3rd Circuit Holds Post-Confirmation, Pre-Effective Date “Claims” Dischargeable in Bankruptcy

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On Aug 30, 2021, the 3rd U.S. Circuit Court of Appeals became the first federal appellate court to confirm that claims arising against a debtor following confirmation of a Chapter 11 plan, but prior to the plan’s effective date, are subject to discharge. This ruling serves as a strong reminder for all creditors and counterparties of a bankrupt entity to stay vigilant through the “effective date” of a Chapter 11 plan, and to strictly adhere to any administrative claims bar date established in a bankruptcy case.

This is particularly important in cases where there is a long gap between the “confirmation date” and the “effective date,” which often happens when the debtor needs time to arrange and consummate its exit financing contemplated by the plan or needs regulatory approval for certain aspects of the plan. It is also imperative for counterparties to executory contracts to be vigilant because the debtor usually reserves the right to amend the plan supplement documents indicating assumption or rejection through the “effective date” and any performance breaches during this gap period may give rise to “claims” that need to be administered through the bankruptcy court process.

Ellis v. Westinghouse Electric Co., LLC involved an employee of Westinghouse Electric Company LLC who was terminated from his employment after confirmation of Westinghouse’s Chapter 11 plan, but prior to the effective date of the plan. The plan and the order confirming it called for all claims against the debtor arising prior to the plan’s “effective date” to be discharged and established an administrative claims bar date that fell on the first business day that was 30 days following the effective date of the Chapter 11 plan. The employee believed he was wrongfully terminated but failed to file a claim by the administrative claims bar date. The question before the court was whether the employee’s wrongful termination claim is now discharged under those circumstances.

At issue in the case was the language of section 1141(d)(1) of the Bankruptcy Code, which provides in relevant part, “Except as otherwise provided in this subsection, in the plan, or in the order confirming the plan, the confirmation of a plan—(A) discharges the debtor from any debt that arose before the date of such confirmation ...” 11 U.S.C. § 1141(d)(1) (emphasis added). The U.S. District Court for the Western District of Pennsylvania, in finding for the employee on the issue of discharge, suggested that the most plausible reading of this statute is that the “[e]xcept as otherwise provided” clause modifies the phrase “any debt” but not the phrase “before the date of such confirmation.”

Reversing the District Court, the Court of Appeals read the “[e]xcept as otherwise provided” language to apply to the entirety of section 1141(d)(1), and therefore held that section 1141(d)(1) of the Bankruptcy Code establishes a default rule with respect to discharge but allows for a plan or confirmation order to trump that rule. The Court of Appeals further found that section 503 of the Bankruptcy Code works in tandem with section 1141(d)(1) by authorizing a bankruptcy court to set and enforce administrative claims bar dates by which claims must be filed or else be subject to discharge. 

The factual circumstances in Ellis were fairly straightforward — there was no dispute that the employee’s claim arose on the date he was terminated, and there was sufficient evidence that the employee received notice of the administrative claims bar date and therefore could have filed a claim. But what if the scenario is more nuanced?

Imagine a counterparty to a contract being assumed in connection with a Chapter 11 plan, where the debtor is technically current on monetary obligations as of plan confirmation but, prior to the effective date, begins to take actions that are not in compliance with its obligations under the agreement. What is the counterparty to do if these actions do not cause the counterparty to incur damages prior to the administrative claims bar date, but instead threaten to prejudice the counterparty in the future?

The lesson learned from Ellis is that the bankruptcy process cannot be bypassed, and the counterparty therefore must assert its rights and seek redress in the Bankruptcy Court. Further, it must do so in a timely fashion — even if it is not certain its claim is truly ripe or cannot yet quantify its damages — because the administrative claims bar date will be strictly enforced.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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