Patterson v. Mahwah Bergen Retail Group Inc.
Patterson v. Mahwah Bergen Retail Group Inc.,___BR___, (E.D. Va. Jan. 13, 2022; appeal from bankruptcy court to district court number 21-167): It is becoming more common for confirmation of Chapter 11 plans, which grant non-debtors releases, are reversed on appeal. In Patterson, a District Judge, Virginia, on appeal from bankruptcy court to district court, emphatically rejects confirmation of a chapter 11 Plan which grants broad releases to non-debtor Third Parties.
In a scorching opinion, US District Judge David Novak of Richmond, Va., set aside confirmation of a chapter 11 plan that contained “extremely broad third-party (non-debtor) releases” and said that the releases in the appeal before him “represent the worst of this all-too-common practice, as they have no bounds.” He described the releases as barring the claims “of at least hundreds of thousands of potential plaintiffs not involved in the bankruptcy . . . , shielding an incalculable number of individuals associated with the Debtors . . . for an unspecified time period stretching back to time immemorial . . . .” [Emphasis in original.]
Judge Novak said that the bankruptcy court “exceeded the constitutional limits of its authority . . . , ignored the mandates of the Fourth Circuit . . . , and offended the most fundamental precepts of due process.”
Referring to what he called the “ubiquity of third-party releases” approved by a bankruptcy judge in Richmond who “regularly approves third-party releases,” Judge Novak said that “[t]his recurrent practice contributes to major companies like [the debtor] using the permissive venue provisions of the Bankruptcy Code to file for bankruptcy here.”
Citing the U.S. Trustee, Judge Novak said that “the Richmond Division (just the division, not the entire Eastern District of Virginia) joins the District of Delaware, the Southern District of New York, and the Houston Division of the Southern District of Texas as the venue choice for 91% of the ‘mega’ bankruptcy cases.”
On the penultimate page of his 88-page opinion reversing and remanding, Judge Novak directed the chief bankruptcy judge to reassign the chapter 11 case to another bankruptcy judge outside of the Richmond division. If there is another appeal after remand, Judge Novak said that the new appeal would be assigned to him. The District Court decision holds that third-party, non-debtor releases must be approved by district judge under Stern and must comply with the strictures of Federal Rule 23.
The Purdue Pharma LLP chapter 11 plan has also recently been reversed on appeal from Bankruptcy Court to District Court, for granting non-consensual releases to non-debtors. On December 16, District Judge Colleen McMahon in New York vacated confirmation of the Purdue Pharma LLP chapter 11 plan, holding that the court had no statutory power to impose non-consensual releases of creditors’ direct claims against non-debtor third parties. In re Purdue Pharma LP, 21-07532, 2021 BL 482465, 2021 WL 5979108 (S.D.N.Y. Dec. 16, 2021). To read ABI’s report, click here.
The January 13 opinion by Judge Novak goes beyond Judge McMahon’s more narrow preservation of creditors’ direct claims against non-debtors. Readers may draw some of the following conclusions from Judge Novak’s opinion.
- Third-party releases are virtually impermissible when the releasing parties are receiving no consideration under the chapter 11 plan and the creditors do not manifest actual consent, under high standards for what constitutes actual consent.
- Just providing creditors with an ability to opt out does not make the release consensual as a matter of fact and law.
- The limited power of a bankruptcy judge under Article I of the Constitution requires that third-party releases be approved by district judges, and confirmation orders with third-party releases should be reports and recommendations.
- The procedure for approval of third-party releases in a chapter 11 plan must comply with Federal Rule 23, which deals with class actions. Among other things, creditors who are losing the right to sue must be involved in negotiations on the plan and must be adequately represented.
- Like the Eighth Circuit, which limited the doctrine of equitable mootness almost to the vanishing point, equitable mootness will not protect third-party releases from appellate review.
- A creditor who opts out has no standing to appeal.
