Another Delaware Bankruptcy Court Approves Third-Party Releases and Opt-Out Mechanisms Amidst Disagreements with Other Circuits

Background: BSA is a nationally-recognized nonprofit organization that relies on 250 Local Councils⁵ and tens of thousands of Chartered Organizations⁶ to operate individual scout units at a local level. BSA, Local Councils, and Chartered Organizations have been named as co-defendants in hundreds of lawsuits by certain plaintiffs alleging sexual abuse within the scouting ranks (“Abuse Claims”) since at least 1920. Faced with 275 lawsuits and 1,400 other similar not-yet-filed claims, on October 18, 2020, BSA filed chapter 11 bankruptcy in the Bankruptcy Court.

The Plan: BSA’s Plan proposes global resolution of Abuse Claims against the debtors, related non-debtor Entities,⁷ Local Councils, Contributing Chartered Organizations, Settling Insurance Companies, and their respective Representatives. The central features of the Plan relate to the establishment of a settlement trust (the “Settlement Trust”) with certain assets contributed to it for the benefit of Abuse Claim holders.⁸

The Plan’s Releases: In the Opinion, Judge Silverstein addressed the appropriateness of the following third-party releases of non-debtors contained in the Plan: (1) releases by holders of Abuse Claims relating to scouting against Local Councils, Chartered Organizations, Settling Insurance Companies, and their respective Representatives (the “Scouting-Related Releases”) and (2) broad releases by holders of claims against all Released Parties from any claims existing before the Effective Date of the Plan related to the Debtors or their estates or assets, whereby certain holders of claims were given an opportunity to opt-out of the third-party releases on ballots (if in a voting class) or by objecting to the Plan (if in a non-voting class) (the “Opt-Out Releases”).

Objections to the Third-Party Releases: The Scouting-Related Releases were challenged by certain claimants and the United States Trustee (“UST”), who argued that: (1) the Bankruptcy Court lacked subject matter jurisdiction to approve third-party releases and (2) the Scouting-Related Releases were not fair and necessary as required by Third Circuit precedent set forth in In re Continental.⁹ Certain claimants also objected to the third-party release of the Church of Jesus Christ of the Latter-Day Saints (the “TCJC”), arguing that releases for claims against the TCJC that were independent of abuse within the scouting ranks should not be approved. The UST also objected to the Opt-Out Releases, arguing they were not consensual and violated due process rights. The UST further objected to releases given by 22 categories of persons related to releasing parties¹⁰ who likely did not receive notice they would be providing releases.

The Opinion

Jurisdiction: Judge Silverstein found she had “arising in” jurisdiction over Plan confirmation and “related to” jurisdiction to approve the third-party releases due to the high degree of interrelatedness, and thus identity of interest, between the Debtors and the released parties.

Scouting-Related Releases: The Scouting-Related Releases released Abuse Claims against Local Councils, Chartered Organizations, Settling Insurance Companies, and their respective Representatives. The Bankruptcy Court concluded that approval of the Scouting-Related Releases was permissible under Bankruptcy Code §§ 105(a),¹¹ 1123(a)(5),¹² and 1123(b)(6)¹³ and explained that because such approval is neither expressly authorized under, nor inconsistent with other provisions of, the Bankruptcy Code, In re Continental serves as an “[aid to] the court in navigating between these two poles.”¹⁴

Judge Silverstein concluded that the Scouting-Related Releases (excluding TCJC releases described below) satisfied the In re Continental standard because they were fair and necessary to the reorganization. Analyzing relevant facts under a jurisprudential factor test, Judge Silverstein found they were fair because:

• The Plan provided 100% payment of all or substantially all Abuse Claims;
• The Plan provided for a timely assessment and payment of Abuse Claims and equal treatment across claimants under the Trust Distribution Procedures;
• The Scouting-Related Releases were consistent with how claimants historically brought and settled claims;
• The Plan was accepted by over 85% of the class consisting of 82,209 Direct Abuse Claimants, which the Bankruptcy Court found represented an “overwhelming acceptance”;
• Without the Plan, litigation would result in either claimants racing to the courthouse or a BSA-only bankruptcy plan yielding a pennies-only recovery; and
• The inclusion of negotiated Youth Protections in the Plan was a critical piece of bringing survivors justice and obtaining their approval of the Plan.

