There is longstanding controversy concerning the validity of release and exculpation provisions in non-asbestos trust chapter 11 plans that limit the potential exposure of various parties involved in the process of negotiating, implementing and funding the plan. The U.S. Bankruptcy Court for the Eastern District of Washington recently contributed to the extensive body of case law addressing these issues in In re Astria Health, 623 B.R. 793 (Bankr. E.D. Wash. 2021). The court ruled that the Bankruptcy Code did not prohibit and, instead, authorized a chapter 11 plan to include a plan exculpation clause and voluntary nondebtor releases. Its reasoning could signal that courts in the Ninth Circuit may be less hostile to such provisions than in the past.
Releases v. Exculpation Clauses
Releases can provide for the relinquishment of both prepetition and postpetition claims belonging to the debtor or nondebtor third parties (e.g., creditors) against various nondebtors. Exculpation clauses, by contrast, specify the scope of, or the standard of care governing, an exculpated party's liability (e.g., ordinary negligence, gross negligence or willful misconduct) for conduct during the course of the bankruptcy case. See In re Murray Metallurgical Coal Holdings, LLC, 2021 WL 105622, *40 (Bankr. S.D. Ohio Jan. 11, 2021); In re Friedman's, Inc., 356 B.R. 758, 764 (Bankr. S.D. Ga. 2005); see also Blixseth v. Credit Suisse, 961 F.3d 1074, 1084 (9th Cir. 2020) (distinguishing releases and exculpation clauses). Both releases and exculpation clauses have become common features of chapter 11 plans, but nondebtor releases are more controversial.
Validity of Chapter 11 Plan Releases and Exculpation Clauses
It is generally accepted that a chapter 11 plan can release nondebtors from claims of other nondebtor third parties if the release is consensual. See generally Collier on Bankruptcy ¶ 524.05 (16th ed. 2020) (citing cases). Such consensual releases are commonly agreed upon by creditors in connection with their vote to accept the plan. In addition, a plan that establishes a trust under section 524(g) of the Bankruptcy Code to fund payments to asbestos claimants can enjoin litigation against certain third parties (e.g., entities related to the debtor or its insurers) alleged to be liable for the debtor's conduct. See 11 U.S.C. § 524(g)(4).
The circuit courts of appeals are split as to whether a bankruptcy court has the authority to approve chapter 11 plan provisions that, over the objection of creditors or other stakeholders, release specified nondebtors from liability or enjoin dissenting stakeholders from asserting claims against such nondebtors. The minority view, held by the Fifth and Tenth Circuits—and until 2020, arguably the Ninth Circuit (see below)—bans such nonconsensual releases on the basis that they are prohibited by section 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." See Bank of N.Y. Trust Co. v. Official Unsecured Creditors' Comm. (In re Pac. Lumber Co.), 584 F.3d 229 (5th Cir. 2009); Resorts Int'l, Inc. v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394 (9th Cir. 1995); In re W. Real Estate Fund, Inc., 922 F.2d 592 (10th Cir. 1990); see also Blixseth, 961 F.3d at 1083-84 (suggesting, contrary to Lowenschuss and other previous rulings, that section 524(e) does not preclude certain nondebtor plan releases of claims that are not based on the debt discharged by the plan).
On the other hand, the majority of the circuits that have considered the issue have found such releases and injunctions permissible under certain circumstances. See SE Prop. Holdings, LLC v. Seaside Eng'g & Surveying, Inc. (In re Seaside Eng'g & Surveying, Inc.), 780 F.3d 1070 (11th Cir. 2015); In re Airadigm Commc'ns, Inc., 519 F.3d 640 (7th Cir. 2008); In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002); In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285 (2d Cir. 1992); In re A.H. Robins Co., Inc., 880 F.2d 694 (4th Cir. 1989). For authority, these courts generally rely on section 105(a) of the Bankruptcy Code, which authorizes courts to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Bankruptcy Code]." Moreover, as the Seventh Circuit held in Airadigm, the majority view is that section 524(e) does not limit a bankruptcy court's authority to grant such releases. Airadigm, 519 F.3d at 656 ("If Congress meant to include such a limit, it would have used the mandatory terms 'shall' or 'will' rather than the definitional term 'does.' And it would have omitted the prepositional phrase 'on, or … for, such debt,' ensuring that the 'discharge of a debt of the debtor shall not affect the liability of another entity'—whether related to a debt or not.").
