Nick Tremps
For corporate debtors that submit to the bankruptcy process, the Bankruptcy Code (the “Code”) provides significant benefits to the “honest, but unfortunate debtor” that cannot fully perform its debt obligations.[1] In a case filed under Chapter 11 of the Code, a corporate debtor may file a plan of reorganization with the bankruptcy court that proposes how the debtor intends to restructure its debts owed to each class of creditors.[2] Upon confirmation of a plan, the corporate debtor then receives a discharge from any debt that arose prior to the bankruptcy court’s confirmation.[3] Included in that plan of reorganization, corporate debtors may attempt to include provisions that extend third-party releases to non-debtors that have a direct impact on the debtor’s restructuring.[4] In other words, a plan may attempt to use the bankruptcy process to extinguish present or future claims held by various third parties against entities that are associated with the debtor. Where the impaired class or classes of creditors affirmatively consent to the binding plan, courts typically confirm these releases.[5] But what happens when a third-party creditor votes against the plan and instead seeks to exercise their constitutional right to have their day in court and pursue a claim directly against the non-debtor? The United States Supreme Court may soon address whether these so-called “non-consensual third-party releases” are permitted by the Code.
While third-party releases are expressly permitted in a plan of reorganization in asbestos cases,[6] circuits have been split for decades about whether this practice is permitted by the Code outside of the asbestos context. The majority of circuits, including the Second, Third, Fourth, Sixth, Seventh, and Eleventh permit third-party releases,[7] albeit in rare or extraordinary circumstances and when “certain factors” are met.[8] Conversely, the Fifth and Tenth Circuits categorically bar these releases based on Section 524(e) of the Code.[9] That provision provides that the “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.”[10]
Following a petition for a writ of certiorari last month, the Supreme Court has a long-awaited opportunity to resolve this circuit split. In Highland Capital Management, L.P. v. NexPoint Advisors, L.P.,[11] the Fifth Circuit, following circuit precedent, held that Section 524(e) of the Code barred the debtor from releasing certain non-debtors from liability in its chapter 11 plan of reorganization.[12] Thus, the debtor’s attempt to exculpate certain non-debtors from liability was precluded by the Fifth Circuit’s steadfast interpretation of Section 524(e).[13] In its petition filed in January, the reorganized debtor, Highland Capital Management, urges the Supreme Court to adopt the majority position, contending that Section 524(e) is “simply a saving clause” and that the plain language of Section 524(e) “simply states that the discharge of a debtor’s liability on a debt does not itself affect any other creditor’s liability on that same debt.”[14] Thus, according to the debtor, Section 524(e), by its plain language, does not preclude a bankruptcy court from confirming a plan containing non-debtor exculpations. Notably, NexPoint Advisors, the respondent in that case, also filed a petition for a writ of certiorari last month, asking the Supreme Court to use this case as a vehicle to “restore uniformity among the circuits”[15] and put an end to this “abus[ive]” practice.[16] While the debtor seeks review of non-debtor exculpations, NexPoint Advisors points out that “the fact that this case involves third-party exculpations that limit liability to gross negligence or willful misconduct, rather than third-party releases that eliminate liability altogether, does not diminish the importance of the issue or make this case a faulty vehicle.”[17]
NexPoint Advisor’s argument is well-founded. While the circuits that do permit third-party releases may do so in limited or extraordinary circumstances,[18] one bankruptcy judge recently noted that “[a]lmost every proposed Chapter 11 Plan that I receive includes proposed releases.”[19] From sexual-abuse scandals[20] to the crippling opioid epidemic,[21] it has become commonplace for a corporate debtor to file a plan of reorganization in which non-debtors receive a release from liability in exchange for a pecuniary contribution to the debtor’s reorganization. Accordingly, this case provides the Supreme Court an opportunity to resolve a contentious issue that has meaningful practical implications. For example, the various interpretations of Section 524(e) among the circuits increases the likelihood for corporate debtors to forum shop in search of a bankruptcy court that endorses third-party releases contained in a plan of reorganization.[22] Moreover, the lack of clarity surrounding the permissibility of third-party releases and when they are integral to the debtor’s restructuring leads to uncertainty for all parties involved when negotiating a plan of reorganization. Therefore, the time has come for the Supreme Court to determine what Section 524(e) actually means and this case welcomes that determination.
[1] John M. Czarnetzky, The Individual and Failure: A Theory of the Bankruptcy Discharge, 32 Ariz. St. L.J. 393, 412 (2000).
[2] Michael S. Etkin & Nicole M. Brown, Third Party Releases?–Not So Fast! Changing Trends and Heightened Scrutiny, 29 AIRA J. 22, 22 (2015).
[3] 11 U.S.C. § 1141(d)(1)(A).
[4] Dorothy Coco, Third-Party Bankruptcy Releases: An Analysis of Consent Through the Lenses of Due Process and Contract Law, 88 Fordham L. Rev. 231, 232 (2019); see also Etkin & Brown, supra note 2, at 22 (“A debtor might seek to extend third party releases to co-debtors, officers, directors, lenders, parents, guarantors, sureties, or insurance carriers where those parties could assert post-confirmation indemnification claims against the debtor, or where the non-debtor party is a potential source of funding for the plan of reorganization.”).
[5] Coco, supra note 4, at 232–33.
[6] See 11 U.S.C. § 524(g), (h).
[7] See In re Metromedia Fiber Network, Inc., 416 F.3d 136, 141 (2d Cir. 2005); In re Millennium Lab Holdings II, LLC, 945 F.3d 126, 140 (3d Cir. 2019); Menard-Sanford v. Mabey (In re A.H. Robins Co.) 880 F.2d 694, 702 (4th Cir. 1989); In re Dow Corning Corp., 280 F.3d 648, 657 (6th Cir. 2002); In re Airadigm Commc’ns, Inc., 519 F.3d 640, 656 (7th Cir. 2008); In re Seaside Eng’g & Surveying, Inc., 780 F.3d 1070, 1078 (11th Cir. 2015).
[8] Coco, supra note 4, at 240.
[9] See In re Pacific Lumber Co., 584 F.3d 229, 252–53 (5th Cir. 2009); In re W. Real Estate Fund, Inc., 922 F.2d 592, 600 (10th Cir. 1990).
[10] 11 U.S.C. § 524(e).
[11] In the Matter of Highland Capital Management, L.P., 48 F.4th 419 (5th Cir. 2022).
[12] Id. at 437–38.
[13] Id.
[14] Brief for a Writ of Certiorari at 4, Highland Capital Management, L.P. v. NexPoint Advisors, L.P., No. 22-631 (petition for cert. filed Jan. 5, 2023).
[15] Brief for Respondents at 2, Highland Capital Management, L.P. v. NexPoint Advisors, L.P., No 22-631 (petition for cert. filed Feb. 10, 2023).
[16] Id.
[17] Id. at 10.
[18] See Etkin & Brown, supra note 2, at 26.
[19] In re Aegean Marine Petroleum Network Inc., 599 B.R. 717, 726 (S.D.N.Y. 2019).
[20] In re Boys Scouts of America and Delaware BSA, LLC, 642 B.R. 504 (Bankr. D. Del. 2022).
[21] In re Purdue Pharma, L.P., 635 B.R. 26 (S.D.N.Y. 2021).
[22] Coco, supra note 4, at 265.
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