Judge Silverstein also found that the Scouting-Related Releases were necessary to Plan confirmation and to ensuring that BSA’s scouting program could continue. She found the releases were the cornerstone of the Plan, premised on funding the Settlement Trust in full, and that they afforded the claimants quick and definitive access to insurance assets worth up to at least another $4 billion. Further, without the releases for Local Councils and Chartered Organizations, BSA membership and revenues would decline, threatening BSA’s ability to continue as a national organization.

However, Judge Silverstein declined to approve the Scouting-Related Releases in favor of the TCJC for non-Abuse Claims, concluding that it was unclear that the evidence supported granting them and that those releases were too broad because they would cover claims against TCJC unrelated to scouting.

Opt-Out Releases: The Bankruptcy Court sustained in part and overruled in part the UST’s objections regarding Opt-Out Releases. The Plan provided that Releasing Claim Holders released all Released Parties from any claims existing before the Effective Date of the Plan related to the Debtors, their estates, or assets. To avoid providing a release, (a) a holder of a claim voting for or against the Plan was required to affirmatively opt-out by checking a box on the ballot, and (b) a holder of an unimpaired claim had to file an objection. However, no holder of an impaired claim would be deemed to release claims to the extent they abstained from voting. Judge Silverstein found that these Opt-Out Releases were appropriate under the circumstances and that claimants’ due process rights were not violated. She examined the extent of the notice of the Opt-Out Releases and found it sufficient where there was abundant evidence in the record that claimants received notice of the proposed releases, including that they were prominently featured on the ballot, in the disclosure statement, and in widely-disseminated published notices, among other places, and that a large number of voters — over 27,000 — elected to opt-out of the releases. However, the Bankruptcy Court declined to find that certain related parties received notice and accordingly did not approve the Opt-Out Releases as to those parties.

Key Takeaways

Third-party releases are frequently contentious because third parties demanding such releases can shed their own independent liabilities in exchange for financial contributions that lead to case resolutions. Despite their often controversial use, circuits are split as to whether they can be approved. Courts that approve third-party releases find their statutory authority to do so under sections 105(a),¹⁵ 1123(a)(5),¹⁶ and 1123(b)(6)¹⁷ of the Bankruptcy Code, reasoning that while the Bankruptcy Code does not explicitly authorize such releases, it does not prohibit them, and, in unique and compelling circumstances, a bankruptcy court may exercise its inherent equitable powers to approve them. Courts refusing to approve such releases do so on grounds that the Bankruptcy Code does not expressly authorize them and § 524(e)¹⁸ expressly prohibits the discharge of debts of non-debtors.

Within the last nine months, five prominent decisions from four different circuits have considered third-party releases. The District Court for the Southern District of New York in the Second Circuit and the District Court in the Eastern District of Virginia in the Fourth Circuit have invalidated third-party releases on grounds that bankruptcy courts lack constitutional and/or statutory authority to approve them.¹⁹ Despite those rulings, Delaware bankruptcy courts in the Third Circuit²⁰ (along with the majority of circuits) continue to approve third-party releases when unique facts and circumstances justify their approval.²¹

Judge Silverstein’s jurisdictional analysis highlights another split among courts — whether a bankruptcy court has constitutional authority to approve third-party releases on a final basis. Courts in the Second and Fourth Circuits have held that such constitutional authority is lacking because a release of those claims is effectively an adjudication on the merits of non-core claims.²² But Judge Silverstein concluded, consistent with Third Circuit precedent²³ that she had “arising in” core jurisdiction over Plan confirmation (in addition to “related to” jurisdiction to approve third-party releases). Contrary to the views of courts on the other side of the split, Judge Silverstein has questioned whether the “related to” analysis is the proper framework with respect to plans containing third-party releases, suggesting that a “related to” analysis in this context might better serve as a check on the outer boundaries of permissible releases.²⁴ How this split is ultimately resolved will impact whether bankruptcy courts have authority to enter final orders confirming plans containing third-party releases or whether such opinions must (absent consent of the parties) take the form of a report and recommendation to the applicable district court,²⁵ which would complicate and delay the confirmation process.

