Ninth Circuit Permits Exculpation in Chapter 11 Plan, Distinguishing Earlier Precedent Barring Nonconsensual Nondebtor Releases

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The Ninth Circuit, in Blixseth v. Credit Suisse, 961 F.3d 1074, 1078 (9th Cir. 2020), issued a significant decision on the issue of whether nonconsensual third-party releases are ever permitted in Chapter 11 plans. Distinguishing its prior decisions on the topic, the Ninth Circuit permitted a nonconsensual third-party release that was limited to the exculpation of participants in the reorganization from claims based on actions taken during the case.

Statutory Background

As background, Section 524(e) of the Bankruptcy Code provides 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,” subject to exceptions not relevant here.

Case Background

Yellowstone Club, an exclusive ski and golf community in Big Sky, MT, filed for bankruptcy in 2008, resulting in highly contentious proceedings. The bankruptcy court approved the Chapter 11 plan in 2009, but Timothy Blixseth, Yellowstone Club’s founder, appealed. The district court reversed the confirmation because of the breadth of the plan’s exculpation clause. The exculpation clause contained a release for a creditor for claims that could have arisen during the Chapter 11 process. On remand, the bankruptcy court conducted two days of hearings and once again confirmed the plan in 2011, not modifying the plan but construing the exculpation clause as “narrow in both scope and time.” Blixseth appealed again, ultimately reaching the Ninth Circuit.

Ninth Circuit Opinion

As relevant here, the Ninth Circuit was asked to decide whether the bankruptcy court could release a creditor from liability for potential claims against it that could have arisen during the Chapter 11 process, by approving the exculpation clause contained in the plan of reorganization.

Blixseth argued that the exculpation clause violated Section 524(e) of the Bankruptcy Code, which provides 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.” Blixseth directed the court toward the broad language used in three prior Ninth Circuit decisions, which interpreted Section 524(e) as barring nondebtor releases.

The Ninth Circuit found that the prior cases cited by Blixseth dealt with “sweeping nondebtor releases from creditors’ claims on the debts discharged in the bankruptcy, not releases of participants in the plan development and approval process for actions taken during those processes.” The Ninth Circuit clarified that Section 524(e) conforms to the basic fact that a discharge in bankruptcy does not extinguish debt — it just releases the debtor from personal liability. The court explained that the debt itself still exists and may be collected from any other entity that may still be liable. The Ninth Circuit distinguished other claims, such as those relevant here, that specifically relate to the bankruptcy proceedings, and agreed with the Third Circuit that “partial exculpation for acts committed during the process of developing and confirming a Chapter 11 plan” does not “affect the liability of another entity on a debt of the debtors within the meaning of Section 524(e).”

The Ninth Circuit quoted the bankruptcy court’s finding that the release provided to the Yellowstone Club creditor was “narrow in both scope and time,” noting it was “limited to releasing the part[y] from liability for any act or omission in connection with, relating to or arising out of the Chapter 11 cases or bankruptcy filing.” The Ninth Circuit emphasized that the release did “not affect obligations relating to the claims filed by creditors and discharged through the bankruptcy proceedings, as it exclusively exculpates actions that occurred during the bankruptcy proceeding, not before,” for only those that were closely involved in drafting the plan. Additionally, the Ninth Circuit noted that the release applied only to negligence claims, not to claims for willful misconduct or gross negligence.

As the exculpation clause did not affect claims for discharged debt and was narrowly tailored, the Ninth Circuit found the nonconsensual nondebtor release was permissible for the Yellowstone Club creditor.

Takeaways

The Ninth Circuit joins other courts that have permitted exculpations in Chapter 11 plans, including the Second, Third, Fourth, Sixth and Eleventh Circuits. The Ninth Circuit’s opinion interprets Section 524(e) to mean that the discharge of debt in no way affects liability of any other entity for such discharged debt. Accordingly, the Ninth Circuit held that Section 524(e) only “prevents a bankruptcy court from extinguishing claims of creditors against non-debtors over the very debt discharged through the bankruptcy proceedings.” As the Ninth Circuit emphasized the narrowness of the exculpation clause in question, it remains to be seen whether broader exculpations (i.e., not relating to the discharged debt) will be permitted.

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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