Some courts have also relied on section 1123(b)(6) of the Bankruptcy Code, which provides that a chapter 11 plan may "include any other appropriate provision not inconsistent with the applicable provisions of [the Bankruptcy Code]," as authority for involuntary releases. See Airadigm, 519 F.3d at 657; In re Scrub Island Dev. Grp. Ltd., 523 B.R. 862, 875 (Bankr. M.D. Fla. 2015).
The First and D.C. Circuits have suggested that they agree with the "pro-release" majority that finds such provision permissible under certain circumstances. See In re Monarch Life Ins. Co., 65 F.3d 973 (1st Cir. 1995) (a debtor's subsidiary was collaterally estopped by a plan confirmation order from belatedly challenging the jurisdiction of the bankruptcy court to permanently enjoin lawsuits against the debtor's attorneys and other nondebtors not contributing to the debtor's reorganization); In re AOV Indus., 792 F.2d 1140 (D.C. Cir. 1986) (a plan provision releasing liabilities of nondebtors was unfair because the plan did not provide additional compensation to a creditor whose claim against the nondebtor was being released; adequate consideration must be provided to a creditor forced to release claims against nondebtors).
In In re Millennium Lab Holdings II, LLC, 945 F.3d 126 (3d Cir. 2019), the Third Circuit refrained from "broadly sanctioning the permissibility of nonconsensual third-party releases in bankruptcy reorganization plans," but, based on the "specific, exceptional facts" of the case, upheld a lower court decision confirming a chapter 11 plan containing nonconsensual third-party releases, finding that the order confirming the plan did not violate Article III of the U.S. Constitution.
Even courts in the majority camp acknowledge that nonconsensual plan releases should be approved only in rare or usual cases. See Seaside, 780 F.3d at 1078; Nat'l Heritage Found., Inc. v. Highbourne Found., 760 F.3d 344, 347-50 (4th Cir. 2014); Behrmann v. Nat'l Heritage Found., 663 F.3d 704, 712 (4th Cir. 2011); In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141-43 (2d Cir. 2005).
Majority-view courts employ various tests to determine whether such releases are appropriate. Factors generally considered by courts evaluating third-party plan releases or injunctions include whether they are essential to the reorganization, whether the parties being released have made or are making a substantial financial contribution to the reorganization, and whether affected creditors overwhelmingly support the plan. See Dow Corning, 280 F.3d at 658 (listing factors).
Exculpation provisions have generally been approved provided the scope of the provisions is not overbroad. See, e.g., Murray Metallurgical, 2021 WL 105622, at *42 (approving an exculpation provision that extended protection to non-estate fiduciaries for claims that might be asserted against them based on the restructuring and also provided a carve-out for gross negligence, intentional fraud and willful misconduct; extension of the provision to acts and omissions occurring prepetition was not overly broad); In re Aegean Marine Petroleum Network Inc., 599 B.R. 717, 721 (Bankr. S.D.N.Y. 2019) (noting that "an appropriate exculpation provision should say that it bars claims against the exculpated parties based on the negotiation, execution, and implementation of agreements and transactions that were approved by the Court").
In Blixseth, the Ninth Circuit held that nothing in the Bankruptcy Code—including section 524(e)—precludes plan exculpation clauses, and that such clauses may be approved under sections 105(a) and 1123(b)(6). In so ruling, the court wrote:
Section 524(e) establishes that "discharge of a debt of the debtor does not affect the liability of any other entity on … such debt." … In other words, "the discharge in no way affects the liability of any other entity … for the discharged debt."… By its terms, § 524(e) prevents a bankruptcy court from extinguishing claims of creditors against non-debtors over the very debt discharged through the bankruptcy proceedings.
