As many bankruptcy practitioners are aware, there is a circuit court split with respect to the allowability of non-consensual third-party releases.  Notably, in the Purdue Pharma case, the United States Court of Appeals for the Second Circuit held that bankruptcy courts have the authority to approve plans with non-consensual releases of direct third-party claims against a non-debtor, articulating seven factors courts should consider before imposing such releases.[1] Since the Second Circuit’s Purdue decision, the Third, Fourth, Sixth, Seventh, and Eleventh Circuits have allowed such third-party releases in Chapter 11 bankruptcy plans. The Fifth, Ninth, and Tenth circuits have expressly disallowed non-consensual third-party releases. The question of whether non-consensual third-party releases are permissible under the Bankruptcy Code is now before the U.S. Supreme Court. The Supreme Court previously issued an order putting the Purdue Pharma bankruptcy confirmation on hold so that it can address the validity of non-consensual third-party releases.  The Supreme Court held oral argument on December 4th, and a decision is expected in June 2024. 

Last month, at the Cyxtera Technologies (“Cyxtera”) confirmation hearing held before Judge Sherwood in the United States Bankruptcy Court for the District of New Jersey, the United States Trustee objected to the plan’s releases and exculpation provisions as overbroad due to including affiliates and related parties.  After clarification regarding the definition of “related parties” and addressing other concerns related to consideration, opt outs, and mutuality of releases, Judge Sherwood confirmed the Cyxtera plan.  It appears that Judge Sherwood gained some comfort allowing the releases, in part because the Plan included a gate-keeping provision.  Gatekeeper provisions require parties to come to the bankruptcy court to determine if their claims are subject to the release, exculpation, and injunction provisions prior to pursuing claims that may be subject to the release, injunction, and exculpation provisions of the Plan. The gatekeeper provisions are designed to address the concern that parties may not have read the releases in the plan, particularly the requirement to affirmatively opt out of the plan’s releases.

Previously, in the RTW Retailwinds case,[2] Judge Sherwood expressed concern with lack of mutual consideration in a plan’s releases, stating that a release where a party is not receiving any consideration is not a “meaningful release” and is not “essential to the plan.”  However, he modified his position in Cyxtera, in part due to the circumstances (notably the absence of any creditor that voted to reject the plan but failed to opt out of the releases), but also due to the gatekeeping provision included in the plan. He also noted the fact that 190 equity investors holding 5.8 million shares selected the opt out as “evidence that the process functions” and that various groups, including the debtors, the unsecured creditors committee, the ad hoc secured creditor group, and a special committee of the debtors’ board of directors, all with counsel and advisors, examined potential claims against the proposed “released parties” and “found none worth pursuing.”   Finally, in response to the United States Trustee’s argument that the gatekeeping provisions foists an unnecessary extra step and expense upon parties to have to come to the bankruptcy court first, Judge Sherwood responded by stating that parties should want to come back to the bankruptcy court to get clarity in the first instance if they are violation the plan’s injunction.  All told, while Judge Sherwood was not comfortable presuming that everyone read and understood the releases and the opt out provision, and he understood the concern regarding a hypothetical claimant that is unsophisticated or that failed to read their mail, but if such a person exists, they can use the gatekeeper process in the plan to plead their case.[3]

Similarly, Chief Judge Kaplan in New Jersey recently confirmed a plan with similar “gatekeeping” provisions in the BlockFi case.[4] 

In the event that the Supreme Court disallows non-consensual third-party releases, gate-keeping provisions are likely to become more frequent element of plans, giving debtors a second bite at the apple to argue why a particular claim has been released in the plan.

[1] In re Purdue Pharma L.P., 69 F.4th 45, 78 (2d Cir. 2023)

[2] In re RTW Retailwinds Inc. et al., Case No.  20-18445-JKS, Docket No. 690.

[3] Judge Sherwood did not make a finding on whether the releases were supported by consideration because he believed there was no need under the circumstances of the case, including the vetting of claims by various parties and the presence of the gatekeeping provision.

[4] In re BlockFi Inc. et al., Case No. 22-19361 -MBK, Docket No. 1660, ¶ 18.