Courts are also split regarding approval of mechanisms (e.g., “opt-out” or “opt-in”) for obtaining claimant consent to third-party releases. Parties, including the UST, frequently object that such mechanisms are insufficient to obtain consent of releasing parties consistent with due process. Courts that authorize consent mechanisms amounting to less than affirmative express consent generally do so where the record demonstrates that sufficient notice of the releases has been given and parties have had ample opportunity to opt-out or object (just as Judge Silverstein found in BSA).²⁶

The issue of third-party releases is a significant, and often central, issue for all constituencies involved in a case. It is common practice for parties to use and rely on third-party releases to maximize value to the estate and enhance creditor recoveries. However, the uncertainty as to whether third-party releases are constitutionally and statutorily authorized brings unpredictability and ambiguity to settlements and deal-making. Given the existing splits among courts regarding third-party releases and mechanisms by which consent to such releases is obtained, debtors and their constituencies are likely to continue to encounter uncertainty as they strategize toward case resolution.

It is worth mentioning, however, that the Supreme Court could take up the issue or Congress could intervene to bring uniformity across the circuits on the issue of third-party releases. The Second Circuit in Purdue presently has the propriety of third-party releases pending before it, and that issue, if appealed further, may potentially reach the Supreme Court in the near future. In addition, there is pending legislation in both the House and the Senate that would prescribe when third-party releases may be approved in bankruptcy; however, that legislation presently appears to have stalled.²⁷ Whether the Supreme Court takes up these issues or Congress intervenes remains to be seen and and bears monitoring.

¹ In re Boy Scouts of America and Delaware BSA, LLC., Case No. 20-10343-LSS, 2022 WL 3030138 (Bankr. D. Del. July 29, 2022) (the “Opinion”).  While Judge Silverstein approved major components of the Plan, she neither confirmed nor denied confirmation of the Plan.  On September 8, 2022, incorporating modifications consistent with the Opinion, Judge Silverstein entered her Supplemental Findings of Fact and Conclusions of Law and Order Confirming the Third Modified Fifth Amended Chapter 11 Plan of Reorganization (with Technical Modifications) for Boy Scouts of America and Delaware BSA, LLC [D.I. 10316].   

² In re Mallinckrodt PLC., Case No. 20-12522 (JTD), 2022 WL 334245 (Bankr. D. Del. Feb. 03, 2022). For more information on the Mallinckrodt decision, third-party releases in general, and the “opt-in” versus “opt-out” debate, see In re Mallinckrodt PLC.: Delaware Bankruptcy Court Approves Non-Consensual Third-Party Releases in Contrast to Purdue and Ascena, VELaw.com (Feb. 14, 2022), https://www.velaw.com/insights/in-re-mallinckrodt-plc-delaware-bankruptcy-court-approves-non-consensual-third-party-releases-in-contrast-to-purdue-and-ascena/. 

³ In re Purdue Pharma, L.P., 635 B.R. 26 (S.D.N.Y. 2021). For more information on the Purdue ruling and third-party releases in general, see In re Purdue Pharma L.P.: S.D.N.Y. Holds Bankruptcy Court Lacks Statutory Authority to Approve Sackler Family Releases, VELaw.com (Dec. 28, 2021), https://www.velaw.com/insights/in-re-purdue-pharma-l-p-s-d-n-y-holds-bankruptcy-court-lacks-statutory-authority-to-approve-sackler-family-releases/. In Purdue, the United States District Court for the Southern District of New York vacated Purdue’s plan of reorganization on the basis that the bankruptcy court did not have statutory authority to approve the non-debtor third-party releases contemplated therein. The plan proponents appealed that decision to the Second Circuit, which held oral argument on the matter on April 29, 2022. As of September 13, 2022, the appeal remains pending.

