Washington, D.C. — The Supreme Court has handed down a significant decision on June 27, 2024, that changes the landscape of bankruptcy law, particularly how claims against third parties are handled in Chapter 11 reorganization cases. The court ruled in a 5-4 decision across ideological lines, prohibiting the inclusion of nonconsensual third-party releases in Chapter 11 reorganization plans, a practice that had previously allowed for the discharge of claims against nondebtors without their consent.
Justice Neil Gorsuch, writing for the majority, which included Justices Clarence Thomas, Samuel Alito, Amy Coney Barrett, and Ketanji Brown Jackson, reversed a decision from the 2nd Circuit Court. The court clarified that Chapter 11 plans cannot forcibly absolve nondebtor third parties from creditor claims, reinforcing that such protections are reserved for debtors under the Bankruptcy Code.
The majority highlighted that section 1123(b)(6) of the Bankruptcy Code, which serves as a general provision allowing for various measures in a reorganization plan, should not contradict other specific sections that limit releases to debtors only. This interpretation by the justices effectively ends a long-standing ambiguity that allowed parties closely associated with debtors, like the Sackler family in the Purdue Pharma case, from being unintentionally shielded from personal liability claims stemming from issues like fraud, willful injury, or wrongful death.
On the other side, Justice Brett Kavanaugh, joined by Chief Justice John Roberts and Justices Sonia Sotomayor and Elena Kagan, penned a strongly-worded dissent. The minority voiced concerns that barring nonconsensual third-party releases could hinder the resolution of complex Chapter 11 cases involving large-scale tort liabilities, such as those seen in cases like the Boy Scouts of America and various cases involving defective medical devices.
These dissenting justices stressed the importance of these releases in preventing the dissipation of a debtor’s estate and ensuring equitable compensation for victims and other creditors, arguing that the majority’s stance overlooks the potential collective-action problems inherent in these unique cases.
Despite this landmark ruling, the majority noted that their decision does not extend to issues concerning consensual third-party releases, or the broader implications on future reorganization plans that fully satisfy claims against third-party nondebtors. This leaves a significant area of bankruptcy law open to interpretation and further litigation, potentially limiting the immediate impact of the decision on bankruptcy practices not involving mass torts.
Historically, many courts have accepted the inclusion of consensual third-party releases in reorganization plans, treating them akin to any other contract or settlement agreed upon by affected creditors. Debates continue on what constitutes adequate “consent” for these releases, showcasing the nuances and complexities of bankruptcy law that continue to challenge practitioners and courts alike.
As the bankruptcy landscape adjusts to this new ruling, its ramifications are expected to reverberate through forthcoming Chapter 11 cases, compelling attorneys and courts to carefully evaluate each plan against this updated judicial framework.
The ruling is poised to become one of the most consequential in the realm of bankruptcy law, particularly for cases that do not involve mass tort implications. Practitioners and stakeholders within the bankruptcy arena are urged to meticulously assess the implications for nonconsensual third-party releases when crafting or contesting reorganization plans.
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