The topic of third-party releases is all the rage in the restructuring world, and has been since Judge Colleen McMahon’s December 2021 decision rejecting the nonconsensual third-party releases in Purdue. While third-party releases are regularly challenged, they had been routinely granted in complex chapter 11 cases. Purdue, however, has opened the floodgates of discussion and doubt as to their propriety. New data points and fresh views have been coming fast and furious from courts, commentators, and even politicians, and likely will continue at least in the near term. Keeping up is difficult, so we decided to take a moment to pull together a list of post-Purdue third-party release decisions (or upcoming decisions) so everyone can keep score at home.
Ascena Retail, District Court for the Eastern District of Virginia (Fourth Circuit)1
Releases not permitted because bankruptcy court failed to engage in meaningful fact finding and lacked constitutional authority over non-core claims.
The first decision after Purdue came in the Ascena Retail Group, Inc. cases. There, the Virginia District Court vacated the confirmation order entered by the U.S. Bankruptcy Court for the Eastern District of Virginia, Richmond Division and voided the third-party releases contained therein—which protected officers who had stopped working for the company prior to the petition date and were not contributing value under the plan. Although the District Court stopped short of finding that nonconsensual third-party releases are never permitted, it stressed that such releases should be granted only cautiously and infrequently, and after meaningful fact finding. The District Court noted that the bankruptcy court failed to analyze a number of factors, including whether released parties made a substantial contribution to the plan, whether the releases were essential to the reorganization, and whether affected classes would receive substantial consideration under the plan. The District Court also criticized the routine approval of third-party releases in the Richmond Division, going so far as to order that the remanded case be reassigned to a bankruptcy judge in another division. The District Court also held that the direct claims of creditors against third parties were “non-core claims,” such that a party’s failure to opt out of the release did not constitute their consent to bankruptcy court jurisdiction—in other words, such claims must ultimately be adjudicated by courts of general jurisdiction (e.g. federal district courts).
Mallinckrodt, Bankruptcy Court for the District of Delaware (Third Circuit)2
Releases permitted because they were necessary to reorganization and fair, and case was extraordinary.
Judge Dorsey of the District of Delaware issued his confirmation order in Mallinckrodt next on February 3, 2022, which confirmed a plan that included third-party releases. While acknowledging the Purdue and Ascena Retail decisions, Judge Dorsey found that such releases were proper under existing Third Circuit precedent.3 Judge Dorsey concluded that he had the jurisdictional authority to approve releases that were integral to the plan’s success. As to the merits, he found that the releases were both necessary to the debtors’ reorganization and fair. Judge Dorsey noted that the releases were necessary because the third parties being released were involved with the debtors’ business to such a degree that a suit against them would implicate and ultimately be a drain on the debtors. He found that the releases were fair because they were part of multiple settlements negotiated at arm’s length between sophisticated parties representing diverse interests, and substantial consideration was provided in the form of a trust to which opioid claimants could turn to for potential compensation. Notably, Judge Dorsey highlighted the “extraordinary nature” of the case, including the massive opioid liability faced by the debtors and overwhelming support of the releases by the creditor body. The alternative, according to Judge Dorsey, would be “protracted and expensive litigation, which would not help the victims of the opioid crisis but would instead generate significant litigation costs that would drastically reduce the funds available to opioid creditors.”4
Kettner Investments, Bankruptcy Court for the District of Delaware (Third Circuit)5
Releases not permitted because not necessary for plan to succeed.
Judge Karen Owens of the U.S. Bankruptcy Court for the District of Delaware applied the same Third Circuit precedent as Judge Dorsey, but in doing so rejected a plan that included nonconsensual third-party releases on February 15, 2022. Judge Owens found that there was no evidence the releases were necessary or that there was any substantial contribution by the released parties. Notably, Judge Owens found that the settlement acting as the backbone of the plan was not contingent on the releases and, under the plan, creditors would not receive any consideration for the releases. The juxtaposition of this case and the “extraordinary” Mallinckrodt cases shows that judges, even in Circuits where releases are permissible, may find them unacceptable based on the facts (and the evidence presented) in the case before them.
