Chapter 11 of the Bankruptcy Code (or the “Code”) allows a troubled business debtor the opportunity to restructure its financial affairs so that it may successfully operate in the future. To facilitate this process, a Chapter 11 debtor is given the exclusive right to propose a reorganization plan that, among other things, “provides for distribution on, and discharge of, all of the debtor’s prebankruptcy debts.” Under some circumstances, a Chapter 11 debtor may choose to include a nondebtor release provision in its reorganization plan with creditors. Nondebtor releases (or “third-party releases”) vary in scope and form but generally are designed to shield nondebtors from liability on pre- and/or post-petition claims and are accompanied by injunctions barring actions against the released party. Nondebtor releases are often provided in exchange for contributions to the reorganization. For example, guarantors of the debtor may distribute funds to the reorganization effort in exchange for a release from their obligation under the guaranty. If a bankruptcy judge were to approve the nondebtor release and issue an accompanying injunction, any claims a creditor might have had against the guarantor are effectively extinguished.
So long as the enjoined party consents to the release, courts typically have no difficulty in finding the nondebtor release valid. But when bankruptcy courts are asked to approve the release over the objection of an enjoined party, courts are confronted with fundamental questions about the objectives of the Bankruptcy Code and the rights of the enjoined party. How courts decide these issues can have significant consequences for the parties to the bankruptcy case and society more generally.
Does a bankruptcy court have the authority to extinguish otherwise valid claims against a nondebtor to protect the debtor’s reorganization effort? And if so, under what conditions? These questions have divided circuit courts for more than three decades. Practically every jurisdiction weighing in on the merits of nondebtor releases has established its own rules regarding their approval or prohibition. A majority of circuit courts hold that nondebtor releases are an appropriate use of the bankruptcy court’s equitable powers. They differ, however, on what circumstances justify the inclusion of a nondebtor release in a reorganization plan. Some majority opinions focus on how necessary the release is to ensure the success of the reorganization and thereby avoid liquidation of the debtor’s assets. Other courts in the majority balance considerations of necessity with concerns about fairness to enjoined creditors. A minority of jurisdictions prohibit the use of nondebtor releases in reorganization plans under any circumstances. According to these courts, nondebtor releases “improperly insulate” nondebtors and function as de facto discharges outside of bankruptcy.
Until 2020, the Ninth Circuit had “repeatedly held, without exception,” that nondebtor releases were precluded by the provisions of the Code. Its decisions denying nondebtor releases used broad language that seemed to foreclose the possibility of the Ninth Circuit approving any nondebtor release, regardless of form or scope. The Ninth Circuit was one of the first appellate courts to disapprove of a nondebtor release under the Bankruptcy Code of 1978, and its opinions laid out a blueprint for other courts in their disapproval of nondebtor releases. To say the Ninth Circuit was firmly established in the minority of jurisdictions prohibiting nondebtor releases is a bit of an understatement. In many ways, it was the leading authority on the invalidity of nondebtor releases.
The Ninth Circuit’s decision in Blixseth v. Credit Suisse revised its stance on nondebtor releases. Blixseth involved a type of nondebtor release known as an exculpation clause. Exculpation clauses are designed to release any named party, including nondebtors, from liability for any negligent acts or omissions related to the formulation, negotiation, or confirmation of the Chapter 11 case itself. Seemingly upending decades of precedent, Blixseth held the language of the Bankruptcy Code did not prohibit such a “narrow” nondebtor release. Contrasting the “sweeping nondebtor releases” denied in previous Ninth Circuit decisions, the court opined that the exculpation clause in Blixseth did “nothing more than allow 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.” After decades of disapproving of nondebtor releases, Blixseth’s reasoning and statutory interpretation indicate an important, yet incremental, shift towards the majority view on nondebtor releases.
