Although nondebtor, third-party releases are no longer permissible in chapter 11 plans after Purdue, Bankruptcy Judge John P. Mastando, III, of New York decided that a Subchapter V plan may contain a preliminary injunction barring suits against a nondebtor for the five-year life of the plan.

The corporate debtor was a notable Broadway producer. An individual was the sole owner and president of the corporate debtor.

Claiming it had not received its share of the income from a pair of productions, an investor initiated an arbitration against the corporate debtor and the owner. The arbitrator gave the investor an award of $2.6 million against the debtor and the owner, jointly and severally. The district confirmed the award, which was automatically stayed for 30 days.

On the 29th day, the debtor corporation filed a chapter 11 petition under Subchapter V. The debtor filed an adversary proceeding and persuaded Judge Mastando to enter a preliminary injunction preventing the investor from enforcing the arbitration award against the owner.

The debtor filed a chapter 11 plan that would have given the owner a release from liability on the arbitration award. In return, the plan required the owner to supply $600,000 toward payments under the plan.

In an opinion in November 2023, Judge Mastando found authority to confirm the plan over objections by the investor and the U.S. Trustee. However, he read the Second Circuit’s decision in In re Purdue Pharma LP, 69 F.4th 45 (2d Cir. May 30, 2023), cert. granted sub nom. Harrington v. Purdue Pharma L.P., No. (23A87), 2023 WL 5116031 (U.S. Aug. 10, 2023), as requiring him to issue a report and recommendation to the district court regarding confirmation of the plan. See In re Hal Luftig Co., 655 B.R. 508 (Bankr. S.D.N.Y. Nov. 22, 2023). To read about the bankruptcy court’s rationale for imposing a nonconsensual, nondebtor release, click here.

The Rejected R&R

The U.S. Trustee and the investor objected to the report and recommendation. District Judge Denise Cote sustained their objections in an 11-page opinion in March 2024. See In re Hal Luftig Co., 657 B.R. 704 (S.D.N.Y. March 19, 2024). To read ABI’s report, click here.

Having issued her decision before the Supreme Court decided Purdue, Judge Cote stopped short of precluding nonconsensual, nondebtor releases in all Subchapter V cases. However, she found that the case failed one of the Second Circuit’s Purdue factors, which required that the impacted class must have voted “overwhelmingly.” Purdue, supra, 69 F.4th at 78-79. In the case before her, the affected class had rejected the plan.

Judge Cote remanded for “further proceedings consistent with this Opinion.” She held, “Resolving these issues through a nonconsensual release within the Debtor’s bankruptcy is not permissible.” Hal Luftig, supra, 657 B.R. at 709.

On Remand

On return to bankruptcy court, the debtor dropped the idea of a nondebtor release, naturally. Instead, the revised plan extended the preliminary injunction protecting the owner until the closure of the chapter 11 case, dismissal, or the grant or denial of discharge. The injunction applied only to the investor’s claims against the owner.

Both unsecured classes voted against the plan, including the class with the investor and its claim, which by that time had risen to $2.9 million.

Conceding that the plan satisfied the other confirmation requirements for a nonconsensual plan under Section 1129(a) as incorporated by Section 1191, the investor argued that the plan was not “fair and equitable” and thus failed to comply with Section 1191. More particularly, the investor contended that the plan was “untenable” under the Supreme Court’s decision in Harrington v. Purdue Pharma L.P., 602 U.S. 204 (2024). To read ABI’s report, click here.

Dealing with the investor’s confirmation objection in his February 24 opinion, Judge Mastando cited Second Circuit authority for the notion that a preliminary injunction may cover nondebtors under Sections 362(a) and 105(a). Queenie, Ltd. v. Nygard Int'l., 321 F.3d 282 (2d Cir. 2003). Furthermore, he said that the “Supreme Court did not address the bankruptcy courts’ authority to grant non-consensual third party automatic stay extensions in Purdue Pharma.”

Judge Mastando said it was an issue of first impression as to whether a nondebtor preliminary injunction could be extended for the life of a chapter 11 plan. In part, he found the answer in Section 362(c)(4), where the Code provides that the automatic stay continues in a chapter 11 case until a discharge is granted or denied.

Given that the plan’s stay extension was consistent with Section 362(c)(4), Judge Mastando held that the longer “duration [of the stay] does not render the relief facially impermissible.” Next, he ruled that the extended stay satisfied the four requirements for a preliminary injunction.

Judge Mastando closed his opinion by examining whether the longer stay duration made the plan unfair and inequitable. As to the investor’s idea “that Purdue Pharma prohibits bankruptcy courts from, as part of a plan, temporarily enjoining creditors’ collection efforts against non-debtors,” he said that the argument was “without merit.” He also rejected the idea that the stay extension “‘amounts to a discharge’ over the life of the Third Amended Plan.”

Judge Mastando explained that the investor was not left without recourse. The claim remains valid, he said, and the investor could pursue the claim after the debtor’s discharge. He similarly “reject[ed] the argument that such relief ‘goes against all concepts of fairness and equity.’”

Overruling the objection and awaiting submission of an order confirming the plan, Judge Mastando said it was “inappropriate to impose any requirement that would effectively allow an objecting unsecured creditor to derail an otherwise confirmable plan . . . solely because that creditor holds the largest unsecured claim against the estate.”