The Supreme Court recently issued its long-awaited decision in Harrington v. Purdue Pharma L.P., 144 S.Ct. 2071 (U.S. 2024) (“Purdue Pharma”), addressing whether nonconsensual third-party releases are permissible under the Bankruptcy Code. In a 5-4 decision, the Court ruled that nonconsensual third-party releases are not permitted under the Bankruptcy Code. Notably, however, the Supreme Court did not opine on the issue of whether for a release to be deemed consensual it must contain an “opt-in” or “opt-out” provision for creditors and parties-in-interest. See Purdue Pharma, 144 S.Ct. at 2087–88 (“As important as the question we decide today are ones we do not. Nothing in what we have said should be construed to call into question consensual third-party releases offered in connection with a bankruptcy reorganization plan; those sorts of releases pose different questions and may rest on different legal grounds than the nonconsensual release at issue here. . . . Nor do we have occasion today to express a view on what qualifies as a consensual release or pass upon a plan that provides for the full satisfaction of claims against a third-party nondebtor.”). Thus, this issue remains open.

While there are variations as to process, an “opt-out” release typically requires parties entitled to vote on the plan and who have received ballots to do so, or nonvoting parties (who are deemed to accept or reject a plan) who have received notice, to check a box affirmatively indicating that they do not agree to provide the releases which the plan seeks to provide. In other words, in order not to be deemed to have agreed to the releases, the party must take affirmative action demonstrating a conscious decision to do so. Parties that abstain from voting will typically be deemed to have consented to the releases. In some cases, where no ability to opt-out has even been provided, parties that vote in favor of a plan are also deemed to consent to the releases. In contrast, under an “opt-in” mechanism, voting and nonvoting parties must check a box affirmatively agreeing to the nondebtor releases. Any party that does not check the box, or “opt-in,” is deemed to be a non-releasing party, including parties who do not return ballots at all. Bankruptcy Judge Craig T. Goldblatt from the District of Delaware is one of the latest judges to grapple with this issue.

Last month, Judge Goldblatt issued a written ruling in In re Smallhold, Inc., No. 24-10267, 2024 WL 4296938 (Bankr. D.Del. Sept. 25, 2024)(“Smallhold”), addressing whether opt-out releases are permissible following the Supreme Court’s ruling in Purdue Pharma. At issue in Smallhold was what constitutes “consent” in granting a third-party release, and whether a creditor can be deemed to have consented to a third-party release if the creditor fails to opt-out of the release. Judge Goldblatt held that an opt-out provision is permissible only if the creditor was on notice that it would be subject to a third-party release and the creditor took an affirmative act, such as voting on the plan, but failed to exercise the opt-out right. According to Judge Goldblatt, creditors who were not given an option to opt-out cannot be bound by a third-party release.

Facts of the Case

The relevant facts of the case are as follows. In June 2024, the Debtor filed an amended subchapter V plan of reorganization and a proposed solicitation order that included a notice and ballot form that would be sent to creditors. The plan contained the following provision that purported to release creditors’ claims against the Debtor and its attorneys, professionals, the DIP lender, and non-debtor third parties:

all persons. . . who voted to accept this Plan or who are presumed to have voted to accept this plan and [all persons] who voted to reject this Plan but did not affirmatively mark the box on the ballot to opt out of granting the releases provided under this Plan . . . shall . . . forever release . . . the Released Parties of . . . all . . . causes of action . . . based upon any. . . act, omission[,] occurrence, transaction or other activity. . . arising . . . prior to the Effective Date . . . relating to. . . . the Debtor [or] the Debtor’s prepetition operations.

(emphasis supplied).[1] The notice provides that the term “Released Parties” include, among others, the Debtor’s prepetition attorneys and professionals, the Debtor’s attorneys retained in the bankruptcy case and “representatives of the debtor.” At the hearing, it was announced that as a result of negotiations with the DIP Lender, former officers and directors of the Debtor, as well as the DIP lender and its representatives, were carved out of the definition of Released Parties.[2] 

The proposed solicitation order contained the form of ballot for creditors in each of the two classes entitled to vote on the plan, (a) Class 1 consisting of the DIP Lender, and (b) Class 2, consisting of general unsecured creditors. The proposed ballots for Class 1 and Class 2 included an option to opt-out of the third-party releases – the failure to check the box to opt-out meant that the creditor would be subject to the third-party release. Priority creditors whose claims would be paid in full, and equity holders whose interests were unimpaired, would receive a clear notice of the third-party release. Because no party objected to the solicitation procedures, the court entered the solicitation order in the form proposed. The U.S. Trustee objected to the plan, arguing that the third-party release should be binding only for creditors that affirmatively consent to the release. 

