CSG Law Alert: Delaware Bankruptcy Court Clarifies Meaning of “Consensual” Third-Party Releases Under Purdue Pharma, and What Sureties Should Consider to Preserve Recovery Rights
This past June, the U.S. Supreme Court ruled that a Chapter 11 bankruptcy plan cannot release non-debtor third-parties from liability without consent from the respective creditors. Harrington v. Purdue Pharma L. P., 144 S. Ct. 2071 (2024). A question left open by the decision with which debtors and creditors have since been grappling is what exactly constitutes “consent” in order to support an effective third-party release. A recent opinion from a Delaware bankruptcy court provides some guidance. In In re: Smallhold, Inc., Debtor., No. 24-10267, 2024 WL 4296938 (Bankr. D. Del. Sept. 25, 2024), Judge Goldblatt held that proper consent will be found where creditors voted on a plan that has a “clear and conspicuous” option to opt out of the release provision.
Smallhold is a mushroom farming company that filed for bankruptcy under subchapter V of Chapter 11 in February. The company sent a notice of the confirmation hearing to all creditors that the court found “clearly and conspicuously disclosed” that creditors who voted on the plan – as well as those unimpaired creditors which were deemed to accept the plan – released the defined “releasing parties” from any prepetition cause of action unless they marked a box on the ballot to opt out of the release. Creditors that did not return a ballot were not deemed to have accepted the release. The released parties included representatives of the debtor, which originally included directors and officers until such parties were later carved out of the definition, as well as the debtor-in-possession (“DIP”) lender and its representatives. Priority, unimpaired creditors were not provided with the check-box option to opt out of the release because they were being paid in full and were thus deemed to have accepted the plan. Class 1 creditors, which only included the DIP lender, were similarly not offered the option because they had agreed to the release during negotiations.
As to those creditors which voted on the plan and did not check the opt-out box, Judge Goldblatt held that the affirmative act of voting, along with the clear and conspicuous disclosure regarding the release and its opt-out option, was sufficient to constitute consent under Purdue Pharma, so as to make the release effective. The opt-out option provided clear notice and was a simple mechanism so as not to risk coercion or voting distortion. Regarding the unimpaired creditors, however, the court held that the release was not effective as to them because there was no affirmative step to indicate consent. The U.S. Trustee additionally argued that the DIP lender/Class 1 creditor’s consent was invalid because it was coercively required as a condition to vote in favor of the plan, but this issue was procedurally dismissed because the Trustee did not properly preserve the objection.
Affirmative step of consent – According to Smallhold, this affirmative step of consent must be sufficient as a matter of contract law, where silence is (typically) not held to constitute acceptance. Previous precedent that held creditors could be bound by a third-party release where they failed to check an opt-out box simply because they never returned the voting ballot had relied upon the idea that in any civil action, default judgment can be entered against a non-responsive party. However, a court can only enter default judgments in relation to the type of relief the non-responsive party could properly expect to be subject to in the given action. In the bankruptcy context, that meant plan provisions. Under Purdue Pharma, a third-party release is no longer considered such a typical plan provision. While it is reasonable to expect creditors to be wary of forfeiting their rights against the debtor by way of non-responsiveness in a bankruptcy proceeding, the same cannot be said for forfeiture of rights against another party. The right to sue third parties belongs to the creditors, not to the bankruptcy estate.
In ruling that the opt-out form in Smallhold satisfied this standard as applied to the creditors who voted on the plan, Judge Goldblatt compared the form to consumer internet purchases where users accept terms and conditions by clicking an accept box – a set of facts consistently held to bind users to the terms. Note that the court’s holding applied to any vote, regardless of whether a given vote was for or against the plan, because the form was clear that any vote without checking the opt-out box indicated acceptance of the release.
Sureties are often creditors in Chapter 11 cases faced with voting and should be cognizant of when they will and will not be bound by non-debtor releases. Sureties (or their counsel) should be mindful of third-party releases and opt-out options/requirements when reviewing a proposed plan, and make sure to opt-out if the surety is even considering a third-party suit. In fact, unless there is some enhanced treatment of a creditor that does not opt out, it would seem prudent for creditors to always opt-out of third-party releases contained in a plan. The law in this area is still developing. However, if the Smallhold approach is more widely adopted, creditors should be aware that submitting a ballot without checking the opt-out box may result in the creditor’s waiver of rights against non-debtor released parties.