* * *
A bankruptcy discharge thus protects the debtor from efforts to collect the debtor's discharged debt indirectly and outside of the bankruptcy proceedings; it does not, however, absolve a non-debtor's liabilities for that same "such" debt.
Blixseth, 961 F.3d at 1082–83 (citations omitted); accord In re PWS Holding Corp., 228 F.3d 224, 245–46 (3d Cir. 2000). The Ninth Circuit also distinguished its previous rulings regarding section 524(e)'s preclusion of third-party plan releases. All of those cases, the court wrote, "involved 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." Blixseth, 961 F.3d at 1083–84.
Although Blixseth involved an exculpation clause, the Ninth Circuit's reasoning arguably indicates that section 524(e) does not preclude nondebtor chapter 11 plan releases, provided the claims released are not based on the "debt" discharged under the plan, such as claims against co-obligors or guarantors). Thus, with this caveat, the Ninth Circuit arguably joined the majority camp on the validity of certain kinds of nondebtor releases.
Astria Health ("Astria") owned and operated hospitals and health care clinics in Washington. It filed for chapter 11 protection in May 2019 in the Eastern District of Washington. Astria clashed with its main secured creditor and postpetition lender, Lapis Advisers LP ("Lapis"), and Astria's unsecured creditors' committee ("committee") on many aspects of the case during the next year. However, the combatants ultimately reached a global settlement incorporated into a plan of reorganization that all voting classes accepted by significant margins.
The chapter 11 plan included the following release and exculpation provisions as part of the settlement:
Key case participants, including Astria, Lapis, the committee, directors and certain other parties would be exculpated from liability arising from their postpetition conduct in connection with, among other things, the chapter 11 case or formulating, confirming or implementing the plan or any related agreements, except for liability stemming from any act or omission determined to be gross negligence or willful misconduct.
Astria and its estate would release substantially the same entities from all causes of action arising from or related in any way to, among other things, Astria, its assets, management of Astria, the chapter 11 case or any restructuring of claims or interests undertaken prior to the plan's effective date.
Various non-debtors, including creditors that voted to accept the plan and did not affirmatively opt out of the third-party release on their plan ballots, would release substantially the same parties for similar claims.
Therefore, under the plan, an individual creditor would not release any nondebtor unless the creditor voted to accept the plan and did not opt out of the releases on its ballot. The plan did not treat creditors that elected not to opt out differently from those that made the opt-out election.
The Office of the U.S. Trustee ("UST") objected to confirmation of the plan, arguing that the plan's release and exculpation provisions were overbroad and inconsistent with Ninth Circuit precedent.
The Bankruptcy Court's Ruling
The bankruptcy court overruled the UST's objections and confirmed Astria's chapter 11 plan.
Initially, Bankruptcy Judge Whitman L. Holt explained that lawmakers "recognized the futility of any exercise to anticipate the boundless issues requiring treatment in a given chapter 11 plan." For this reason, Congress included section 1123(b)(6) in the Bankruptcy Code, which "invites creativity in drafting a plan" and permits plan proponents to tailor a plan to the particular requirements of any given case, provided the terms of the plan are not inconsistent with other provisions of the Bankruptcy Code.
Because nothing in the Bankruptcy Code prohibits (or even addresses) exculpation provisions in a plan, Judge Holt reasoned, section 1123(b)(6) permits such plan provisions—a conclusion that the Ninth Circuit validated in Blixseth. He rejected the UST's argument that the exculpation clause was improperly broad because it: (i) covered conduct during the entire postpetition period; (ii) included parties with no role in the reorganization or who were not bankruptcy estate fiduciaries; and (iii) excused culpable conduct.
