Less than a month later, a United States District Court in Virginia issued a similar ruling. The district court’s blunt ruling ruled that in the Fourth Circuit (which includes North Carolina’s federal courts), third-party releases are disadvantaged because they can lead to abuse and should be granted cautiously and infrequently.
The decision came during the bankruptcy of Mahwah Bergen Retail Group. Mahwah and several affiliates owned and operated over 2,800 retail clothing stores under the Ann Taylor, LOFT and Lane Bryant brands. Debtors had approximately $1.6 billion in secured debt and $800 million in unsecured debt. In Chapter 11, they liquidated the company for over $650 million, then came up with a plan to pay certain secured creditors and set aside $7.25 million for pro-rata payments to unsecured creditors. The bankruptcy court upheld the plan over objections from the United States trustee, the Securities and Exchange Commission and plaintiffs in a securities fraud case.
Prior to file bankruptcy, a group of plaintiffs had filed a securities fraud lawsuit against the debtors, their CEO and CFO, and others. The lawsuit alleged that the defendants engaged in a deceptive, false and deceptive scheme to artificially inflate the price of their common stock. The plaintiffs were seeking class action status when bankruptcy put the case on hold.
The plan contained convoluted and general statements. Basically, if you had a claim against a person or entity associated with the debtors, you released everything if you did not object or withdraw in a timely manner. In rejecting the plan, the district court said the releases closed the doors of the courthouse to potential plaintiffs while protecting company insiders. The Court interpreted the waivers as barring the claims of hundreds of thousands of potential plaintiffs uninvolved in the bankruptcy, protecting countless individuals associated with the debtors for an indefinite period of time going back forever. The releases effectively killed the securities fraud lawsuit.
The district court recognized that there was no absolute ban on third-party broadcasts in the Fourth Circuit. A bankruptcy court may approve non-consensual, non-debt discharges after considering these factors:
(1) Is there an identity of interest between the debtor and the third party?
(2) Did the non-debtor contribute substantial assets to the reorganization?
(3) Is the release essential to the reorganization?
(4) Did the relevant classes vote overwhelmingly to accept the plan?
(5) Does the plan provide a mechanism for paying the classes affected by the release?
(6) Does the plan provide an opportunity for claimants who choose not to settle to recover fully?
But the bar is almost insurmountable and all factors must be supported by precise, detailed and rigorous factual findings.
A key thing to remember is that parties whose claims will be extinguished must be given proper notice and due process, the opportunity to negotiate, and some value for their release. The district court found that the notification process was insufficient. The debtors sent notices and opt-out forms to 300,000 potential class members and published notices in two national newspapers. Less than half of the 1% withdrew. The debtors had no record of who actually received the forms. The debtors argued that since the parties could opt out of the proposed plan if they did not, there was implied consent to the plan. The district court rejected this argument. There must be real and not tacit consent.
The back-to-back decisions in Purdue Pharma and Mahwah highlight contentious issues with third-party non-consensual releases in bankruptcy. These decisions are not the final word, and we will continue to monitor them on appeal. If you are a Chapter 11 party fighting for or against these releases, you should consult with an attorney about the prospects for success and the best strategy, based on the facts and the proposed plan in your case.