A U.S. District Court judge in the Eastern District of Virginia1, Richmond Division, set aside confirmation of a Chapter 11 plan that contained “extremely broad third-party (non-debtor) releases.” What makes this case so exceptional is the analysis, and also how critical this judge was of the bankruptcy judge who approved these third-party releases.
Opinion of the Eastern District
In an opinion one rarely sees, the district court judge found that the releases “represent the worst of this all-too-common practice, as they have no bounds.”2 He described the releases as “… shocking. [t]hey release the claims of at least hundreds of thousands of potential plaintiffs not involved in the bankruptcy, shielding an incalculable number of individuals associated with Debtors in some form, from every conceivable claim – both federal and state claims – for an unspecified time period stretching back to time immemorial.”3 He further stated that the bankruptcy court “exceeded the constitutional limits of its authority . . . , ignored the mandates of the Fourth Circuit . . . , and offended the most fundamental precepts of due process.”4 One generally does not see this kind of language in an appeal.
The district court judge went further in noting that the bankruptcy courts for the Eastern District of Virginia, Richmond Division, the District of Delaware, the Southern District of New York, and the Southern District of Texas, Houston Division are the venue choices for 91% of the “mega” bankruptcy cases and though not specifically stated, the Court insinuated that the favorable treatment of Debtors in certain venues is contributing to venue shopping in the mega cases. Thus, he ruled that the bankruptcy judge for the Richmond Division must reassign the bankruptcy case outside the Richmond Division.5
The Situation in Patterson v. Mahwah Bergen
Background, the Debtors operated thousands of retail stores, including such well-known stores as Ann Taylor, LOFT, and Lane Bryant. The Debtors had about $1.6 billion in secured debt and about $800 million in unsecured debt.
The bankruptcy plan contained the following Release provision.
[E]ach Released Party is conclusively, absolutely, unconditionally, irrevocably, and forever released and discharged by each and all of the Debtors, the Reorganized Debtors, and their Estates … from any and all Causes of Action, including any derivative claims, asserted or assertable on behalf of any of the Debtors … based on or relating to, or in any manner arising from, in whole or in part, the Debtors (including the management, ownership, or operation thereof), the purchase, sale, or rescission of any Security of the Debtors or the Reorganized Debtors, the subject matter of, or the transactions or events giving rise to, any Claim or Interest that is treated in the Plan, … or any other related agreement, or upon any other act, omission, transaction, agreement, event, or other occurrence (in each case, related to any of the foregoing) taking place on or before the Effective Date.6
The term “Released Parties” was broadly defined to include all of the Debtors, officers, directors, shareholders, lenders, and any party voting in favor of the plan or abstained from voting. Now, even though creditors were given the option of “opting out of the plan” and thus not required to release the “Released Parties,” which is a common technique for approving these broad releases, the district court judge found that that the opt-out provision was not sufficient in terms of whether failing to opt out gave rise to the level of consent required to enforce these types of non-consensual third-party release provisions.7 In other words, consent based on inaction is not permissible.
The district court further pointed out that the Fifth , Ninth, and Tenth Circuit Courts of Appeals prohibit third-party releases under Section 524(e) of the Bankruptcy Code.8 Other circuits, like the Second and Third, permit releases in rare cases. And the Fourth Circuit, which is the governing circuit for the Richmond court, follows the Sixth Circuit. The Sixth Circuit permits third-party releases if: (a) they are essential to the reorganization, (b) were overwhelmingly approved by the affected class, and (c) if the released parties gave a substantial contribution to the estate. Here, the court noted that the released claims were extinguished without any value being given in return and, at the end of the day, they were not needed to confirm the plan.
Now, the non-consensual third-party release provisions discussed above should not be confused with the release of “Exculpated Parties,” which includes each of the debtors and those professional and committee members involved in the plan process as well as employees including management and other persons inextricably involved in the bankruptcy process. Exculpation Releases are permitted, but are subject to review to ensure they are not overly broad. Here, the district court found the exculpation clause was overly broad and thus remanded this issue to narrow the exculpation clause to cover “fiduciaries who have performed necessary and valuable duties.”
Again, one rarely sees an opinion that is critical of a lower court, which in and of itself makes for interesting reading. That said, it is instructional as to issues pertaining to third-party non-consensual releases. The takeaway as to third-party non-consensual releases is that even in those circuits which permit them, generally speaking, there has to be some evidence that the release is necessary for the reorganization and that the released parties substantially contributed to the estate in consideration for the release.
In addition, there appears to be some push back on venue shopping by certain courts. Senators Cruz and Warren, an unlikely pair, have unsuccessfully pushed for legislation limiting venue. And, though it appears that the U.S. District Court for the Eastern District of Virginia is pushing back, it is unknown whether others will. Thus, though venue shopping for favorable Debtor treatment including approval of non-consensual third-party releases will continue, Debtors beware, as sentiment may be growing to ensure more consistent outcomes, especially in these mega cases.
- The Fifth Circuit Court of Appeals governs the Federal courts in Texas.
- Patterson v. Mahwah Bergen Retail Group, Inc., No.21-167 at 5 (E.D. Va. Jan 13, 2022).
- Id. at 5.
- Id. at 5.
- Id. at 4.
- Id. at 9 and 10.
- Id. at 37.
- Section 524(e) states: “Except as provided in (a)(3) of this section, 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 a debt.” Sub-section (a)(3) prohibits creditors from trying to recover from the debtor community property acquired after the commencement of the case.