According to Judge Holt, "[a]n exculpation provision may sweep broadly and cover the entire period after the filing of a bankruptcy petition" because establishing a standard of care in the bankruptcy case that shields parties from liability under state law is clearly within a bankruptcy court's power and exclusive jurisdiction. He further explained that all of the parties covered by the clause played a significant role during the chapter 11 case and "engaged in conduct potentially subject to second guessing or hindsight-driven criticism."
Judge Holt noted that, although some courts in other jurisdictions limit exculpation to estate fiduciaries, the Ninth Circuit considered the question and expressly declined to do so in Blixseth. He further reasoned that such a limitation would be inconsistent with section 1125(e), which protects parties, including creditors who are not estate fiduciaries, from liability for good-faith acts related to soliciting votes for a plan. The judge explained that, if the Bankruptcy Code provides such protection for a creditor who is a plan proponent, "then logic and fairness would not be served by excluding the same creditor from participating in plan-based exculpation," particularly if the party actively participated in and contributed to the progress of the bankruptcy case.
Finally, the judge concluded that the exculpation provision was not overly broad because it expressly carved out gross negligence or willful misconduct, consistent with requirements several other courts have "imposed to prevent exculpation clauses from transforming into overbroad releases."
Next, Judge Holt ruled that the plan's release of claims belonging to the estate was appropriate. However, instead of relying on section 1123(b)(6), he invoked section 1123(b)(3)(A), which provides that a plan may provide for "the settlement or adjustment of any claim or interest belonging to the debtor or to the estate." According to Judge Holt, the proposed estate releases satisfied Ninth Circuit precedent governing the approval of settlements, even applying heightened scrutiny to compromises or releases benefiting insiders. Among other things, he wrote, "the plan's global settlement, including the releases of estate claims, is in the paramount interests of creditors as evidenced by key stakeholder support for confirmation and the overwhelming acceptance of the plan by voting classes."
Finally, Judge Holt held that the plan's release of claims of nondebtors against other nondebtors did not violate section 524(e) and was appropriate under section 1123(b)(6).
In Blixseth, he explained, the Ninth Circuit "clarified and corrected [the] misguided conventional wisdom" regarding section 524(e). According to Judge Holt, Blixseth clarified that the limitation in section 524(e) applies only to a "debt" owed by the debtor, thereby precluding a court from "'extinguishing claims of creditors against nondebtors over the very debt discharged through the bankruptcy proceedings'" (quoting Blixseth, 961 F.3d at 1082).
"Based on this crucial distinction," Judge Holt wrote, "section 524(e) prevents a chapter 11 plan from releasing a nondebtor co-obligor of the debtor from liability on a common claim, but is inapplicable to the release of other claims against the nondebtor." Therefore, he ruled, "a release of these other claims is … permissible using the bankruptcy court's residual reorganizational powers under the circumstances." Because the nondebtor releases in Astria's plan did not relate to any liability common to Astria and any released party, Judge Holt concluded that "section 524(e) has no relevance to the court's evaluation."
In addition, Judge Holt explained that the nondebtor releases were "entirely consensual under any framework" because: (i) individual creditors would not release any nondebtors unless the creditors affirmatively voted to accept the plan and separately elected not to opt out; and (ii) any creditor who declined to provide a release would not be penalized.
Based on all of the foregoing, Judge Holt held that the nondebtor releases "are a feature permissibly included in a plan pursuant to Bankruptcy Code section 1123(b)(6)."
In Astria Health, the bankruptcy court concluded that the rationale applied by the Ninth Circuit in Blixseth to plan exculpation clauses applied to the consensual, nondebtor releases included in the debtor's chapter 11 plan. Even so, it would be premature to declare that the Ninth Circuit rests firmly in the majority camp on the validity of nondebtor releases. The Ninth Circuit did not consider the validity of a nondebtor release in a chapter 11 plan in Blixseth, but the court's analysis of the scope of section 524(e) suggests that such releases should not be barred by the Bankruptcy Code.
It bears adding that neither Astria Health nor Blixseth involved involuntary nondebtor releases. Thus, these rulings do not clarify the Ninth Circuit's approach to this controversial issue.