Client Alert: Corporate Bankruptcy Reform: Bill to Address Controversial Chapter 11 Practices | Shumaker, Loop & Kendrick, LLP
Following recent high-profile Chapter 11 cases, such as Purdue Pharma and Johnson & Johnson, Congress and the media have given considerable attention to controversial Chapter 11 practices. the search for judges, non-consensual releases by third parties of non-debtors in the reorganization plan and the use of divisional mergers to isolate liabilities in special purpose entities.
In 2021, to address these concerns, two bills were introduced in the US Senate and House of Representatives:
- Bankruptcy Venues Reform Act (Bankruptcy Venues Bill) 2021 and
- Non-Debtors Discharge Prohibition Act (Discharge Bill) 2021.
Currently, a corporate debtor can file a case under Chapter 11 when it has had its domicile (usually state of incorporation), principal place of business (usually head office), or location of major assets for at least 180 days . Or, when there is an ongoing Chapter 11 case from an affiliate. Chapter 11 debtors have regularly filed their cases basically wherever they want. According to testimony at a July 28, 2021 House Judiciary Subcommittee on Combating Abuse of the Chapter 11 System, some U.S. bankruptcy courts are eager to attract large, complex Chapter 11 cases to their districts. . In fact, it was noted that three of the 375 U.S. bankruptcy judges presided over more than 57% of large public company cases in 2020. Further, the suggestion is that some courts may be more likely to rule in favor of debtors. of Chapter 11 on key issues, such as in the form of third-party versions, incentive compensation packages and accelerated sales of assets or pre-packaged plans. In Purdue Pharma, the bankruptcy court for the Southern District of New York (White Plains Division) approved a plan of reorganization that included the release of all claims against the Sackler family (officers, directors or shareholders), including claims by opioid victims.
In addition, some bankruptcy courts have case assignment procedures that direct cases to certain judges. In the Southern District of New York, all of the White Plains cases were assigned to Judge Robert Drain, who presided over the Purdue Pharma case. In the Southern District of Texas, all complex cases are assigned to Judges David Jones or Marvin Isgur. Delaware’s case assignment procedures are random. As a result of media attention and third-party legal challenges to releases, the Southern District of New York changed case assignment procedures so that White Plains cases are now randomly assigned. The same change occurred in the Eastern District of Virginia.
Under the Venue Bill, companies could only file their Chapter 11 filings where they had their principal place of business or where their principal assets were located. The Venue Bill eliminates filings based on affiliates unless the affiliate is the majority shareholder of the debtor.
The Venue Bill would certainly put an end to the debtors’ forum and the shopping around of judges, which would likely reduce the alleged bias of debtors by some bankruptcy courts. On the other hand, some bankruptcy courts, including Delaware, the Southern District of New York, and the Southern District of Texas, have developed a high level of expertise in handling complex Chapter 11 cases efficiently. review of the Venue Bill, these conflicting political issues must be taken into account.
Receipts from non-debtor third parties
The release bill would generally prohibit bankruptcy courts from approving non-consensual releases by third parties of claims against nondebtors, such as the Sacklers in Purdue Pharma. In addition, the discharge bill would prohibit bankruptcy courts from applying the automatic stay of Section 362 (injunction of all actions) to non-debtors for more than 90 days. Finally, the discharge bill would require the dismissal of Chapter 11 cases where the debtor was created by a “divisional merger,” thus ending so-called “Texas 2-Step” cases, such as in Johnson & Johnson.
To date, US bankruptcy courts have issued conflicting rulings on third-party releases. The most notable decision was in the Purdue Pharma case, where on December 16, 2021, the U.S. District Court for the Southern District of New York reversed the order confirming the Chapter 11 reorganization plan and releases in favor of the Sackler family. The district court found that there was no statutory authority in the Bankruptcy Code for third-party releases, except in cases involving asbestos-related claims (where injunctions to discharge are permitted). However, in another opioid case, Mallinckrodt PLC, the Delaware bankruptcy court ruled that non-consensual releases by third parties were permitted.
The release bill would simply prohibit non-consensual releases of non-debtors by third parties, applicable to all U.S. bankruptcy courts. Additionally, the release bill only requires consent to a proposed release by a written consent signed by the releasing party (e.g., opioid claimants). This would eliminate consent by voting for a plan, failing to reject or oppose a proposed plan, or failing to opt out or oppose discharges, all of which are common tactics used by debtors.
Controversial third-party release cases have typically been associated with mass tort actions, such as opioid claims in Purdue Pharma and Mallinckrodt or asbestos-related claims. However, the third-party versions are very heavily redacted and may have released unintended claims. We were involved in a Delaware case where our client had large enforceable contracts, specifically a $3.5 billion supply agreement and related consignment and security agreements. Negotiations regarding the assumption of these contracts were complex and sometimes contentious. In the end, our client was able to obtain a favorable resolution, demanding that the debtor honor 100% of its obligations after the confirmation of the plan on a fully secured basis. However, the plan contained general releases of all claims against any creditors which would include obligations owed to our client which were negotiated and approved by the bankruptcy court. As such, we were required to file an objection to the Third Party Waivers of the Plan, in order to preserve the performance and other obligations of the debtor and its lenders, with respect to our client’s enforceable contracts.