Rochelle's Daily Wire

In December, we reported how a New York bankruptcy court made nonconsensual, nondebtor releases easier to obtain in Subchapter V than in large, mass tort chapter 11 cases.

District Judge Denise Cote rejected the bankruptcy court’s report and recommendation, denied confirmation of the plan and wrote an opinion suggesting that nondebtor releases won’t be available in Subchapter V (depending on how the Supreme Court rules in Harrington v. Purdue Pharma L.P., No. 23-124 (Sup. Ct.)).

The Nondebtor Releases

The corporate debtor was a Broadway producer. Claiming it had not received its share of the income from a pair of productions, an investor initiated an arbitration against the corporate debtor and the individual who was the debtor’s owner. The investor won an award of $2.9 million against the debtor and the owner, jointly and severally. The district court confirmed the award, which was automatically stayed for 30 days.

On the 29th day, the debtor corporation filed a chapter 11 petition under Subchapter V. In an adversary proceeding, the debtor convinced the bankruptcy judge to enter a preliminary injunction preventing the investor from enforcing the arbitration award against the owner.

Of course, the Subchapter V plan would discharge the corporate debtor’s debt owing to the investor. But there was more.

The plan called for giving the owner a release from liability on the $2.9 million arbitration award. To justify the nondebtor release and allow the owner to retain ownership, the plan required the owner to supply $600,000 toward payments under the plan and to work for the debtor after bankruptcy.

Secured and priority claims of about $275,000 were to be paid in full on confirmation. Unsecured creditors with $300,000 in claims were to receive a portion of the debtor’s disposable income over the duration of the plan.

In a class by itself, the unsecured investor with the $2.9 million claim was to receive a portion of the cash from the owner, plus a share of the debtor’s disposable income over the life of the five-year plan. The plan would mean a haircut for the investor of some $2 million.

The unsecured class voted in favor of the plan, but the investor class voted against the plan, requiring the bankruptcy judge to consider confirmation as a cramdown under Section 1191(b).

Over objection by the investor and the U.S. Trustee, the bankruptcy judge recommended confirmation of the plan. See In re Hal Luftig Co., 655 B.R. 508 (Bankr. S.D.N.Y. Nov. 22, 2023). To read about the bankruptcy court’s rationale for imposing a nonconsensual, nondebtor release, click here.

Rejection of the Report Recommendation

The U.S. Trustee and the investor objected to the report and recommendation. District Judge Cote sustained their objections in an 11-page opinion on March 19.

Judge Cote began her review of the merits with a focus on the foundational authority for nondebtor releases in the Second Circuit, In re Metromedia Fiber Network Inc., 417 F.3d 136 (2d Cir. 2005). She quoted Metromedia for saying that nondebtor releases are “proper only in rare cases.” Id. at 141. She went on to say that the Second Circuit’s most recent authority, Purdue Pharma LP v. City of Grand Prairie (In re Purdue Pharma LP), 69 F.4th 45, 79 (2d Cir. May 30, 2023), set forth seven factors for courts to consider before imposing nonconsensual, nondebtor releases.

(Note to readers: The Supreme Court granted certiorari in Purdue. To read ABI’s report on the December 4 oral argument in the Supreme Court, click here.)

Judge Cote went on to quote the Second Circuit for saying in Purdue that there may be cases where all seven factors are present, but the plan “should not be approved.” Id.

On the “threshold question” of whether nondebtor releases are proper in Subchapter V cases, Judge Cote paraphrased Metromedia for saying that “courts are reluctant to permit nonconsensual releases outside of the context of asbestos litigation.” Metromedia, supra, 416 F.3d at 142.

Focusing on the case at hand, Judge Cote said that “there is nothing unique about this small business bankruptcy that would set it apart from many others in which the debtor entity is closely connected to a non-bankrupt principal.”

Judge Cote stopped short of precluding nonconsensual, nondebtor releases in all Subchapter V cases, because she found that the case failed one of the Purdue factors.

The sixth Purdue factor asks whether the impacted class voted “overwhelmingly” in favor of the plan and said that a 75% vote for the plan is “the bare minimum.” Purdue, supra, 69 F.4th at 78-79.

The bankruptcy court conceded that the sixth factor was not satisfied but gave the objection little weight, since a Subchapter V plan may be confirmed without creditor consent. Judge Cote said, “The standard for confirming a small business bankruptcy . . . does not excuse the Bankruptcy Court from applying the critical Purdue factors.”

Judge Cote addressed another rationale cited by the bankruptcy court for “minimizing” the sixth Purdue factor: the bankruptcy judge’s conclusion that there would be no tangible harm from the nondebtor releases.

“This is clearly wrong,” Judge Cote said, alluding to the fact that the investor would lose its rights to pursue collection of the arbitration award from the owner.

Judge Cote rejected the bankruptcy court’s proposed findings of fact and conclusions of law, denied confirmation of the plan and remanded for “further proceedings consistent with this Opinion.” She held, “Resolving these issues through a nonconsensual release within the Debtor’s bankruptcy is not permissible.”