Ninth Circuit Now Allows Some Nonconsensual Third-Party Releases in Chapter 11 Plans

By Bob L. Olson

The Ninth Circuit has generally prohibited nonconsensual third-party releases in bankruptcy reorganization plans since at least 1949.  See In re Lowenschuss, 67 F.3d 1394, (9^th Cir. 1995) (citing Commercial Wholesalers, Inc. v. Investors Commercial Corp, 172 F.2d 800, 801 (9^th Cir. 1949) (decided under the Bankruptcy Act of 1898)). The Lowenschuss Court reasoned that section 524(e) of the Bankruptcy Code limits a discharge to only the debtor and “precludes discharging the liabilities of non-debtors.”  Id. at 1401.

On June 11, 2020, the Ninth Circuit retreated from a general prohibition of such nonconsensual third-party releases in bankruptcies and now allows them in some instances. See Blixseth v. Credit Suisse, ___ F.3d ___ (9^th Cir. June 11, 2020)¹ . At first glance, Blixseth seems to be at odds with Lowenschuss, but the Ninth Circuit reconciled those cases because the third-party releases were far different.

The Lowenschuss Global Release provision that was held invalid was very broad. The Lowenschuss Global Release provided in part:

Global releases will be given to Debtor, Debtor’s children . . . Fred Lowenschuss Associates, a professional corporation, Fred Lowenschuss Associates Pension Plan, as well as releasing of all liens against all trusts, custodian accounts, pension plan, Fred Lowenschuss Associates and satisfying of all outstanding judgments, executions, and levies against the aforementioned or any person or entity connected with them. 

Lowenschuss, 67 F.3d at 1401. 

The Blixseth Exculpation Clause the Ninth Circuit found to be permissible was far narrower than the Lowenschuss Global Release and limited primarily to actions taken during the bankruptcy case. The Blixseth Exculpation Clause provided in part:

None of [the Exculpated Parties, including Credit Suisse, CrossHarbor, and Edra Blixseth], shall have or incur any liability to any Person for any act or omission in connection with, relating to or arising out of the Chapter 11 Cases, the formation, negotiation, implementation, confirmation or consummation of this Plan, the Disclosure Statement, or any contract, instrument, release or any other agreement or document entered into during the Chapter 11 Cases or otherwise created in connection with this Plan; provided, however, that nothing in this Section 8.4 shall be construed to release or exculpate any Exculpated Party from willful misconduct or gross negligence as determined by a Final Order or any breach of the Definitive Agreement or any document entered into in connection therewith.

Blixseth, slip op. at 6. 

The Ninth Circuit summarized the impermissible release provisions in a number of Ninth Circuit cases, including Lowenschuss² as involving “sweeping nondebtor releases from creditors’ claims on debts discharged in bankruptcy.”  Id. at 17. The Blixseth Exculpation Clause was different from those cases. The Ninth Circuit noted that the liability release in the Blixseth Exculpation Clause is “narrow in both scope and time” and “does not affect obligations relating to the claims filed by creditors and discharged through the bankruptcy proceedings, as it exclusively exculpates actions that occurred during the bankruptcy proceeding, not before.” Id. at 12. One justification for such an exculpation is that it “allows[s] the settling parties . . . to engage in the give-and-take of the bankruptcy proceeding without fear of subsequent litigation over any potentially negligent actions in those proceedings.” Id. at 18. The Ninth Circuit further noted that the Blixseth Exculpation Clause applied only to negligence claims and did not include gross negligence and willful misconduct.  Id. at 12-13. Thus, Bankruptcy Code section 524(e) “does not bar a narrow exculpation clause of the kind here at issue – that is, one focused on actions of various participants in the Plan approval process and relating only to that process.” Id. at 14. 

Blixseth may make it easier for debtors within the Ninth Circuit to confirm Chapter 11 plans containing exculpation provisions which immunize participants in the bankruptcy process such as estate professionals and key creditors from liability for claims arising from their actions during the bankruptcy case. Blixseth, however, raises a number of questions. First, will the Supreme Court ultimately address the legality of such exculpation clauses and third-party releases because there is a split among the Circuits on whether they are permissible?  See id. at 19, N. 7; In re Pacific Lumber Co., 584 F.3d 229, 252-53 (5^th Cir. 2009) (“We see little equitable about protecting the released non-debtors from negligence suits arising out of the reorganization.  In a variety of contexts, this court has held that Section 524(e) only release the debtor, not co-liable third parties”). Second, will Blixseth be extended in ways which erodes the general rule (at least in the Ninth Circuit) that nonconsensual third-party releases from creditors’ claims on discharged debts are not permitted in reorganization plans?