The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, analyzing a recent decision of interest:
In In re Astria Health, ___ B.R. ___, 2021 WL 237672 (Bankr. E.D. Wa. January 22, 2021) (“Astria”), the United States Bankruptcy Court for the Eastern District of Washington (the “Court”) ruled that the exculpation provisions in the debtors’ proposed plan of reorganization, focusing on parties that were active during the postpetition period in the case and central to the intense negotiations for the plan, were permissible under Ninth Circuit precedent and Bankruptcy Code (the “Code”) section 1123(b)(6) (“section 1123(b)(6))” because they were carefully and narrowly tailored to achieving confirmation of the plan.
The case can be found here.
The joint debtors owned and operated several regional hospitals and clinics when they filed their Chapter 11 cases (several affiliates did not file). Not only were the debtors struggling financially when they filed, but their woes were exacerbated by the subsequent advent of the COVID pandemic. Indeed, they closed one of their hospitals shortly after filing their cases.
As the Court described the proceedings in the opinion, the cases were a classic example of the potential for bankruptcy law to bring together warring parties in the interest of avoiding massive costs and of preserving value and (in the case of the debtors) jobs and critical services for the public. Out of the gate there was a fight between the debtors and their prepetition secured lender over the use of cash collateral. Eventually, the debtors and the lender reached an understanding on cash collateral. Later, they and the lender agreed on a restructuring of the lender’s claims to be included in the plan they negotiated. However, the creditors committee opposed the deal and plan. Negotiations followed, again with the parties keeping an eye on potential financial and other costs of the fight.
Eventually, the debtors, the lender and the committee agreed on a plan. The plan included several sets of releases. These extended to such parties as the lender, the committee, the debtors’ boards, and various third parties. One key to the releases was that they only covered postpetition activities of the released parties in connection with the case, including such items as negotiation for, formulation of, and soliciting acceptance of the plan itself. Another vital provision was that only creditors who both voted for the plan and opted into the release provision were bound by the releases.
The plan received the affirmative vote of the impaired classes, including, of course, the lender, and it had the support of all the constituencies, including the committee. However, the United States Trustee (the “UST”) objected to the release provisions, arguing that they were impermissible on a variety of grounds. Finding that the plan otherwise met the confirmation requirements of Code section 1129, the Court overruled the UST’s objections and confirmed the plan.
The Court began by observing how the case and plan reflected what it thought of as the best of Chapter 11: a process by which parties with disparate interests reached common ground in the interest of avoiding endless costs and delay, as well as the collapse of the case what would benefit none of them and harm the public welfare by taking vital health care resources off the table. It also noted that there is no express prohibition of exculpations in Chapter 11 cases in the Code. Indeed, if anything the Code implicitly permits the right kind of releases. In doing so, it recognizes that for Chapter 11 to work, parties in interest must be given considerable (but not boundless) latitude to formulate plan terms to fit the circumstances they face. Specifically, section 1123(b)(6) provides that a plan “may include any other appropriate provisions not inconsistent with the applicable provisions of this title [Title 11, the Code].” The Court also pointed out that the Ninth Circuit has approved the inclusion of similar appropriate exculpation provisions in a plan, noting that there is no Code prohibition. In re Blixseth, 961 F.3d 1074, 1081 (9th Cir. 2020).
The Court then specifically addressed the UST’s objections. First, the UST argued that the “temporal scope” of the releases went beyond what Blixseth contemplated. In response, the Court pointed out that the releases related only to the period during which it had jurisdiction over the parties and the process that their conduct comprehended. According to the Court, it clearly was empowered to regulate the standard of care for case/plan process-related conduct of the parties before it.
Next, the UST contended that that the scope of the releases in terms of parties protected was overbroad. But the Court emphasized that the releases covered only parties who “played a significant role during these cases and engaged in conduct potentially subject to second guessing or hindsight-driven criticism.” Once again, the Court was focusing on its interest in and exclusive jurisdiction over setting the standard for regulating the parties before it in connection with the objective of formulating a confirmable plan. The Court also rejected the UST’s objection that the releases extended to parties who had no fiduciary duties to the bankruptcy estates or bankruptcy-created constituencies (such as the creditors committee). Here, the Court pointed out that Blixseth had declined to impose such a limitation. It added that Code section 1125(e) governs the liability of various parties in the Chapter 11 process regardless of whether they owed any fiduciary duties, indicating that owing such duties is not a condition of exculpation associated with Chapter 11. Thus, it explained, there is no inherent conflict between the Code and the release of non-fiduciaries.
Finally, the Court considered and rejected two other objections. First, it approved the release by the estates of claims they might have against the released parties. On that point, the Court explained it need not rely on section 1123(b)(6) because the releases in the context of the plan amount to settlements, which it had the well-recognized independent power to approve if they meet certain standards. It found those standards satisfied. And lastly, it disagreed that Code section 524(e) and Ninth Circuit authority prohibits authorizing releases between third parties. Once again, Blixseth provided the answer, for that decision concluded that section 524(e)’s limitation of a bankruptcy discharge to liability for “such debt” only applies to the to the debtor’s affected obligation and debts for the discharged debt (e.g., a guarantor’s liability to a third party beneficiary), but not other claims between third parties that are otherwise somehow related to the discharged debt. The Ninth Circuit had added that since the bankruptcy court is a court of equity, any permissible release would have to be narrowly tailored to promote the Chapter 11 goal of reorganization. Although the Court did not specifically reference this aspect of Blixseth, its lengthy discussion of how the releases were both limited and were vital to confirmation of the plan effectively covered that ground.
Perhaps most notable about Astria is that it is a judicial paean to the operation of Chapter 11 at its best. The Court’s focus on section 1123(b)(6) as empowering the participants in a Chapter 11 case to use their creativity and imaginations to formulate a confirmable plan and on how the parties in Astria did just that is the fulcrum of the opinion. It is followed by a systematic consideration of the UST’s objections that employs reliance on policy, precedent that mirrors that policy, and careful attention to the facts, particularly the history of the cases and the specific terms of the releases at issue. It is also pretty obvious that the Court was going to do what it could to avoid sapping all the work and time that went into intense negotiations over what amounted to a consensual plan for the survival of a vital public resource.
There are two other striking points. First, the plan ducked headwinds by including very careful opt out provisions that did not put the onus on creditors to protect themselves and leave them exposed unless they took affirmative action, see, e.g., In re Emerge Energy Services LP, 2019 Bankr. LEXIS 3717 at *52-53 (Bankr. D. Del. Dec. 5, 2019) (court cannot approve third party release provisions because it cannot infer consent when mere silence construed as failure to opt out). Second, as explained at footnote 13, originally the releases included prepetition conduct as well, but later they prudently were limited to postpetition acts in response to an objection by the UST.
These materials were authored by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLC, a member of the ad hoc group, with editorial assistance by Meredith Jury, (bankruptcy judge, C.D. Cal. (Ret.)), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.