In analyzing the opt-out provisions proposed by the Debtor, the bankruptcy court noted that there are three categories of creditors where the validity of their opt-out releases were at issue:

• Creditors whose claims would be paid in full and equity holders who were unimpaired and thus presumed to have accepted the plan. Notably neither of these groups was provided a ballot;
• General unsecured creditors in Class 2 who voted in favor of or against the plan, but did not check the box indicating that they intended to opt-out of the third-party release; and
• The sole creditor in Class 1—the DIP Lender—who received the form ballot indicating that a vote in favor of the plan necessarily operated to grant the third-party release, without providing an opportunity to opt-out of the third-party release.[3]

The bankruptcy court first analyzed whether its prior ruling in In re Arsenal Intermediate Holdings, LLC, No. 23-10097, 2023 WL 2655592 (Bankr. D. Del. Mar. 27, 2023) (“Arsenal”) was still valid in the wake of Purdue Pharma. In Arsenal, Judge Goldblatt held that the use of opt-out provisions is generally permissible, but that the unique circumstances of that case required the debtor to provide creditors with additional protections before the court would confirm an opt-out plan. The rationale of Arsenal was that creditors that did not object to, or opt-out of, a third-party release, could essentially be “defaulted,” with the release being imposed on them, despite their silence. 

Judge Goldblatt noted that after the Supreme Court’s ruling in Purdue Pharma, Arsenal’s holding is no longer appropriate under the ordinary principles that govern when a default may be entered. Instead, affirmative consent of a creditor is required. This is because “third-party release[s] [are] no longer an ordinary plan provision that can properly be entered by ‘default’ in the absence of an objection.”[4] As a result, “it is no longer appropriate to require creditors to object or else be subject to (or be deemed to ‘consent’ to) such a third-party release.”[5] Relying on contract principles and case law, Judge Goldblatt concluded that third-party releases “were only appropriate in circumstances in which, following a contract model, there was evidence of an agreement to grant the release.”[6]

In applying this analysis to issues at hand, the bankruptcy court ruled that the unimpaired equity holders and creditors whose claims will be paid in full and thus were not given the opportunity to vote cannot be said to have consented to the releases. 

As to the Class 2 creditors, however, the bankruptcy court found that they had manifested consent because they voted either for or against the plan, and thus had taken affirmative steps to consent to third-party releases. The bankruptcy court noted that these creditors were clearly informed and put on notice of the right to opt-out of the releases before casting their votes. Judge Goldblatt stated that “a creditor who voted in favor of the plan, the act of casting the vote, in light of the clear instructions and the failure to check the available box to ‘opt-out’, was a sufficient action to say that the creditor had evidenced its consent.”[7] Further, the bankruptcy court noted that the DIP Lender (Class 1) actively participated in the case, and negotiated an arrangement with the Debtor before it ultimately voted in favor of the plan and granted the third-party release. The bankruptcy court noted that the ballot for both Classes 1 and 2 provided a simple mechanism by which these creditors could opt-out, and so there was no risk of coercion of the plan voting process.

However, Judge Goldblatt rejected the opt-out release for unimpaired equity holders and creditors receiving full payment under the plan, finding that these two groups were not provided the opportunity to vote under the plan. Because they did not have an opportunity to opt-out of the releases, they could not be said to have consented to the releases. Judge Goldblatt noted that a creditor’s silence on a plan is no longer sufficient to establish consent. 

Judge Goldblatt noted that his ruling “hardly pose[s] an insurmountable barrier to the successful reorganization of most troubled businesses and their ability to obtain a measure of finality through the bankruptcy process.”[8] In fact, nothing in Purdue Pharma can be read to call into question the kind of exculpation approved by the Third Circuit in In re PWS Holding Corp., 228 F.3d 224 (3d Cir. 2000). Notably, while a third-party release is similar to an exculpation clause, the exculpation clause is a limited release of liability for certain parties who acted during the bankruptcy case and provides protection from any claim or obligation arising out of any act or omission occurring during the bankruptcy case. In contrast, the third-party release purposes to release claims for actions taken prior to and during the bankruptcy case. Judge Goldblatt also noted that Purdue Pharma does not provide a reason why a debtor may not reach an appropriate resolution of an estate cause of action and thereby relieve third parties of potential liability on alter-ego or veil-piercing claims.

The bankruptcy court specifically noted that it remains open to the possibility that it may be appropriate to build class-action protections into the plan process, and thus allow a named representative to act on behalf of creditors who do not affirmatively opt-out. 

Takeaways

While Purdue Pharma is a bar to non-consensual third-party releases, the Supreme Court did not opine on what constitutes consent or how that consent may be manifested to establish consensual third-party releases. As Judge Goldblatt stated in his Smallhold ruling, “[c]reative lawyers will undoubtedly dream up other tools, which will be considered, when presented, on their merits in light of applicable law.”[9]

[1] In re Smallhold, Inc., No. 24-10267, 2024 WL 4296938, at *4 (Bankr.D.Del., Sept. 25, 2024).

[2] Id.

[3] Id. at *5.

[4] Id. at *2.

[5] Id. at *10.

[6] Id.

[7] Id. at *15.

[8] Id.

[9] Id.