Congressional Bill Would Ban Non-Debtor Releases in Chapter 11 Reorganization Plans

The promise of Chapter 11 bankruptcy is that it can offer a corporate debtor a fresh start through the confirmation of a plan of reorganization. That is non-controversial. What is almost always controversial is when a plan seeks to shield non-debtor parties, typically corporate officers and directors, from liability through the inclusion of a non-debtor release provision.

The ability to confirm a plan with non-debtor releases, however, may be coming to an end.

Recently, members of Congress introduced proposed legislation known as the “Nondebtor Release Prohibition Act of 2021” (the “NRPA”). The bill seeks to prohibit the release of non-debtors through non-consensual third-party releases in Chapter 11 cases by altering the way bankruptcy courts interpret the application of Bankruptcy Code Section 105(a) and 524(e), which are the key provisions related to non-debtor releases. The NRPA builds upon previously proposed legislation known as the Stop Shielding Assets from Corporate Known Liability by Eliminating Non-Debtor Releases (SACKLER) Act.

The introduction of both bills comes after pharmaceutical giant Purdue Pharma filed for Chapter 11 bankruptcy in September of 2019 and subsequently proposed an exit plan in 2021. The plan sparked concern from states and families of victims of the opioid crisis because it included a release of non-debtors including owners, officers, and directors of Purdue Pharma. The plan provided for the release of the Sackler family, owners of Purdue Pharma, from liability claims stemming from hundreds of thousands of deaths caused by the opioid crisis.

How Courts Evaluate Non-Debtor Releases

While legislation has been introduced to end the use of non-debtor release in Chapter 11 bankruptcy, it is uncertain whether it will become law. Until then, bankruptcy debtors and practitioners are left to grapple with how courts have interpreted and ruled upon non-debtor releases, and in particular courts’ analysis of Bankruptcy Code Sections 105(a) and 524(e).

• Section 524(e) states: “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.”
• Section105(a) states: “The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”

Section 105 is considered the Bankruptcy Code’s equitable catchall provision, used by bankruptcy courts to grant relief and fashion remedies for issues that aren’t squarely addressed by the statute. This includes bankruptcy courts across the nation interpreting and reconciling Section 524(e) and its relation to a bankruptcy court’s equitable powers under Section 105(a) to determine whether there is a right to release non-debtors. Their conclusions have differed.

The majority of jurisdictions have determined that Section 524(e) does not bar release of non-debtors. The Seventh Circuit summarized the majority approach in Airadigm Communs., Inc. v. FCC (In re Airadigm Communs., Inc.), in which the court set forth three important concepts: “1. Bankruptcy code section 524(e) does not prevent bankruptcy courts from granting third-party releases; 2. Bankruptcy courts have the affirmative power to grant third-party releases; and 3. The applicable standard for granting a third-party release is that the release must be necessary for the reorganization and the release must be as narrowly tailored.” The Second, Fourth, Sixth and Tenth Circuit have joined the Seventh Circuit in this stance; that is, non-debtor releases are permitted to the extent they are “necessary for the reorganization” and “narrowly tailored.”

Each of the circuits that permit non-debtor releases identify Section 105(a) as the basis for the court’s discretionary power to approve plans that allow for non-debtor release. The Sixth Circuit, in the case of In re DOW CORNING Corp., illustrated the practice when it concluded, “11 U.S.C.S. § 105(a), along with § 1123(b)(6), provides the bankruptcy courts with broad authority to approve plans of reorganization that include provisions affecting creditors' rights to recover against non-debtors, if the provisions are necessary to carry out the plan”

Since the decision in In re DOW Corning Corp., some courts have cited the so-called “Dow Corning factors” to determine when releases in a plan will be affirmed. The factors include:

• An identity of interests between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete the assets of the estate.
• The non-debtor has contributed substantial assets to the reorganization.
• The injunction is essential to reorganization, namely, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor.
• The impacted class, or classes, has overwhelmingly voted to accept the plan.
• The plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction.
• The plan provides an opportunity for those claimants who choose not to settle to recover in full.
• The bankruptcy court made a record of specific factual findings that support its conclusions.

Other courts, including the Fifth, Ninth and Tenth Circuits, have reached a different conclusion, and interpret Section 524(e) to bar non-debtors from release. The Ninth Circuit, in In re Am. Hardwoods, concluded, “Section 105 limits the court to ordering those injunctions 'necessary or appropriate to carry out the provisions of this title . . . While endowing the court with general equitable powers, section 105 does not authorize relief inconsistent with more specific law.” Subsequently, in Resorts Int’l v. Lowenschuss the Ninth Circuit further solidified its stance stating, “this court has repeatedly held, without exception, that § 524(e) precludes bankruptcy courts from discharging the liabilities of non-debtors.”

The Implications of the NRPA

The Nondebtor Release Prohibition Act of 2021 would end the debate among the circuits about the permissibility of non-debtor releases by ending the practice of shielding owners, officers, or insiders of bankrupt entities from claims.

In a press release, the sponsors of the the bill explained that: “The Nondebtor Release Prohibition Act of 2021 would prevent individuals who have not filed for bankruptcy from obtaining releases from lawsuits brought by private parties, states, Tribes, municipalities, or the U.S. government in bankruptcy by: (1) Prohibiting the court from discharging, releasing, terminating or modifying the liability of and claim or cause of action against any entity other than the debtor or estate. (2) Prohibiting the court from permanently enjoining the commencement or continuation of any action with respect to an entity other than the debtor or estate.”

Along with Purdue Pharma’s proposed plan, the practice of shielding non-debtors gained national attention through other highly publicized bankruptcy cases including the Boys Scouts of America, USA Gymnastics, and the Catholic dioceses.

In each case, potential tort actions dealing with highly sensitive claims against third parties may be affected, which has sparked backlash similar to the statements made by members of Congress in connection with the introduction of the NRPA.

Some argue the NRPA would negatively impact the discretionary power of the bankruptcy courts and may alter the efficiency and speed of future bankruptcy cases.

Time will tell whether the NRPA becomes law. Until then, we are left to deal with the splintered, majority/minority approach to non-debtor releases that currently exists. We will continue to keep you apprised of further developments in this area.

In the meantime, if you have any questions regarding Chapter 11 bankruptcy, please contact David Dragich at ddragich@dragichlaw.com or Amanda Vintevoghel at avintevoghel@dragichlaw.com.