate over the use of chapter 11 to shield nondebtor parties as part of a plan. As a result, representatives in both the U.S. House and Senate introduced identically titled bills — H.R.4777 and S.2497 — the “Nondebtor Release Prohibition Act of 2021,” in an attempt to limit nonconsensual third-party releases.
The bills propose to add a new § 113 to the Bankruptcy Code. In summary, subsection (a) of § 113 would prevent a bankruptcy court from approving any plan provisions that would discharge, release or modify the liability of a nondebtor or the bankruptcy estate. Further, a court may not enjoin the commencement or continuation of any other proceeding to enforce the claim or cause of action, except for a short-term stay.
Subsection (b) of proposed § 113 provides that notwithstanding the prohibition of subsection (a), the prohibition does not prevent a court from authorizing a sale, transfer or other disposition of property free and clear of claims or interests; the court may continue to prevent third parties from exercising control over a right or interest that is property of the estate; and the prohibition is not a bar against any claim for indemnity, reimbursement or contribution that a nondebtor entity has against a third party once it has been released by the debtor or the estate.
Finally, the proposed prohibition does not apply to court approval of a plan providing for the release of a nondebtor in circumstances where clear and conspicuous consent to the release is given by each creditor. However, that consent must be individually given and cannot be inferred to be given by acceptance or failing to accept or reject a proposed plan. Moreover, the treatment of similar creditors cannot be different by reason of such entity’s consent or failure to consent.
Practical Implications of Proposed § 113
At first glance, the bills appear to be narrowly targeted to prohibit use of releases in mass tort cases, and they have already garnered criticism of their impracticalness in these types of cases, where it will be virtually impossible to solicit the consent contemplated from each claimant. However, if enacted, the bills could also prevent the use of such releases in ordinary commercial cases, except those with only a small number of unsecured creditors. As a result, it will be difficult to generate any recovery for smaller creditors. Without the ability to include creditor releases, nondebtor third parties and their insurers will have no incentive to contribute to creditor recovery.
Moreover, the bills likely increase the chances of the liquidation or sale of assets, rather than use of a chapter 11 plan to reorganize because the reorganization process cannot be used to fully implement a collective solution.
Conclusion
As of this writing, the bills are both sitting in committee. S.2497 was referred to the Committee on the Judiciary on July 28, 2021 — the day the bills were introduced — and no further action has been taken. H.R.4777 has surprisingly seen a little more traction. On Nov. 3, 2021, the House Committee on the Judiciary held a hearing and mark-up session, after which an amended version was sent to the House as a whole for consideration after a 23-17 vote in committee.
With these considerations in mind and the mounting concerns regarding the application of the proposed section, it is hard to imagine that the bills will be passed and enacted without significant revisions.