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The Bankruptcy StrategistFeaturesBankruptcyLegislation

Congress Seeks to Restrict Nondebtor Releases in New Bankruptcy Reform Bill

By Thomas R. Califano and Anna Gumport
October 01, 2021

On July 28, 2021, certain members of Congress introduced the Nondebtor Release Prohibition Act of 2021 (S. 2497) (NRPA), which proposes to amend the Bankruptcy Code to, among other things, restrict courts' ability to approve third-party releases of nondebtors and related injunctions under plans of reorganization or otherwise in Chapter 11 cases. Although the NRPA was introduced in response to testimony criticizing the third-party releases and injunctions proposed in the USA Gymnastics cases and Purdue Pharma cases, the NRPA's provisions are not limited to the mass tort context, and, if enacted, would have significant implications for all Chapter 11 cases. The authors submit that while some of the concerns regarding nonconsensual third-party releases may be valid, the NRPA goes too far in limiting what can, in the right circumstances, be a valuable tool in restructurings.

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Third-Party Releases Under Current Law

Third-party releases, i.e., releases of nondebtor individuals and entities from claims of creditors and other third parties, and injunctions barring released third-party claims, have become increasingly prevalent in Chapter 11 cases. Releases and corresponding injunctions are key to obtaining funding and other contributions to the restructuring process from nondebtors who might be concerned about potential liability arising from their interactions or relationship with the debtors. These provisions tend to be heavily-negotiated and litigated in the Chapter 11 plan context. Yet this practice remains controversial, hence the proposal of the NRPA.

Courts distinguish between consensual and nonconsensual third-party releases. Consensual releases are generally viewed as permissible, but courts have reached varying conclusions as to whether the indication of consent must be affirmative or can be implied from inaction such as a failure to submit a ballot or "opt out" when voting on a plan. See, e.g., In re SunEdison, 576 B.R. 453, 458-61 (Bankr. S.D.N.Y. 2017) (discussing differing views). Federal circuits are split regarding the permissibility of nonconsensual third-party releases, but a majority of circuits permit them under certain circumstances. Compare, e.g., Deutsche Bank AG, London Branch v. Metromedia Fiber Network (In re Metromedia Fiber Network), 416 F.3d 136, 141-42 (2d Cir. 2005) (discussing circuit split and siding with courts permitting third-party releases), with, e.g., Resorts Int'l v. Lowenschuss (In re Lowenschuss), 67 F.3d 1394, 1401-02 (9th Cir. 1995) (holding that 11 U.S.C. §524(e) precludes bankruptcy courts from discharging liabilities of nondebtors). While courts permitting nonconsensual third-party releases differ in the particular fact-specific tests they apply in determining whether such relief is justified, they all treat such releases as requiring heightened scrutiny for approval.

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