In a recent decision, Judge David Novak of the US District Court for the Eastern District of Virginia vacated the Chapter 11 plan confirmation order entered by the bankruptcy court in the Mahwah Bergen Retail Group (formerly known as Ascena Retail Group) case, holding that the plan’s non-consensual third-party releases were unenforceable.1 The ruling arrived shortly after an opinion issued by the US District Court for the Southern District of New York in the Purdue Pharma bankruptcy case, in which the district court there held that the Bankruptcy Code does not authorize non-consensual third-party releases outside of the asbestos context.2 The decision in the Mahwah Bergen case marks another recent instance where non-consensual third-party releases have not withstood scrutiny on appeal, and it also is notable for having been issued in a venue that has been among the most popular for major Chapter 11 filings in recent years.
Ascena was an apparel retailer that, due to the Covid-19 pandemic, temporarily had to close its retail stores and furlough nearly all of its store-level and corporate workforce.3 Ascena ultimately filed for Chapter 11 bankruptcy on July 23, 2020, in the US Bankruptcy Court for the Eastern District of Virginia.4
During the case, Ascena sold substantially all of its assets and filed a Chapter 11 plan of reorganization (the “Plan”).5 The Plan contained broad non-consensual releases of claims by all of Ascena’s creditors in favor of various non-debtor parties (the “Third-Party Releases”). The Third-Party Releases applied to any and all claims, whether known or unknown, relating to Ascena that existed or could have been brought as of the effective date of the Plan, unless a creditor timely opted out of or objected to the release.6 Among other claims, the Third-Party Releases effectively barred a putative class action asserting securities fraud claims against two of Ascena’s former officers. The lead plaintiffs in the putative class action objected to the Third-Party Releases, but the bankruptcy court overruled those objections (as well as objections to the Third-Party Releases raised by other parties, including the US Trustee) and denied the lead plaintiffs’ request to opt out of the Third-Party Releases on behalf of the putative class.7 The bankruptcy court subsequently confirmed the Plan, and the lead plaintiffs and US Trustee appealed the confirmation order.8
District Court’s Ruling
On appeal, the district court held that the Third-Party Releases were unenforceable for three primary reasons. The district court:
- Held that the bankruptcy court had exceeded its constitutional authority in granting the Third-Party Releases without the consent of the parties whose claims were released.9
- Held that the parties whose claims were released did not “consent” to the bankruptcy court’s adjudication of their claims in accordance with the standards set forth by the US Supreme Court.10
- Found that the bankruptcy court had improperly failed to conduct a “Behrmann” analysis to determine whether the Third-Party Releases met the standard for granting them under applicable precedent in the US Court of Appeals for the Fourth Circuit. The district court further found that the Third-Party Releases failed to satisfy that standard.11
Based on this, the district court vacated the order confirming the Plan, voided the Third-Party Releases, and severed the Third-Party Releases from the Plan.12
1. Bankruptcy Court Lacked Constitutional Authority to Approve the Third-Party Releases
In reaching its holding that the bankruptcy court exceeded its constitutional authority in granting the Third-Party Releases, the district court explained that the bankruptcy court failed to make the necessary findings to establish that it had the authority to grant the Third-Party Releases consistent with the US Supreme Court’s decision in Stern v. Marshall.13 In Stern, the Supreme Court held that a bankruptcy court lacked constitutional authority to enter final judgment on a state common law counterclaim brought by a debtor against a private party creditor where the resolution of the counterclaim neither stemmed from the debtor’s bankruptcy itself nor would necessarily be resolved in the claims allowance process.14 The district court explained that Stern required the bankruptcy court to engage in a “herculean undertaking” to analyze the content of each released claim in order to determine whether it had jurisdiction to release each claim. The bankruptcy court’s failure to undertake such analysis rendered appellate review “virtually impossible” and “speaks to the impropriety of the approval of the Third-Party Releases.”
