The following is an update analyzing a recent case of interest:
The United States Bankruptcy Court for the Eastern District of Washington upheld several different release and exculpation clauses in confirming a Chapter 11 plan over the objection of the United States Trustee. In re Atria Health, 623 B.R. 793 (Bankr. E.D. Wash. 2021).
To view the full opinion, click here.
The Debtors owned and operated several hospitals and related clinics in Washington State. During their Chapter 11 cases, the Debtors engaged in extensive (and apparently fruitful) negotiations with the other key constituencies and ultimately proposed a consensual plan of reorganization. The U.S. Trustee objected to three different provisions in the plan:
An “exculpation” provision under which the key players in the cases–debtors, committee, secured lender/DIP financer, officers and directors–were exculpated from liability for any post-petition acts taken in connection with the case, other than gross negligence or willful misconduct;
An “estate release” provision under which the debtors and their bankruptcy estates released a similar set of parties for essentially any claim arising prior to the Plan’s effective date; and
A “creditor release” provision under which creditors who voted in favor of the Plan and did not check an “opt out” box on the ballot released a similar set of parties–this time with a carveout for claims of actual fraud, gross negligence, or willful misconduct.
The U.S. Trustee raised a number of objections to the three provisions. The Court overruled all of the objections, upheld all three provisions, and confirmed the plan.
For background, the Court first looked to Bankruptcy Code section 1123(b)(6), which allows Chapter 11 plans to include any “appropriate provision not inconsistent with the applicable provisions of this title.” The Court noted the flexibility and creativity that the statute invites.
The Court then turned to the individual provisions in the plan.
In upholding the exculpation provision, the Court turned to the recent decision in Blixseth v. Credit Suisse 961 F.3d 1074 (9th Cir. 2020), finding that the provision comported with the Ninth Circuit standard, in that the exculpation was limited to (1) post-petition acts, which were subject to the Court’s jurisdiction, and (2) parties who played significant roles in the Chapter 11 and who were deserving of protection from “second guessing or hindsight-driven criticism” from stakeholders who “all too often blame others for failures to get the recoveries they desire; seek vengeance against other parties; or simply wish to second guess the decisionmakers in the chapter 11 case.”
In upholding the releases given by the estates, the Court noted that in addition to the general latitude afforded by Bankruptcy Code section 1123(b)(6), more specific authority existed–section 1123(B)(3)(A), which expressly authorizes “the settlement or adjustment of any claim or interest belonging to the debtor or to the estate.” The Court noted that the standard for evaluating settlements in plans is the same for evaluating those under Rule 9019 motions: the four factors enumerated in Martin v. Kane (In re A & C Props.), 784 F.2d 1377, 1381 (9th Cir. 1986), which the Court found satisfied here. The Court placed great important on the fact that no one–debtors, committee, lender–believed that any such claims existed. And the Court again noted the released parties’ contributions to the Chapter 11 cases, giving particular importance to the fact that a consensual plan had been achieved in large and complex cases, allowing creditors to avoid years of delay and diminished distributions caused by extensive litigation.
In upholding the releases given by nondebtors (including creditors) against other nondebtors, the Court first discussed the “misunderstanding” by many that such creditor releases were impermissible in the Ninth Circuit based on section 524(e), which 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.” The Court discussed how the Blixseth decision had cleared that issue up, focusing on the fact that section 524(e) applies only to “such debt ”–i.e., a debt owed by the debtor–and thereby “prevents a bankruptcy court from extinguishing claims of creditors against non-debtors over the very debt discharged through the bankruptcy proceedings”–but not from extinguishing other types of claims against nondebtors.
Perhaps I don’t see these issues enough to be an expert in them–I practice primarily in the Chapter 11 backwaters of San Diego. But these issues trouble me (and apparently the U.S. Trustee, who loves to object to them–this case was no exception). As a lawyer who represents Chapter 11 debtors, I’m in favor of these types of provisions–but the few times I have had clients take issue with them, I have struggled to explain the rationale for certain aspects of them. Next time I find myself in that situation, I will pull out a copy of this opinion, as I found it very helpful–particularly the Court’s discussion of the difference between releases and exculpation provisions. Releases effect the “relinquishment of claims held by the debtor or third parties against certain nondebtors.” Exculpation provisions “establish the standard of care that will trigger liability in future litigation by a non-releasing party against an exculpated party for acts arising out of a debtor’s restructuring.”
I did find some weaknesses in the opinion. The Court seemed to rely heavily on the debtors’ representations that they were not aware of any claims they were releasing. But it typically takes time to discover claims. Aren’t most malpractice claims not discovered until well after the fact?
And the Court also relied on the “opt out” on the ballot, deeming the releases to be “voluntary.” But are they really voluntary? Why would any creditor grant this release? They get nothing in exchange for doing so. Isn’t this really a result of inertia? Most creditors simply check one box–for or against the plan–and don’t bother with the second box needed to opt out of the releases. The Court acknowledges this weakness in a footnote.
And while the decision illuminated me on the distinction between releases and exculpation provisions, it did not fully clear the muddy waters. Doesn’t an exculpation provision simply effect a release by all parties of claims for negligence against the exculpated parties (while carving out claims for gross negligence or willful misconduct)?
The trend in the Ninth Circuit seems to be in favor of plan releases, and I hope it continues. Chapter 11 remains horribly expensive and out of reach for all but large businesses. Perhaps Subchapter V alters that landscape favorably. But in the meantime, plan releases and exculpation clauses should lower the risk for professionals, and theoretically (and hopefully) make Chapter 11 more affordable (and thus more available) to more businesses.
The Commercial Finance Newsletter is written by an ad hoc group of the California Lawyers Association (CLA) Business Law Section. These materials were written by Christopher V. Hawkins, a partner at Sullivan Hill Rez & Engel, APLC, and a member of the ad hoc group, with editorial contributions by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also a member of the ad hoc group. The opinions expressed herein are solely those of the author. Thomson Reuters holds the copyright to these materials and has permitted the Commercial Transactions Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.
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