This Note will conduct a critical analysis of Blixseth to illuminate how the decision differs from the court’s previous decisions on nondebtor releases and what it means for the future of nondebtor releases in the Ninth Circuit. The Note will then draw from that analysis to critique Blixseth’s reasoning and point to an alternative position on nondebtor releases that better aligns with the provisions and goals of the Bankruptcy Code. Part I will discuss the policy goals of Chapter 11 of the Bankruptcy Code and their relationship to nondebtor releases, analyze the statutory provisions relevant to the debate on nondebtor releases, and review the most common forms of nondebtor releases. Part II contains an analysis of the court’s reasoning in Blixseth and its predecessors and attempts to forecast how the court will rule on nondebtor releases in the future. Finally, Part III will argue that the Ninth Circuit should have embraced a more liberal position on nondebtor releases because the Code does not prohibit nondebtor releases and it sufficiently mitigates the “potential for abuse” posed by nondebtor releases.
. 4 Collier on Bankruptcy ¶ 524.05 (Richard Levin & Henry J. Sommer eds., 16th ed. 2021), LexisNexis; Brubaker, supra note 2, at 961; Richard L. Epling, Third-Party Releases in Bankruptcy Cases: Should There Be Statutory Reform?, 75 Bus. Law. 1747, 1749 (2020).
. See, e.g., In re AOV Indus., Inc., 792 F.2d 1140, 1152 (D.C. Cir. 1986) (describing a nondebtor release given in exchange for the nondebtor’s commitment of “millions of dollars to a reorganization plan”).
. Joshua M. Silverstein, Hiding in Plain View: A Neglected Supreme Court Decision Resolves the Debate over Non-Debtor Releases in Chapter 11 Reorganizations, 23 Emory Bankr. Devs. J. 13, 25–26 (2006).
. The Ninth Circuit denied a nondebtor release as early as 1985 in Underhill v. Royal, 769 F.2d 1426, 1432 (9th Cir. 1985). One year later, the D.C. Circuit approved a nondebtor release in In re AOV Indus., Inc., 792 F.2d at 1154.
. SE Prop. Holdings, LLC v. Seaside Eng’g & Surveying, Inc. (In re Seaside Eng’g & Surveying, Inc.), 780 F.3d 1070, 1077–78 (11th Cir. 2015) (describing the circuit split); see infra Table 1 (describing competing interpretations among different circuits).
. See, e.g., In re Drexel Burnham Lambert Grp., Inc., 960 F.2d 285, 293 (2d Cir. 1992) (holding “a court may enjoin a creditor from suing a third party, provided the injunction plays an important part in the debtor’s reorganization plan”).
. See, e.g., In re W. Real Est. Fund, Inc., 922 F.2d 592, 602, 600 (10th Cir. 1990) (“Obviously, it is the debtor, who has invoked and submitted to the bankruptcy process, that is entitled to its protections; Congress did not intend to extend such benefits to third-party bystanders.”).
. See id. at 1401–02; see also Am. Hardwoods, Inc. v. Deutsche Credit Corp. (In re Am. Hardwoods, Inc.), 885 F.2d 621, 626 (9th Cir. 1989) (concluding § 524(e) “limits the court’s equitable power under section 105 to order the discharge of the liabilities of nondebtors”).
. See In re W. Real Est. Fund, Inc., 922 F.2d at 601–02 (“[W]e follow the Ninth Circuit’s lead . . . and hold that . . . the stay may not be extended post-confirmation in the form of a permanent injunction that effectively relieves the nondebtor from its own liability to the creditor.”).
. Deutsche Bank AG, London Branch v. Metromedia Fiber Network, Inc. (In re Metromedia Fiber Network, Inc.), 416 F.3d 136, 142 (2d Cir. 2005) (“The potential for abuse is heightened when [nondebtor] releases afford blanket immunity.”).
* Executive Senior Editor, Southern California Law Review, Volume 95; J.D. Candidate 2022, University of Southern California Gould School of Law. I dedicate this Note to my wife, Elizabeth, who has selflessly supported me throughout my legal education. I also would like to thank Lecturer in Law George Webster for his generosity, patience, and insight throughout the development of this Note.