Sequential Brands, Bankruptcy Court for the District of Delaware (Third Circuit)6
Releases permitted because they were narrow in scope.
On February 22, 2022, Judge Dorsey again approved a plan that included what the U.S. Trustee dubbed nonconsensual third-party releases, this time in the bankruptcy cases of fashion brand retailer Sequential Brands Group Inc. The U.S. Trustee had objected to the releases contained in the plan, which the Trustee argued were unjustified and unsupportable, in part, because they applied to past professionals, officers, and directors not involved in the chapter 11 cases. In overruling the U.S. Trustee’s objection, Judge Dorsey found that the relevant releases contained within the plan were narrow in scope and that parties giving releases were also receiving a release in exchange. He stressed that it was significant to his decision that the parties not entitled to vote were not bound by the releases—thus calling into question whether such releases were fairly characterized as “nonconsensual.”
Boy Scouts of America, Bankruptcy Court for the District of Delaware (Third Circuit)7
Releases questioned by U.S. Trustee.
The releases in the Boy Scouts of America cases have also come under fire. For those that have been following, this was going to be a hotly contested confirmation in any circumstance, releases or not. Still, on February 7, 2022, the U.S. Trustee has objected to the debtors’ plan and is arguing that the releases contained therein are not authorized under the Bankruptcy Code and violate the rights of certain claimants under the Due Process Clause.8 Specifically, in language similar to Judge McMahon’s Purdue decision, the U.S. Trustee argues that a bankruptcy court is only empowered to impose third-party releases in asbestos-related cases and that there is no binding precedent or statutory authority that authorizes the grant of such releases. Although the decision does not specifically address the Mallinckrodt decision, the U.S. Trustee argues in the alternative that, even assuming nonconsensual releases may be permissible, the debtors fail to establish the “extraordinary circumstances” necessary for their approval. Judge Silverstein will render another notable Delaware decision on third-party releases (presumably) in March, which decision will certainly be closely scrutinized.
Takeaways
The Purdue decision has certainly altered the bankruptcy landscape. Releases which were once seemingly a fait accompli are now being called into question regularly. Each new decision that is handed down is looking at the issue with fresh eyes. How this ultimately plays out is unclear, although there are certainly a lot of moving pieces to watch. For example, Purdue is still live, although a settlement (which, based on reports from mediation, seems likely) may deprive us of a Second Circuit decision on the issue. The Boy Scouts decision could be another significant landmark. It is anybody’s guess what happens next.
What is clear, however, is that if a debtor or third parties are filing specifically to obtain third-party releases (which was often the case), they are now going to be put to the test. As mentioned at the top, these releases will be scrutinized, and will likely draw an objection. So, at a minimum, debtor’s counsel will have to be prepared to put on an evidentiary showing that the releases are appropriately tailored and justified based on consideration received.
It will also be interesting to see what happens with respect to cases in the Eastern District of Virginia. Richmond has been a popular place to file a case (this statement is a bit loaded, but we will save the venue debate for another day). Will that trend continue in light of the Ascena Retail decision, which not only denied third-party releases but did so with some amount of vitriol? Or will the Ascena decision lead prospective debtors to file elsewhere? No matter what, the complex case paradigm is shifting on a daily basis, and it is something that we, and all restructuring professionals, will be watching closely.
1 Patterson v. Mahwah Bergen Retail Grp., Inc., Case No. 21-167, 2022 U.S. Dist. LEXIS 7431 (E.D. Va. Jan. 13, 2022).
2 In re Mallinckrodt PLC., Case No. 20-12522, Dkt. No. 6347 (Bankr. D. Del. Feb. 3, 2022).
3 See In re Millennium Lab Holdings II, LLC, 945 F.3d 126 (3d Cir. 2019); In re Continental, 203 F.3d 203 (3d Cir. 2000).
4 Id. at 40.
5 In re Kettner Investments LLC, Case No. 20-12366 (Bankr. Del.).
6 In re Sequential Brands Group Inc., Case No. 21-11194 (Bankr. Del.).
7 In re Boy Scouts of America and Delaware BSA, LLC , Case No. 20-10343 (Bankr. Del.).
8 Id., Dkt. No. 8710.
