The Supreme Court will decide in a few months whether bankruptcy courts have the power to issue nonconsensual, nondebtor releases as part of a chapter 11 plan. See Harrington v. Purdue Pharma LP, 23-124 (Sup. Ct.). Bankruptcy Judge Sage M. Sigler of Atlanta went ahead and confirmed a chapter 11 plan with nondebtor releases.
As Judge Sigler explained in her October 31 opinion, the Subchapter V case before her was less controversial than Purdue. There were no unknown or future creditors whose claims were being released. Every creditor releasing a nondebtor either voted in favor of the plan or was given notice and did not vote. All voting classes approved the plan.
Furthermore, Judge Sigler said that creditors who didn’t vote (and thus didn’t explicitly consent to the releases) might be paid in full as a result of the nondebtors’ contribution to the plan. Unlike mass tort cases such as Purdue, Judge Sigler’s case comes closer to being consensual because no creditors objected to confirmation and none sought to “opt out.”
If the Supreme Court rules this term in Purdue that nondebtor releases are verboten, one wonders whether the Court will issue a blanket prohibition or carve out cases where the releases are consensual, or almost consensual.
Are nondebtor releases permissible if all creditors are known and no one objects to confirmation? Are nondebtor releases permissible if all creditors are known, all classes vote for the plan, but some creditors vote against the releases?
The Broker-Dealer
The Subchapter V debtor was a broker-dealer that allegedly made inappropriate investments for some of its customers, who initiated a slew of arbitrations with the Financial Industry Regulator Authority. In some of the arbitrations, the customers were making claims against the debtor’s principals and other employees. We shall refer to the principals and employees as the nondebtors.
Unable to bear the cost of the arbitrations, the debtor halted operations, liquidated the assets, dropped its registration as a broker-dealer and filed a chapter 11 petition. Evidently, the debtor held no customer property at the time of the chapter 11 filing, and thus was not subject to liquidation under the Securities Investor Protection Act.
From the outset, the debtor intended for the plan to include releases in favor of the nondebtors. After months of mediation, the debtor, the nondebtors and some of the customers reached a settlement that was incorporated into the debtor’s chapter 11 plan. The plan included releases in favor of the nondebtors that would bar claims by customers, whether they voted for the plan or not.
The plan had two classes with customers. The customers who agreed to settle were put in one class by themselves. Customers who did not settle were put in the class for general, unsecured creditors. The nonsettling customers comprised the bulk of the creditors in the unsecured class.
As part of the settlement, the nondebtors committed to making a $1.3 million contribution to the plan, with $1 million earmarked exclusively for customers in the settling class. By taking the settling customers out of the unsecured class, the recovery by nonsettling creditors in the unsecured class rose from as little as 7% to as much as 36%. Customers in the settling class agreed to a pro rata portion of the $1 million.
Once customers’ claims were reduced to the losses on their investments, Judge Sigler recounted testimony at the confirmation hearing to the effect that creditors in the nonsettling class might be paid in full.
There were no votes against the plan. Every voting creditor in the unsecured and settling customer classes voted in favor of the plan. In the settling customer class, all voted for the plan. In the unsecured class for nonsettling customers, only 17 out of 38 eligible creditors voted, but they all voted for the plan.
The U.S. Trustee alone objected to confirmation. The U.S. Trustee primarily contended that the bankruptcy court had no power to issue nondebtor releases and also argued that the plan violated due process.
Nondebtor Releases
Judge Sigler laid out the circuit split on nondebtor releases, listing the Fifth, Ninth and Tenth Circuits as prohibiting them. She cited the Second, Sixth, Seventh and Eleventh Circuits as being among the majority of circuits to hold that Section 524(e) does not bar nondebtor releases. The section says that a “discharge of a debt of the debtor does not affect the liability of any other entity on . . . such debt.”
From the Eleventh Circuit, Judge Sigler cited SE Prop. Holdings, LLC v. Seaside Eng’g & Surveying (In Re Seaside Eng’g & Surveying), 780 F.3d 1070 (11th Cir. 2015), as governing authority. She quoted Seaside for saying that Section 524(e) “says nothing about the authority of the bankruptcy court to release a non-debtor from a creditor’s claims.” Id. at 1078.
From Seaside, Judge Sigler held “that § 524(e) does not preclude it from approving the Releases.” However, the absence of preclusion does not mean that the court has power to issue releases.
Judge Sigler examined law from the Second, Sixth, Seventh and Eleventh Circuits and found “statutory authority under §§ 105(a) and 1123(b)(6) to grant nonconsensual third-party releases such as those included in the Plan.” She quoted the Eleventh Circuit for saying that third-party, nondebtor releases “ought not to be issued lightly[] and should be reserved for those unusual cases in which such an order is necessary for the success of the reorganization, and only in situations in which such an order is fair and equitable under all the facts and circumstances.” Id. at 1078. [We won’t parse Sections 105(a) and 1123(b)(6), because they surely will be the focus of the Supreme Court’s Purdue opinion.]
The Standards for Nondebtor Releases
The Eleventh Circuit, Judge Sigler said, has adopted the Sixth Circuit’s seven-factor test for nondebtor releases contained in Class Five Nev. Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648 (6th Cir. 2002).
Among the more significant Dow Corning conditions, Judge Sigler said that the nondebtors’ contribution of $1.3 million represented a “substantial contribution” to the plan. Also, the contribution was “essential,” because the plan would fall apart without it. In addition, she said that “the impacted classes overwhelmingly voted in support of the Plan.”
Another significant Dow Corning factor requires an opportunity for nonsettling creditors to be paid in full. In that regard, Judge Sigler noted that no creditor had objected to confirmation or sought a right to “opt out.”
“Even though this factor weighs against approving the Releases,” Judge Sigler said that “the failure to meet this factor alone is insufficient to render the releases inappropriate.”
Judge Sigler ended her opinion with findings of fact to support approval of the releases. She found the plan to be “fair and equitable” and said that the Subchapter V Trustee’s “endorsement” was a “relevant factor[] that weigh[s] in favor of confirmation of the Plan and granting the Releases therein.”
Concluding, Judge Siger explained how the plan met the test for nondebtor releases contained in the Second Circuit’s Purdue opinion, Purdue Pharma LP v. City of Grand Prairie (In re Purdue Pharma LP), 69 F.4th (2d Cir. May 30, 2023). To read ABI’s report, click here.
Judge Sigler confirmed the plan.
The Supreme Court will decide in a few months whether bankruptcy courts have the power to issue nonconsensual, nondebtor releases as part of a chapter 11 plan. See Harrington v. Purdue Pharma LP, 23-124 (Sup. Ct.). Bankruptcy Judge Sage M. Sigler of Atlanta went ahead and confirmed a chapter 11 plan with nondebtor releases.
As Judge Sigler explained in her October 31 opinion, the Subchapter V case before her was less controversial than Purdue. There were no unknown or future creditors whose claims were being released. Every creditor releasing a nondebtor either voted in favor of the plan or was given notice and did not vote. All voting classes approved the plan.
Furthermore, Judge Sigler said that creditors who didn’t vote (and thus didn’t explicitly consent to the releases) might be paid in full as a result of the nondebtors’ contribution to the plan. Unlike mass tort cases such as Purdue, Judge Sigler’s case comes closer to being consensual because no creditors objected to confirmation and none sought to “opt out.”