Judge Novak’s opinion is required reading for anyone involved in chapter 11 practice. He gathers together authorities that are either hostile to or limit third-party releases.
However, Judge Novak does not proscribe third-party releases altogether. Indeed, he could not in view of Behrmann v. Natl. Heritage Found. Inc., 663 F.3d 704 (4th Cir. 2011), where the Fourth Circuit adopted the Sixth Circuit’s approach to approval of third-party releases and rejected the idea that Section 524(e) bars them outright.
The Circuit Split on Third-Party Releases
Judge Novak cited the Fifth, Ninth and Tenth Circuits for prohibiting third-party releases under Section 524(e). He cited other circuits, like the Second and Third, that permit releases in rare cases.
In Behrmann, supra, the Fourth Circuit followed the test laid down by the Sixth Circuit for third-party releases. He ruled that the failure to opt out did not amount to the level of consent required by Behrmann.
Judge Novak said that the bankruptcy court “failed to conduct any Behrmann analysis.” He said that the released parties gave no substantial contribution as required by Berhmann. In addition, the releases were not essential to the reorganization and were not “overwhelmingly” approved by the affected class.
“Because the Plan extinguishes these claims entirely without giving any value in return, this weights strongly against granting the Releases,” Judge Novak said.
Beyond Behrmann, Judge Novak said that “no court” would have found the instant settlement “fair, reasonable and adequate under Rule 23.” No one represented the interests of those who were giving releases, and the releases did not result from negotiations with those on whom releases were imposed. Instead, he said, the negotiations only occurred between those who would benefit from the releases. Furthermore, he found that the releases given by the debtor to shareholders “lacked any value and [were] purely fictional.”
Judge Novak went on to hold that the third-party releases failed three of the four elements required to afford due process under Rule 23. “Accordingly,” he said, allowing releases only based on the failure to opt out “does not comport with due process.” He voided the third-party releases and held them unenforceable.
Appeal NOT Equitably Moot
The debtors in the Patterson case appeal, argued for dismissal of the appeal as equitably moot, but Judge Novak found four reasons why the appeal was not equitably moot. “First and foremost,” he said, the confirmation order was no longer a final order, and equitable mootness does not apply when the confirmation order has been converted to a report and recommendation. Second, equitable mootness does not apply when the government, via the U.S. Trustee, is representing absent individuals. “Not only did the parties craft a release that would extinguish the rights of countless individuals, they did so in a way that would insulate the release from judicial review,” Judge Novak said. He refused to “apply the doctrine of equitable mootness against the Trustee when the Trustee seeks to protect the rights of absent individuals. Third, the “seriousness” of the bankruptcy court’s “errors counsels against a finding of equitable mootness.” Fourth, effective relief was available. Judge Novak said he could sever the releases without altering any creditor’s recovery “or affect[ing] the bankruptcy estate in any way.”
Applying the factors to the appeal at hand, Judge Novak observed that equitable mootness “is all too often invoked to avoid judicial review, as Debtors seek to do here,” citing the recent Eighth Circuit opinion that limited equitable mootness dramatically. FishDish LLP v. VeroBlue Farms USA Inc. (In re VeroBlue Farms USA Inc.), 6 F.4th 880 (8th Cir. Aug. 5, 2021). Judge Novak’s order vacated the confirmation order, voided the third-party releases, severed the third-party releases from the plan, and voided the exculpation clause. Judge Novak remanded the case to another bankruptcy judge with instructions to redraft the exculpation clause and “then to proceed with confirmation of the Plan without the voided Third-Party Releases.”
Comment of attorney March of The Bankruptcy Law Firm, PC: The Bankruptcy Code does NOT allow non-debtors to be granted releases in a debtor’s Chapter 11 plan. This practice has always been illegal, and it is reassuring to see that more Judges are reversing confirmation of Chapter 11 plans, on appeal, which grant releases to non-debtor parties.