House Judiciary Committee to Markup Nondebtor Release Prohibition Act of 2021

On Wednesday, November 3, the House Judiciary Committee approved legislation on a party-line vote that could drastically reshape chapter 11 restructurings, particularly in cases involving significant tort liability. The bill, the Nondebtor Release Prohibition Act of 2021 (the “NRPA”) is sponsored by Judiciary Chairman Jerry Nadler (D-NY), Oversight Chairman Rep. Carolyn Maloney (D-NY), and Rep. David Cicilline (D-RI), who chairs the House Judiciary Subcommittee on Antitrust, Commercial and Administrative Law, which has jurisdiction over bankruptcy law-related issues.

Specifically, the NRPA would:

  • Prohibit non-consensual third-party releases in chapter 11 plans;
  • Limit bankruptcy court injunctions that stay lawsuits against third parties to no longer than 90 days after the bankruptcy filing; and
  • Require bankruptcy courts to dismiss cases in which the debtor underwent or was formed by a divisional merger designed to separate assets and liabilities within the ten years preceding the bankruptcy filing.

Taken together, these provisions would make it more difficult for entities to use the bankruptcy process to shed existing and future tort claims. While the NRPA’s prospects of passing the House, much less the Senate, are unclear, clients should be aware that the issue of non-consensual third-party releases is very much on Congress’s radar, and we expect future congressional action, including additional legislation and hearings.

Background

A string of recent high-profile bankruptcy cases, including Purdue Pharma and USA Gymnastics, have thrust third-party releases and the Bankruptcy Code’s treatment of tort liability into the limelight, and Democrats in Congress have taken note. In response, Democratic lawmakers have introduced bills designed to limit third-party releases or prohibit them altogether.1 The NRPA is the first such bill to progress through the House or Senate Judiciary Committee.

Specifically, the NRPA categorically disallows third-party releases in bankruptcy other than (1) third-party releases provided for under certain enumerated sections of the Bankruptcy Code (e.g., section 524(g), applicable where an asbestos trust has been created); and (2) where a party to a release “expressly consent[s] in a signed writing” to such release. The prohibition on nonconsensual third-party releases is drafted broadly, prohibiting through the bankruptcy process any discharge of liability of any entity other than the debtor and its estate. Thus, the NRPA prohibits the exculpation provisions and releases covering non-debtor parties involved in the restructuring (e.g., professionals, postpetition/DIP lenders and plan sponsors) for actions they undertook in connection with the bankruptcy that are quite common in modern chapter 11 bankruptcy practice. Critically, however, the NRPA states that its provisions do not affect free and clear sales under section 363(f) of the Bankruptcy Code, or the ability of a bankruptcy court to enforce a “bar [to] a claim or cause of action for indemnity [or] reimbursement” against a contributing insurer if the bankruptcy estate has released such claim.

In addition to slamming the door shut to nonconsensual third-party releases, the NRPA sets forth specific requirements for consensual releases, such that consent may be given “only after clear and conspicuous notice [has been given to the releasing party] in language appropriate for the typical holder of such claim or cause of action,” and may not be given by “accepting a proposed plan,” or by “failing to accept or reject a proposed plan, or any other silence or inaction.” Thus, the NRPA forecloses the possibility of non-debtor parties to a bankruptcy obtaining releases via an opt-out process or from non-voting creditors at plan confirmation, as currently permitted by certain Delaware and New York bankruptcy judges.

A second component of the NRPA is the proposed limitation on a bankruptcy court’s ability to temporarily stay or enjoin “third-party” litigation between non-debtors that may have an impact on the bankruptcy estate. Specifically, the NRPA provides that, if appealed, a bankruptcy or district court order temporarily staying litigation between third parties cannot last longer than 90 days, unless a court of appeals rules on the appeal during that period. This limitation exists irrespective of the impact it has on the debtor’s ability to reorganize or obtain value for stakeholders. As one of the primary benefits of bankruptcy is the automatic stay halting litigation affecting the bankruptcy estate, the NRPA greatly compresses the timeline that a debtor has in bankruptcy to reorganize its affairs (to the extent a stay of litigation against a third party is required), and may change the strategy and tactics of potential debtors considering a bankruptcy filing.

A third aspect of the NRPA is the categorical disallowance of “divisional mergers,” or the moving of a company’s liabilities into an underfunded shell company that subsequently declares bankruptcy. Specifically, the NRPA provides that a bankruptcy court may, upon request of a party in interest, dismiss the bankruptcy of a “debtor or predecessor of the debtor” if such debtor “was formed or organized in connection with a divisional merger . . . that . . . had the intent or foreseeable effect of . . . separating material assets from material liabilities” of the debtor or “assigning or allocating all or a substantial portion of those liabilities to the debtor . . . .” The lookback period for the divisional merger prohibition under the NRPA is 10 years from the petition date.

Outlook

The House Judiciary Committee previously held a hearing examining the third-party release issue in July 2021. At the hearing, Democrats generally took an aggressive stance opposing nonconsensual third-party releases, often pointing to the Purdue case as an example of non-debtors using the Bankruptcy Code to limit liability and reduce payouts to tort victims. Republicans, meanwhile, took a more cautious approach, expressing concern about certain outcomes but arguing that third-party releases may be useful in certain cases.

This dynamic played out again at Wednesday’s markup, where the bill was approved on a party-line vote. Republicans were not convinced that the NRPA is the right solution and warned against potential unintended consequences and improperly tying the hands of bankruptcy courts to help facilitate restructurings. Essentially, they argued that the NRPA prohibition on third-party releases is akin to throwing the baby out with the bathwater. It is not clear if or when the NRPA will be voted on by the full House, but we expect a similar party-line split should it come to the House floor. 

The Senate Judiciary Committee has yet to consider the NRPA or other bankruptcy reform legislation. Thus far, the Committee has focused on reforming the treatment of student loans in bankruptcy, but we expect it to turn to the third-party release issue and other bankruptcy issues in the future.  Importantly, Senate Judiciary Committee chair Richard Durbin (D-IL) is a cosponsor of the Senate version of the NRPA and has a long history of engaging on bankruptcy issues. That said, we expect little, if any, Republican support for the bill and, with Democrats and Republicans split 50-50 in the Judiciary Committee (and the Senate as a whole), the bill faces a difficult path to becoming a law.

References
See, e.g., SACKLER ACT (H.R. 2096 / S.2472), Nondebtor Release Prohibition Act of 2021 (H.R. 4777 / S. 2497)

 

 

Authored by Aaron Cutler, Chris Donoho, David Simonds, Ches Garrison, and Aroon Jhamb.

Contacts
Aaron Cutler
Partner
Washington, D.C.
Christopher Donoho
Partner
New York
David Simonds
Partner
Los Angeles
Ches Garrison
Counsel
NW Washington, D.C.
Aroon Jhamb
Senior Associate
Los Angeles

 

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