⁴ Patterson v. Mahwah Bergen Retail Grp., Inc., 636 B.R. 641 (E.D. Va. 2022).  For more information on the Ascena ruling, third-party releases in general, and the “opt-in” versus “opt-out” debate, see District Court in Virginia Continues Questioning of Third-Party Releases – At Least in the Absence of Detailed Findings of Necessity, VELaw.com (Jan. 25, 2022), https://www.velaw.com/insights/district-court-in-virginia-continues-questioning-of-third-party-releases-at-least-in-the-absence-of-detailed-findings-of-necessity/. 

⁵ “Local Councils” have jurisdiction over a set geographical area within the United States, and each is a separate, independent non-profit entity organized under applicable state law, but consistent with BSA’s Bylaws and Rules and Regulations. Each Local Council is responsible for its own operations, including programming, fundraising, and recruiting membership into the scouting program.

⁶ “Chartered Organizations” are religious, civic, or community institutions that work directly with Local Councils to help deliver scouting in their respective communities. Chartered Organizations provide facilities for scout meetings and other infrastructure at the local level, as well as provide assistance with selecting troop leaders and volunteers.

⁷ Capitalized terms used but not otherwise defined herein retain the meanings given to them in the Opinion.

⁸ All Abuse Claims are channeled to the Settlement Trust under the Plan, whether they are Direct Abuse Claims (classified in class 8) (“Direct Abuse Claims”) held by individuals for Abuse or Indirect Abuse Claims (classified in class 9) (“Indirect Abuse Claims”) held by insurance companies, Local Councils, or Chartered Organizations for contribution, indemnity, reimbursement, or subrogation.

⁹ Gillman v. Continental Airlines (In re Continental Airlines), 203 F.3d 203 (3d Cir. 2000).

¹⁰ Such parties are “predecessors, successors and assigns, subsidiaries, affiliates, current and former officers, directors, principals, shareholders, members, partners, employees, agents, advisory board members, financial advisors, attorneys, accountants, investment bankers, consultants, representatives, management companies, and other professionals, and all such Persons’ respective heirs, executors, estates, servants and nominees, in their respective capacities as such.” Opinion at *126.

¹¹ “The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. . . .” 11 U.S.C. § 105(a).

¹² “Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall . . . provide adequate means for the plan’s implementation . . . .” 11 U.S.C. § 1123(a)(5).

¹³ “[A] plan may . . . include any other appropriate provision not inconsistent with the applicable provisions of this title.” 11 U.S.C. § 1123(b)(6).

¹⁴ In response to certain objectors’ arguments that the inclusion of section 524(g) in the Bankruptcy Code suggests that third-party releases are not appropriate in a non-asbestos context, Judge Silverstein disagreed, citing section 524(h), which provides that “nothing in [subsection 524(g) and (h)] shall be construed to modify, impair, or supersede any other authority the court has to issue injunctions in connection with an order confirming a plan of reorganization.” Opinion at *62.

¹⁵ “The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. . . .” 11 U.S.C. § 105(a).

¹⁶ “Notwithstanding any otherwise applicable nonbankruptcy law, a plan shall . . . provide adequate means for the plan’s implementation . . . .” 11 U.S.C. § 1123(a)(5).

¹⁷ “[A] plan may . . . include any other appropriate provision not inconsistent with the applicable provisions of this title.” 11 U.S.C. § 1123(b)(6).

¹⁸ “[A] discharge of a debt of the debtor does not affect the liability of any other entity on, or the property of any other entity for, such debt.” 11 U.S.C. § 524(e).

¹⁹ See supra nn. 3 & 4. The Fifth Circuit has also recently reiterated its view that third-party releases are not permitted under Bankruptcy Code § 524(e). See, e.g., NexPoint Advisors L.P. et al. v. Highland Cap. Mgmt., L.P. (In re Highland Cap. Mgmt., L.P.), 2022 WL 4093167, at *11 (Sept. 7, 2022, 5th Cir. 2022) (citing In re Pacific Lumber Co., 584 F.3d 229, 252−53 (5th Cir. 2009)).