The district court further reasoned that although it could not determine precisely which released claims the bankruptcy court had constitutional authority to adjudicate and which it did not, it was clear that “the universe of released claims [covered by the Third-Party Releases] include[d] claims between non-debtors which may have [had] no connection to the property of [Ascena’s] bankruptcy estate or the administration of [the case].”15 By way of example, the court noted that such claims included securities claims against the debtor’s former officers, even when those claims arose before the debtor’s bankruptcy and even when those officers had no involvement in the bankruptcy proceedings, as well as claims brought by an accountant for one of the debtor’s loan agents against the agent for failure to pay for work the accountant performed in the agent’s transaction with the debtor.16 The district court held that because such claims clearly lacked an “integral connection to the bankruptcy process,” the bankruptcy court lacked the power to release them.17
2. The Affected Parties Did Not Consent to the Bankruptcy Court’s Adjudication of Their Claims
The district court also rejected Ascena’s argument that the releasing parties consented to the bankruptcy court’s adjudication of their claims.18 The district court interpreted prior US Supreme Court precedent to require that a party’s consent—whether express or implied—to a bankruptcy court’s adjudication of a claim must be given knowingly and voluntarily.19
The district court held that that standard was not satisfied, noting that there did not appear to be any action undertaken by the releasing parties to support a finding that they knowingly and voluntarily consented to the bankruptcy court’s adjudication of the released claims. In particular, the district court held that the notice and an opportunity to opt out of the Third-Party Releases did not suffice to establish consent to the bankruptcy court’s adjudication, as the notice failed to provide any information about agreeing to the bankruptcy court’s adjudication.20 Further, the record failed to show how many claimants actually received the notice or whether those claimants took any overt action in response to the notice.21
3. The Bankruptcy Court Failed to Make Findings Supporting the Third-Party Releases
Finally, the district court also addressed the Fourth Circuit’s seven-factor test for approving third-party releases set forth in Behrmann v. Nat’l Heritage Foundation,22 in which the Fourth Circuit held that third-party releases should only be granted “cautiously and infrequently.”23 The district court held that the bankruptcy court failed to make specific factual findings to show that the seven Behrmann factors were satisfied.24 Additionally, after conducting its own analysis, the district court itself found that the Behrmann factors did not support approval of the Third-Party Releases in any event. Among other things, the district court found that the record did not establish that the beneficiaries of the Third-Party Releases made any financial or other contribution to the reorganization and that the releases were not essential to the reorganization because there was no discernable reason why the Plan would be doomed without them. Both of those findings “weigh[ed] heavily against granting the release.”
Because it found the Third-Party Releases were unenforceable, the district court severed them from the Plan and then otherwise vacated the Plan confirmation order, remanding the case back to the bankruptcy court for further consideration. On remand, the bankruptcy court held that the Plan could be consensually “reconfirmed” without the voided Third-Party Releases.
The Mahwah Bergen decision marks another recent example of courts holding non-consensual third-party releases contained in Chapter 11 plans of reorganization unenforceable. The issue bears continued watching, however, as additional courts, including potentially the US Court of Appeals for the Second Circuit in the Purdue Pharma case, seem likely to continue to weigh in on this significant unsettled issue of law in the near term.
1 The opinion is available at Patterson v. Mahwah Bergen Retail Grp., Inc., 636 B.R. 641 (E.D. Va. 2022).
2 In re Purdue Pharma, L.P., No. 21 cv 7532, 2021 WL 5979108 (S.D.N.Y. Dec. 16, 2021). We described the district court’s decision in a prior Legal Update. The debtor has appealed the decision to the US Court of Appeals for the Second Circuit. On April 29, 2022, oral arguments were held and the case was taken under advisement.
3 Mahwah Bergen, 636 B.R. at 655-56.
13 Id. at 669. Stern v. Marshall, 564 U.S. 462 (2011).
14 Stern, 564 U.S. 462, 499, 503 (2011).
15 Mahwah Bergen, 636 B.R. at 669-70.
22 The seven Berhmann factors are:
- there is an identity of interests 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 the assets of the estate;
- the non-debtor has contributed substantial assets to the reorganization;
- the injunction is essential to the reorganization, namely, the reorganization hinges on the debtor being free from indirect suits against parties who would have indemnity or contribution claims against the debtor;
- the impacted class, or classes, has overwhelmingly voted to accept the plan;
- the plan provides a mechanism to pay for all, or substantially all, of the class or classes affected by the injunction;
- the plan provides an opportunity for those claimants who choose not to settle to recover in full; and
- the bankruptcy court made a record of specific factual findings that support its conclusions.
23 Behrmann v. Nat’l Heritage Found., 663 F.3d 704, 712 (4th Cir. 2011).
24 Mahwah Bergen, at 689. The district court also rejected the argument that Behrmann did not apply because the Third-Party Releases were consensual. The district court held that the failure to opt out of the Third-Party Releases did not suffice to establish that they were consensual. Id.at 684.