²⁰ See supra nn. 1 & 2.

²¹ To determine whether third-party releases are justified based on the facts and circumstances of a case, courts frequently look to factor tests like the one in In re Master Mortgage, which examine whether: (i) there is an identity of interest between the debtor and the third party, usually an indemnity relationship, such that a suit against the non-debtor is, in essence, a suit against the debtor or will deplete assets of the estate; (ii) the non-debtor has contributed substantial assets to the reorganization; (iii) the injunction is essential to reorganization such that without it there is little likelihood of success; (iv) a substantial majority of the creditors agree to such injunction, specifically, the impacted class, or classes, has “overwhelmingly” voted to accept the proposed plan treatment; and (v) the plan provides a mechanism for the payment of all, or substantially all, of the claims and the class or classes affected by the injunction. In re Master Mortgage, 168 B.R. 930, 937-38 (Bankr. W.D. Mo. 1994). See also In re Dow Corning Corp., 280 F.3d 648 (6th Cir. 2002).

²² See supra nn. 3 & 4.

²³ See In re Millennium Lab Holdings II, LLC, 945 F.3d 126, 133-140 (3d Cir. 2019).

²⁴ See Opinion at n. 416 (citing In re Millennium Lab Holdings II, LLC, 575 B.R. 252, 287 n.160 (Bankr. D. Del. 2017)).

²⁵ See 28 U.S.C. § 157(c).

²⁶ See also e.g., In re LATAM Airlines Group S.A., 2022 WL 2206829, at *45 (Bankr. S.D.N.Y. June 18, 2022); In re Fieldwood Energy LLC, 2021 WL 2853151, at *14 (Bankr. S.D. Tex. June 25, 2021).

²⁷ Given the proceedings in the Purdue case, the Stop Shielding Assets from Corporate Known Liability by Eliminating Non-Debtor Releases Act (the “SACKLER Act”) has been proposed in House and Senate bills to prevent third parties from using the bankruptcy process to obtain a release from governmental claims. The SACKLER Act would specifically amend § 105(b) of the Bankruptcy Code to prohibit a court from enjoining or releasing a claim against a non-debtor by a State, municipality, federally recognized Tribe, or the United States (except as provided by Bankruptcy Code section 524(g)). However, it would also permit a temporary stay, for a period not to exceed 90 days, of the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding by a State, municipality, federally recognized Tribe, or the United States against a non-debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against a non-debtor that arose before the commencement of the case under this title.

The Nondebtor Release Prohibition Act of 2021 has also been introduced in House and Senate bills to prevent third parties from using the bankruptcy process to obtain releases by non-debtors without their express consent. The Nondebtor Release Prohibition Act of 2021 would, among other things, amend chapter 1 of title 11 by adding section 113 to provide for a prohibition (except as provided in sections 524, 1201, and 1301) of the discharge, release, termination, or modification of liability of non-debtors for claims of third- parties and of any enjoining of actions to enforce such claims or causes of action. However, it would permit the disposition of a non-debtor third-party claim if (a) such party expressly consents in writing after clear and conspicuous notice of the proposed disposition in language appropriate for the typical holder of such a claim, (b) with such consent not to be given by (i) acceptance of a proposed plan or (ii) failing to accept or reject a proposed plan, or failing to object to a plan or any other silence or inaction, and (c) the treatment of such entity and any of their claims under a plan cannot be more or less favorable due to such consent or failure to consent. It would also permit temporary stay or injunction of the commencement or continuation of an action to enforce a claim or cause of action against a non-debtor or the estate against a non-debtor or property of a non-debtor, but not beyond 90 days after the date of the order for relief without the express consent of the entity whose claim or cause of action is being stayed or enjoined, with such stays subject to appellate jurisdiction under 28 U.S.C. § 158(d).